Singapore has long been known for its attractive corporate tax rates, but that tax advantage could be under the Group of Seven’s groundbreaking tax treaty (“G-7“) Enters into force.
The G-7 represents a large part of the world’s gross domestic product (GDP) and global net wealth and consists of the seven countries Canada, France, Germany, Italy, Japan, Great Britain and the United States. On June 5, 2021, the G-7 made waves around the world when it reached an agreement to implement two rules, namely (a) the redistribution of the taxable profits of the largest multinationals (“MNUs“) to” market areas “where their customers are located; and (b) a minimum global tax rate of 15% for large multinational corporations.
The agreement has a number of objectives, ranging from modernizing tax laws for the digital economy, avoiding a “race to the bottom” with countries offering progressively lower tax rates to attract multinational companies, to closing cross-border tax loopholes.
While there is no clear indication of when this agreement could enter into force and what the specific rules will entail, it will have far-reaching implications beyond the borders of the G7 countries. The G-7 agreement could also create the conditions for similar agreements, for example within the Group of 20 (“G-20“) or the more than 130 countries included in the framework of the Organization for Economic Cooperation and Development. However, as a member of the G-20, China has already raised objections to a worldwide minimum tax rate for companies.
Below we examine the implications of this agreement, and specifically what it could mean for Singapore.
The agreement encompasses two key aspects, namely (a) the global minimum corporate tax rate and (b) the taxation of the digital economy.
Global minimum corporate tax rate
Corporations have increasingly recognized revenues from intangible sources such as drug patents, software and license fees in jurisdictions where they pay little or no tax. The global minimum tax rate is aimed at multinational companies that design their international corporate structures in such a way that they lower their overall tax rate. In essence, the global minimum tax rate aims to prevent companies from getting better tax results by doing their business in a particular jurisdiction. While jurisdictions retain the right to levy any corporate tax rate, a multinational with a customer base in a G7 country – even though it has no physical presence there – must pay a “top-up tax” to that country.
In fact, the MNE pays at least 15% tax, split between the country in which it operates and the remainder tax to the G-7 country. This eliminates any tax advantage that a low-tax country can offer an MNE.
The 15% rate is likely to be calculated on a country basis rather than a global or company-wide basis.
Taxation of the digital economy
Currently, technology giants can sell their services remotely and derive much of their profits from intellectual property rights in jurisdictions with low corporate tax rates. This leads to an erosion of the tax base for the traditional home countries of such companies.
In recent years, several countries have pushed unilateral measures to tax the digital economy. Since these taxes mainly affect US companies, the US has responded with retaliation threats. This has resulted in a confusing global tax landscape with prohibitive compliance costs. The agreement stipulates that the G-7 countries give up their right to impose taxes on the digital economy, but receive greater taxation rights on the global profits of the largest MNEs. It is unclear what threshold will be set to determine which MNEs are covered by this agreement, but market countries are likely to be granted taxation rights on at least 20% of profits that exceed a 10% margin for such MNEs.
Further details need to be clarified whether some sectors such as mutual funds and real estate funds can be excluded.
Impact on Singapore
Although the corporate tax rate in Singapore is 17%, the effective tax rates of many Singapore companies can fall below the global minimum of 15% due to tax incentives and the non-taxation of capital gains and income from foreign sources. Accordingly, Singapore would fall into the category of low-tax countries that run the risk of losing their tax advantages over high-tax areas. In the worst case scenario, some US MNEs may relocate certain functions currently held in Singapore to their home or other jurisdiction.
However, not everything is gloomy. While the deal will mainly benefit high tax countries, Singapore will also benefit from it. In the short term, Singapore is likely to get rid of some tax incentives, which will lead to higher corporate tax revenues. Second, jurisdictions with lower tax rates than Singapore are also losing their tax advantages over Singapore, allowing Singapore to potentially benefit from the exodus of companies from tax havens such as the British Virgin Islands, Cayman Islands and Bermuda. Third, small and medium-sized enterprises (“SMEs“) will not be affected by the new rules, as SMEs make up the bulk of economic activity in many legal systems.
In the longer term, however, Singapore will have to move away from its traditional reliance on low tax rates to continue attracting multinational corporations to its shores. Singapore can maintain its competitive advantage by exploring other strategies, such as helping multinationals through capital grants and other non-tax incentives. Additionally, Singapore needs to capitalize on its non-tax strengths, including:
- economic and political stability;
- robust infrastructure;
- educated workforce;
- strong intellectual property (“IP“) Laws; and
- a focus on minimizing compliance burdens for companies, recently highlighted by the finance minister in a parliamentary response in May 2021.
It’s worth noting that Singapore’s legal infrastructure has been in the spotlight recently, having been equated in a first for Singapore with London as the preferred seat of international arbitration. Another natural asset is Singapore’s convenient geographic location, which makes it the “Gateway to Asia”.
While the G-7 deal presents an undeniable challenge to Singapore’s ability to attract business, Singapore continues to shine in many areas that make it an attractive option for MNEs. In addition to the above-mentioned strengths, dealing with the COVID-19 pandemic in April 2021 also earned him the top spot in Bloomberg’s “Covid Resilience Ranking”.
With the deal likely to take years to implement, the implications for Singapore remain to be seen. However, Singapore’s value proposition has never been based on taxation alone. Singapore’s other strengths, such as its strong rule of law, the integrity of its institutions, adaptability, and the conducive business environment, give a measure of reassurance that Singapore will be able to weather the changes brought about by the G-7 and maintain its competitive advantage in asserting the future -changing international business landscape.