One of the major initiatives of the new administration at the Capitol Hill in Washington is Joe Biden's recommendation for a minimum corporate tax rate of 15%. This initiative in my view is one of the most important changes in the international fiscal system after the World War-II. In the post-World War-II scenario, Multinational Companies (MNCs) were allowed all kinds of incentives including independence to locate their tax base anywhere in the world, including at places where incidence of tax was substantially lower than the base corporate rate which ranged between 25 and 30 percent. There are (a) jurisdictions which were tax free without a regulatory framework like Cayman Islands, etc. (b) tax friendly locations providing incentive for onward investments like Netherlands, Singapore, Mauritius and the UAE or (c) relatively developed economies providing special incentives for tax such as Ireland and Luxembourg. If we consider the rate of tax for tech companies, China also falls under the same classification of (c).
Another feature that led to reconsideration on this subject is the nature of operation of these MNCs. Comprises such as Royal Dutch Shell, Unilever and Coca-Cola were replaced by tech companies like Amazon, Microsoft, Facebook and Google. An important feature of these tech companies is relatively less physical infrastructure and ease in relocating the tax base and profit shifting.
The ultimate result of changes over the period was relocation of MNCs, especially tech companies' tax base in countries where the tax rates were substantially lower than the base rate of 25 to 30 percent. One such place, for example, was Ireland where there was a corporate rate as less as 12.5 percent. OECD countries feel that special incentives provided by such countries are eroding their tax base. In addition to the same, such relocations also affect investments and employment in a parent's headquarters. In other words, if there is some form of relocation of Google to Ireland then that ultimately affects the investment and employment in the USA.
The OECD was working on this subject for a long time and introduction of the Multilateral Treaty was in effect part of measures to stop base erosion and profit shifting practices of the MNCs. Nevertheless, these measures were not enough for the primary reason that in most of the cases there was an actual substantive relocation of business activity to vibrant cities of Dublin, Singapore, Dubai and Shenzhen. In this situation, there was no possibility to invoke any provision of applying, for example US/Irish tax treaty, to stop that base erosion or profit shifting. The only proper manner is the prescription of a minimum corporate tax rate in the jurisdiction where the income arises. This effectively means that Ireland or Luxembourg, for example, will not be able to provide any tax incentive in a manner where the effective rate of companies operating in their jurisdiction is less than 15%.
It is important to note that this minimum corporate rate provision is not being prescribed for places which are tax havens without any regulatory framework like Cayman Islands, British Virgin Islands (BVI) and others. There is a valid rationale for the same. This has been explained in the following paragraphs.
The corollary question that arises from the above discussion is whether this minimum corporate rate will be applicable on tax haven countries or they will continue to operate in the same manner. The answer is both 'yes' and 'no'. The future tax regime as understood by me is to be looked at from two angles. Firstly, under the FATF recommendations such jurisdictions will be required to follow a regulatory framework for corporate, banking and other aspects. If so, a relative advantage will be diluted. An example is the UAE's agreement to comply with FATF. Secondly, the tax regulations within the developed countries are being modified in a manner that any transaction or operation with the tax haven country is subject to a higher rate of tax. For example, recent French tax regulations have provided an almost prohibitive withholding tax rate for companies in tax free jurisdictions like BVI.
In short, it is being designed that tax havens which were created by the developed economies to provide a lucrative avenue to invest outside the high tax rate jurisdictions should now be made economically and practically unfeasible. Now the priority is employment and investment, and taxes and just not the returns to companies in the developed countries. Developing countries have little say in this game as in this issue China too works in tandem with the West.
The future appears to be a situation where relocations will be possible; however, there will be a minimum corporate rate of 15% percent in that jurisdiction that will provide disincentive for relocating only for tax purposes. This, however, proves that in cases like Ireland the relocation is substantive and the only recourse to stop the trend is to provide a minimum corporate rate of, say 15%. Furthermore, almost all the tax haven jurisdictions will be required to comply with the FATF. Prohibitive withholdings on dealings with tax haven jurisdictions will effectively finish the incentive to locate the business there.
It is my view, these developments will lead to a paradigm change for the UAE and resultantly Pakistan. The UAE is a tax-free jurisdiction; however, it is completely different from BVI or Cayman Island in two aspects (i) the possibility of actual location of offices in substance on account of infrastructure available and being developed; and (ii) partial compliance to international tax and fiscal regulations including the FATF. This will lead to a question whether the UAE with its infrastructure for relocations will be allowed to operate at zero corporate income tax. If so then the possibility of actual relocation of MNCs or their regional headquarters cannot be discounted. If this is so then the objective of minimum corporate rate of 15% will not be achieved and the developed world will place the UAE in the camp of BVI. The UAE, in my view, would like to be bracketed with Singapore, not BVI.
In case there is any regulatory change in the UAE then Pakistan will be directly and positively affected. At present, due to the zero tax rate in the UAE there are kosher and non-kosher means to shift the taxable income from Pakistan to the emirates. If we just take out the list of Pakistanis who are tax residents of the UAE then we will be able to identify what is happening within the legal framework to avoid Pakistan and avail the tax-free status of the UAE. As we see the UAE is moving towards a regulated and non-tax free jurisdiction we can easily anticipate a reverse trend in income generation of Pakistanis' owned assets in Pakistan instead of the UAE. In order to practically understand the subject we would have to see the investments of Pakistanis in portfolio investments through the UAE banks where the income arises for a Pakistani being a non-resident in the UAE. This avenue, in my view, is going to be closed for the benefit of Pakistan.
To summarise the discussion, it is my view that Joe Biden's suggestion of minimum corporate tax rate will be implemented as the West cannot afford to have a relocation of tech businesses to China and other countries where the effective tax rate is substantially lower than the base corporate tax rate of 25 to 30%. It is my prediction that the UAE will go for a low tax rate, a la Singapore. If so, the real beneficiary will be Pakistan as there is huge base erosion and profit shifting on individual and corporate basis between the UAE and Pakistan. We will see a new post-Covid-19 world soon.
Copyright Business Recorder, 2021
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