BEPS 2.0: The End of Tax Incentives as We Know Them?

Environmental, social, and corporate governance (ESG) is, according to the widely accepted definition, a business framework that allows for the consideration of environmental and social issues in the context of corporate governance. The concept of ESG is adopted and integrated into the strategies of organizations that consider the needs and value-generation methods for all stakeholders – employees, clients, suppliers, and shareholders.

By Răzvan Ungureanu, Director of Direct Taxes, EY Romania

ESG tax incentives have become an important tool in promoting sustainable business activities, with over 1,850 incentives available worldwide. In addition to specific ESG tax incentives, there are numerous other tax facilities available globally.

As the implementation of the second pillar of BEPS 2.0 is at different stages around the world, it is crucial for multinational companies and tax jurisdictions to fully appreciate the impact that a global minimum effective tax rate (ETR) of 15% will have on existing tax incentives.

The second pillar was specifically designed by the OECD/G20 Inclusive Framework to eliminate tax competition based on tax rates between jurisdictions, regardless of the objectives and intentions behind the tax incentives. Under the global anti-base erosion rules (GLoBE), the financial benefit of many tax incentives could be significantly diluted by an additional tax if a tax incentive reduces the effective tax rate (ETR) of a multinational company below 15% in that jurisdiction.

This interaction poses a challenge for many jurisdictions and multinational companies that, faced with climate urgency and ambitious emission targets, have relied on financial and tax incentives to catalyze their ESG objectives.

The latest quarterly study by the EY Green Tax Tracker shows that over 1,850 sustainable development incentives are offered in 45 countries. While tax incentives will not necessarily push a multinational company below the 15% ETR threshold, Pillar II introduces a significant level of uncertainty and complexity that will force many companies and jurisdictions to reconsider their tax and ESG strategies.

The impact of the second pillar will not be uniform worldwide. It may vary depending on the company, sector, and jurisdiction. In conclusion, the 15% ETR will have a tremendous impact on both companies and jurisdictions that are already close to or below the minimum taxation threshold.

In EU countries such as France and Germany, where the OECD reports an average composite effective tax rate of 26% and 27%, respectively, and in Africa, where the average corporate tax rate is 28%, it is less likely that tax incentives will push the average tax rate of a multinational below 15%. Therefore, Pillar II may not have a significant impact. However, in jurisdictions with lower tax rates, such as some Asian countries where the region has an average rate of nearly 20%, the effect is likely to be more pronounced.

To put these figures into perspective, the global average nominal corporate tax rate, measured across 180 jurisdictions, is nearly 24%. When weighted by GDP, the average nominal rate is slightly above 25%.

The 15% minimum ETR will prompt some companies to reconsider where they locate their business activities, considering that tax incentives may be taken off the table. They are likely to view jurisdictions differently: whether they have access to the right talent, an attractive operating environment, cash subsidies, and other types of incentives, accessible land, and so on.

Barbara Angus, EY Global Tax Policy Leader, says that, beyond the challenge of reevaluating their sustainability tax strategy, multinational companies must confront a new, unique, and complex way of calculating the ETR. Unlike other tax calculations, this ETR figure is based on financial accounting data rather than tax data and is calculated for each country individually.

To calculate this ETR figure, companies need to generate and report approximately 200 data points for each country, many of which involve information that is not typically included in financial reporting systems. This data is required to calculate the GLoBE profit.

The implementation of GLoBE rules is likely to intensify cash subsidies for ESG, as jurisdictions seek alternative ways to incentivize desired sustainability behaviors. Instead of enjoying favorable tax rates, multinational companies are likely to receive financial rewards for making appropriate ESG investments. This applies not only to tax incentives in general but also to financial incentives granted by governments that do not affect the ETR and could work within the context of BEPS 2.0.

“Until recently, many governments may have considered tax to be an especially agile way of providing incentives. However, with Pillar II, jurisdictions may want to seek contributions from businesses as they figure out how to achieve their objectives in alternative ways,” says Barbara Angus.

Certainly, subsidies are already used, albeit at a relatively low level, in jurisdictions such as Switzerland, the Nordic countries, and Singapore. In the US, many states utilize subsidies to stimulate workforce and training investments.

Jurisdictions may also seek ways to incentivize sustainability behaviors and more, without transferring money. For example, for projects that require capital expenditures, jurisdictions may sell or lease properties at reduced rates or issue so-called preferential loans, which are granted on highly favorable terms.

As countries have already begun taking steps to implement the BEPS 2.0 Pillar II in 2023, which will come into effect in 2024, multinational companies and jurisdictions should start reassessing their sustainability incentive strategies and the application of tax incentives in general as soon as possible.

Considerations include, among others:

Financial modeling will be a powerful tool for multinational companies, helping them perform a comprehensive assessment of the tax incentives they utilize and calculate whether these incentives reduce the Pillar II ETR below the 15% threshold.
Jurisdictions should evaluate what GLoBE rules mean for tax incentives promoting sustainability from the perspective of each sector, region, and enterprise.
Jurisdictions should explore alternative ways to incentivize sustainability behaviors, while multinational companies should consider and potentially relocate their activities to jurisdictions where alternative incentives are available.

Multinational companies should analyze the data they need to calculate the specific Pillar II ETR and establish the necessary reporting processes to generate and collect this information.

In conclusion:

A global minimum tax will have broad ramifications on how many multinational corporations seek government incentives designed to promote their sustainability objectives and more. Currently, many of these incentives are provided through the tax code. However, under the GLoBE rules, these incentives lose their financial value for companies if they face additional taxes in certain jurisdictions. Other stimulus mechanisms may soon rise in popularity. Sorting through the options will be a challenge.
Specifically for Romania, considering the nominal corporate profit tax rate of 16% is very close to the minimum rate of 15% provided by the GLoBE rules, a series of tax incentives, such as the additional deduction for research and development activities or the exemption of reinvested profits, could become inapplicable for many companies if they lead to an ETR below 15%. Therefore, on the one hand, Romanian companies and multinational groups with a presence in Romania should analyze and quantify the impact of GLoBE rules on their financial performance, while Romanian authorities should consider whether changes to the granting of tax incentives are necessary in the GLoBE context to achieve the intended effect. Time is short for both parties, as GLoBE rules must be implemented by all EU member states, including Romania, by the end of this year.

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