The new global tax rules, agreed upon by members of the Organisation for Economic Co-operation and Development (OECD) Inclusive Framework, will bring about new dimensions and possibilities for tax collection.
Imbalances exist in the global tax structure, where the allocation of taxing rights is at the core of the debate, particularly for developing countries. Perhaps, the biggest part of the debate is how African and other developing countries seem to have lost out. The proposed allocation of Amount A from the residual profits of multinationals is only from the world’s largest and most profitable companies (estimated to be between 80 and 100 multinationals). This then raises the question: would small African economy countries benefit through an increase in their tax base bearing in mind they are generally source countries? And what might the tax implications be for a G20 country such as South Africa, which is both a residence and source country?
This year started with countries who signed the Inclusive Framework agreement of October 2021 scrambling to attend a deluge of Inclusive Framework meetings with the sole purpose of designing the new rules agreed in October. There are a multitude of technical considerations in the design work, and specifically, for African countries, there are some very important areas. The volume of reforms, technical debates and their inputs leave little time for consideration and appropriate responses from African countries. Will these debates address the current imbalance in the allocation of taxing rights between source and residence countries? Probably not, and what is the consequence of that for South Africa, which is both a source and residence country.
The fundamental aim of the new global tax rules was to address the tax problems arising from the digitalisation of the economy. Through the OECD Inclusive Framework, a Two-Pillar Solution has been developed, and the Amount A rules relating to when a country may tax a foreign-based multinational and how its global profits are allocated between countries are the only part of the deal that speaks directly to the digitalisation of the economy.
The Amount A rules only apply to multinational enterprises (MNEs) with sales over €20-billion that generate a net profit above 10% and only reallocate 25% of their global profits that exceeds a 10% profit margin (so-called residual profit). The agreement does not also reallocate part of the routine profit of in-scope MNEs to market jurisdictions, which would have been more beneficial to source countries and increased their tax base. This effectively means that the profit margin to be allocated is already reduced, as only 25% of the residual profits will be allocated. This will not address the current imbalance in the allocation of taxing rights to source countries, as the reallocation of profits to smaller economies is likely to be very limited given the MNEs in scope.
In addressing the remaining issues of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, Pillar Two rules are being developed. The rules will introduce a new tax treaty provision called the Subject to Tax Rule (STTR). The STTR, through the work of the African Tax Administration Forum (ATAF), has been accepted as a minimum standard in certain circumstances. The rule will enable a country to restore some of its source taxation rights applied on a gross income basis where there are payments to a treaty partner which are taxed at below a nominal corporate tax rate of 9%. Developing countries (including South Africa) can require such low tax treaty partners to incorporate the STTR in the bilateral treaty in such circumstances.
The STTR is applied in priority to the so-called GloBE rules of the Income Inclusion Rule (IIR) and Undertaxed Payments Rule (UTPR), which are intended to ensure that all of a multinational’s profits are taxed at least at a minimum effective tax rate of 15%. South Africa has several tax treaties where the source taxing rights of South Africa through withholding tax have been reduced to less than 9% for certain types of payments made to the other country. Where the recipient country taxes that income at below a nominal corporate tax rate of 9% South Africa’s source taxation rights will be restored to the 9% rate.
Where income is taxed at less than 15% on a jurisdiction by jurisdiction basis, the IIR will mean the jurisdiction of the ultimate parent of the group can tax that income up to the 15% rate. The UTPR, which allows the country that made the payments that are lowly taxed, will only apply where the income has not been subject to an IIR. The UTPR would deny a tax deduction in the source country up to the 15% rate.
The priority given to the IIR over the UTPR means that all of the additional tax collected on such low taxed income will go to residence countries rather than source countries, thus exacerbating the already unfair allocation of taxing rights that favour residence countries to the detriment of source countries
What does this mean for South African businesses?
At present, no South African headed MNE will be in the scope of Amount A as none meet the €20-billion revenue and 10% profit margin thresholds. South African MNEs and the South African Revenue Service will not, therefore, have the compliance burden of implementing Amount A. This is likely to change when the global revenue is reduced to €10-billion seven years after the implementation of Amount A.
The Amount A rules will enable South Africa to tax some of the largest and most profitable highly digitised businesses even where those businesses do not have a sufficient physical presence in South Africa to meet the current tax nexus rules. But it will not be able to tax such highly digitised businesses that are smaller or less profitable and outside the scope of the Amount A rules under another tax rule, such as a Digital Services Tax (DST), as it committed in the October statement not to enact a DST or similar unilateral measure for any company not only those in the scope of Amount A.
As South Africa is a residence country with many multinationals where the parent company is in South Africa, and the IIR applies to multinationals with global revenue of more than €750-million, the Pillar Two rules may lead to additional tax revenues for the country and additional tax liability for South African headed multinationals.
But South Africa already collects some tax revenues from such parent companies on some income it earns in low tax jurisdictions under its Controlled Foreign Companies rules. These rules tax income at South Africa’s statutory corporate tax rate of 27% rather than 15% but are narrower in scope than the IIR in terms of the type of income caught under the rules.
What does this mean for South Africa’s position as a G20 country?
This is an Inclusive Framework agreement that has so far been joined by 137 out of 141 members of the Inclusive Framework. But much of the work has been politically driven by the G7 and G20. All G20 countries have joined the agreement, but the October statement is not the end of the story. Amount A will be implemented through a multilateral convention (MLC), which must be signed and ratified by a country. Will all the G20 countries ratify the MLC, and in particular, will the United States ratify it? If it does not, where does that leave the implementation of Amount A, and what in particular are the implications for the rest of the G20 countries, such as South Africa.
Although it seems to be the case that Amount A will be implemented even if not all Inclusive Framework members ratify, it is doubtful it could be implemented effectively if the US does not ratify it. Would South Africa then address the issue of how it taxes these highly digitised businesses by enacting a DST or other unilateral measure, and if it did, how would the US react? Would it launch a trade investigation and possibly impose trade sanctions as it did on some countries that implemented DSTs before the October agreement?
How will Amount B affect South Africa?
Additionally, under Pillar One is the so-called Amount B, which is aimed at being a transfer pricing simplification measure. The key to this simplification is that Amount B will set a standard remuneration for in-scope baseline marketing and distribution activities. African countries might benefit from Amount B if it is well designed. The benefits will be greater tax certainty for both businesses operating distribution activities in Africa and for governments as a simplification measure should reduce the number of transfer pricing disputes in Africa relating to marketing and distribution activities, removing the need for onerous and time-consuming transfers pricing audits.
The ATAF is providing technical advice and support to African Inclusive Framework members who are participating in designing the new rules. The ATAF’s contribution to the debate has resulted in some positive outcomes for developing countries, particularly African countries. But the minimum effective tax rate is set at 15%, and the exclusion of all of an MME’s profits under Amount A is disappointing in achieving a balance of tax rights, levelling the playing field and addressing artificial profit shifting out of Africa.The next few months will be intense, with various technical discussions. What is key is that African countries need to share a common consensus and approaches in ensuring that the design of the new rules benefits them to the maximum extent possible. The ATAF, together with the African Union Commission, is working on these issues to support African countries in mobilising domestic revenues, fighting for more equitable rights and ensuring that countries are not penalised for taking sovereign decisions during these reforms.