National governments around the world have been debating significant changes to international tax rules that apply to multinational companies. Following a July 2021 announcement by countries involved in negotiations at the Paris-based Organisation for Economic Co-Operation and Development (OECD), there was a further agreement last October, by more than 130 governments, on an outline for the new tax rules.
It seems clear that large companies will, in the near future, pay more taxes in countries where they have customers - and a bit less in countries where their headquarters, employees, and operations are. Additionally, the agreement sets up the adoption of a global minimum tax of 15%, which would increase taxes on companies with earnings in low-tax jurisdictions.
Governments are now in the process of developing implementation plans and turning the agreement into law. Infrastructure developers, including P3 investors and managers, are now seeking to understand what it will all mean for them.
Corporate taxation is a pretty abstract topic. The new ‘global minimum effective tax’ represents a change to existing practices and rules. The recent agreements reached by the international community constitute one of the biggest-ever reforms to international corporate tax rules. The reform blueprint encompasses two pillars that aim to ensure all companies pay their fair share to help finance public goods. To this end, former German Finance Minister Scholz and French Finance Minister Le Maire teamed up in October 2018 to propose such a tax. This is the second pillar of the agreed reform. Its ultimate aim is to introduce a minimum level of tax, in order to increase the size of the pie for all countries and put a stop to aggressive tax planning.
According to Daniel Bunn, executive vice president of the US-based Tax Foundation, the global minimum tax “relies on financial accounting numbers that need to be adjusted to turn financial income into something that is closer to a taxable base. Businesses will need to have adjusted financial numbers for every jurisdiction where their activities are potentially impacted by the global minimum tax rules.”
Bunn warns that companies in P3 projects will face the following challenge: “Knowing how to connect the financing and revenue streams from a project to the potential tax consequences of a top-up tax due to low-taxed income in scope of the global minimum tax.
“If a company receives government financing up front and taxable revenue in the future, the financing and income (if untaxed) could lead to a low effective tax rate and a potential top-up tax. However, the global minimum tax has carve-outs for tangible assets and employment costs, both of which can be significant in a public infrastructure project. Initially, the carve-out for tangible assets will be 8% of the carrying value; for payroll initially the carve-out will be 10%.” Bunn says that the carve-outs will both be capped at 5% after 10 years.
Bunn’s conclusion is that the two biggest things to pay attention to are (a) the tax treatment of financing or revenue streams from public infrastructure projects; and (b) the value of the carve-out for tangible assets or employees.
How will the new tax work?
The first pillar will ensure greater fairness in the allocation of taxing rights and tax revenue among the world’s countries. To stick with the pie metaphor, the first pillar is about who gets which piece of the pie. The new rules will ensure greater fairness in the international allocation of tax revenue. Such rules are particularly important for the taxation of tech companies - for example, companies that can reap extremely high profits from internet sales or ad clicks even in countries where they have no factories or other branches. Under the current rules, taxes are payable primarily in the countries where firms have a physical presence. The aim is to change this so that companies also pay taxes in the countries where they generate profits.
On July 1, 2021, a broad-based international agreement was reached by the members of the OECD’s Inclusive Framework on base erosion and profit shifting (BEPS). A total of 137 (out of 141) members of the Inclusive Framework on BEPS have joined the international agreement. The outcomes were approved at the meeting of G20 finance ministers in Washington, DC, on October 13, 2021.
How exactly is the new regime tax being received by investors who develop infrastructure projects? At the UK's Chartered Institute of Taxation in London, Morag Loader, a member of its Corporate Taxes Committee, raised concerns.
“Where the top-up tax percentage is applied to the relevant profit in a given jurisdiction, profit is found after deducting 5% of eligible payroll costs in relation to group activities in that given jurisdiction, one of the ‘substance-based income exclusion’ calculations,” she explained. “However, most project finance companies do not have payroll costs, as work is generally carried out via subcontracts rather than by employees - so this deduction will not be available to the sector when calculating the appropriate profit for the tax.”
It has become crystal clear that the corporate tax rate will be 15%. No company will pay less than that in the end. The tax will apply to all companies that do business internationally and that generate annual revenues above €750m. In future, multinational firms will have to pay a tax rate of 15% on all of the profits they make worldwide, regardless of where the profits are generated. Under current rules, corporate subsidiaries located in tax havens pay very little in taxes, which of course benefits the corporation as a whole. This will no longer be possible in future.
Various measures will be implemented to make sure that the tax is actually paid. If, for example, profits earned by a group subsidiary located in a tax haven are taxed at an effective rate of only 5%, then the new rules will come into play.
With a new tax rate of 15%, the country where the parent company is based will have the right to charge an additional 10% in taxes on the subsidiary’s profits. This will ensure that even those profits located in the tax haven are ultimately subject to an effective tax rate of 15%.
The new rules will apply to taxpayers with consolidated revenues of US$750m or more. According to Peter Connors, a tax partner at Orrick law firm in New York City, “that seems like a relatively large group of companies”. Connors concludes that “it seems like the primary effect will be whether tax incentives will continue to be used to attract investment. To the extent that they reduce the effective tax rate, they are going to be less of a factor.”
Connors explains that the current draft of the rules “treats tax incentives that are refundable (common in the UK) differently than those that are not refundable (typical in the US) in determining whether the minimum tax rate of 15% is met. Those that are not refundable just reduce the effective tax rate of the company. To the extent that they are refundable, they do not affect the computation of the effective tax rate. To the extent that infrastructure projects are taxable, either to the investor or the entity engaged in the project, and tax incentives are contemplated, the method of providing those incentives may need to change.”
However, Renee Leung of Wolters Kluwer, Asia Pacific, points out that many investors in infrastructure funds are pension funds (US or foreign-based), which are excluded from these rules. Ultimate parent entities of a multinational enterprise group that are an investment fund or a real estate investment vehicle are also excluded. Some holding vehicles used by these excluded entities will also be excluded.
Marcello Estevão, the World Bank Group's global director of macroeconomics, trade & investment, suggests that countries “will still have the scope to introduce Pillar Two-compliant incentives”, adding that the rules also allow countries to “revisit their broader tax-incentives frameworks rather than focusing only on those targeting multinational national enterprises”.
He argues that tax regimes should not be considered as the most important tool for countries looking to develop investor confidence. “Despite the growing global prevalence of tax incentives, empirical evidence has found that they play a limited role in influencing investor decisions and often lead to fiscal losses, especially in low-income countries, which are already struggling with revenue mobilization.
“Long advocated by the World Bank and other development partners, countries must consider non-tax factors to strengthen a country’s investment attractiveness, including the general business environment, infrastructure and people/skills investments and strong public administration,” he adds.
However, Kevin Brogan, principal at KPMG, argues that the Pillar 2 global minimum tax could potentially make investments in infrastructure less attractive by reducing the after-tax return to investors. “Investors will have to determine whether Pillar 2 is relevant to their investment. Investors that are governmental entities, pension funds, and, in some cases, investment funds may not themselves be subject to Pillar 2, but the underlying projects they invest in may be, and this determination can be quite complicated,” he explains.
“Perhaps the key question that investors need to keep an eye on is the issue of aggregation,” says Ryan P. McCormick, senior vice president & counsel at The Real Estate Roundtable in Washington, DC. “They should consider whether business activities in different entities must be combined for purposes of meeting the minimum tax threshold ($1bn in revenue, $100m in US revenue). Aggregation most likely becomes an issue when an investor has an ownership interest in a partnership that is greater than 50%.
“The US Senate included an amendment that was designed to provide some relief from aggregation of different businesses, but there will be interest in the actual implementation rules released by the US Treasury Department.”