Impact of global changes on emerging countries
Ruth J Henry
Chancery Chambers, Bridgetown
Report on a session at the 11th Annual IBA Finance and Capital Markets Tax Virtual Conference
Monday 17 January 2022
David Weisner Brown Brothers, Boston
Soo-Jeong Ahn Yulchon, Seoul
Aseem Chawla ASC Legal Solicitors & Advocates, New Delhi
Emil Brincker Cliffe Dekker Hofmeyr, Johannesburg
David Weisner opened the session by explaining that panellists from India, Korea and South Africa, three leading global emerging countries, would discuss four main topics: perspectives on Pillars One and Two; the promotion of inbound investment contrasted with trends in enforcement; trends in tax treaty negotiations; and next steps on the tax horizon for each country.
Approach to Organisation for Economic Co-operation and Development (OECD)/Group of Twenty (G20) Global Pillars One and Two
Emil Brincker explained that South Africa fully supports the anti-avoidance initiatives of the OECD. He noted, however, that the challenge is to get the rest of Africa on board. The African Tax Admin Forum (ATAF), which represents 40 out of 56 countries in Africa, including South Africa, is supportive of certain aspects of these initiatives, such as the exclusion of extractives from Pillar One and the fact that there is no mandatory dispute resolution mechanism. The ATAF is also in favour of residual profit being the allocation factor for Pillar One, although the preference is for at least 35 per cent of residual profit to be allocated to market jurisdictions.
The ATAF is, however, of the view that the processes are complex and need to be simplified and there is concern about the extent to which there will be a reallocation of profits in the African countries. There is also a preference of a minimum of 20 per cent for Pillar Two. Brincker noted that more work is required to ensure a more equitable tax allocation and to stem illicit financial flows from Africa. Finally, there is the view that a sourced-based rule, such as the Undertaxed Payments Rule, should be applied, and a suggestion that the Subject to Tax Rule should include service payments, in addition to interest, royalties and capital gains.
With respect to digital tax, this was introduced indirectly by South Africa at the rate of 15 per cent for the supply of electronic services from a place in a foreign country. Relevant factors are: (1) if the recipient is a resident of South Africa; (2) if the payment originates from a bank in South Africa; and (3) if the recipient has an address in South Africa. If two of these factors are present, a vendor account must be registered for VAT.
Korea is actively participating in the Inclusive Framework (IF), and generally embraces, is compliant with and responsive to the OECD initiatives. Soo-Jeong Ahn noted, however, that the Korean business community has concerns about the complexity and compliance costs of Pillar Two, in particular, the potential increase in tax burden, given that many outbound investments are in low-tax jurisdictions and countries that provide tax incentives. Solutions proffered include a long transition period and safe harbours, if possible.
The Korean government is taking a cautious approach to digital taxation from both a market and resident jurisdiction perspective. Ahn explained that Korea wants to ensure that it is not short-changed by unexpected results hidden in the complexities behind Pillars One and Two. This is especially in light of fast-evolving Internet Protocol (IP) infrastructure, fast and widespread internet availability, and robust digital consumerism in the younger generation, as well as given the multinational companies headquartered in Korea.
While there is no digital services tax, there is an extraterritorial VAT regime, similar to South Africa, so even if foreign companies do not have a permanent establishment in Korea, if they supply digital services to Korean consumers, they have to register and comply with VAT rules. Digital services include digital content, online advertisement, plug computing and online platforms.
Ahn discussed that multinational Korean companies are more likely to be driven by a desire to establish regional manufacturing facilities or a distribution hub than a desire to lower their effective tax rate. This point is reinforced by the fact that the most commonly triggered income tax bracket is the range of 22.5–27.5 per cent, the fact that there is worldwide taxation and by the very tight controlled foreign corporation (CFC) rules. There is also a more stringent income tax of 17.5 per cent being implemented.
Aseem Chawla explained that India would want to take advantage of the new taxing right created as a result of the IF from a market jurisdiction perspective, especially given its large population. He noted that actual tax flows from global companies must be checked and monitored to ensure there is a fair allocation in favour of market economies such as India, and that the collections are equivalent or less than the estimated future tax collections from the equalisation levy. India is in favour of a consensus solution that is simple to implement and user-friendly and should result in the allocation of sustainable revenue to market jurisdictions.
Chawla provided insight into India's tax structure, which is designed in a way that the income of foreign companies or non-residents having place of effective management in India are subject to comprehensive tax liability. The current rate of corporate income tax is 25 per cent and 17 per cent for new Indian manufacturing companies, coupled with extensive taxing rights in the form of source rules in the form of withholding tax.
To eliminate double taxation, Chawla outlined that there must be a suitable mechanism for the implementation and administration of the Global Anti-Base Erosion (GloBE) rules through possible changes to the domestic tax legislation and the current framework of tax treaties.
Chawla also commented extensively on the likelihood of active participation by countries considering the domestic tax and geopolitical landscape at an individual country level and regional level, especially in light of United Nations Article 12B. He also commented on the practicality of the OECD being able to assess the proper allocation of tax revenue across all countries.
Chawla further observed that India, as a member of the IF, will have to roll back the equalisation levy once the IF and global minimum tax are implemented. He cautioned the removal of the digital service tax (DST) given the success of DST collections over the last 24 months, all while widening the source-based pool.
The panel then discussed briefly how the changes required under the IF will be implemented: through the executive or legislature. From a South African perspective, Brincker noted that this is more of an executive function than legislative, which makes the transition easier. In Korea, Ahn explained that tax legislation is usually proposed by the Ministry of Finance to the Congress. For tax treaties, the executive branch signs them, but they must be ratified in order to take effect, making the executive and legislature equally involved. In India, where tax treaties are concerned, changes are usually executive-driven, but the changes in domestic tax law are a legislative function.
Promoting inbound investment contrasted with trends in enforcement
The global minimum tax rate of 15 per cent, which is proposed, does not adversely impact inbound investment into India given the recent introduction of the lower tax rate of 17 per cent for new manufacturing units. This then allows India to focus on improving various non-tax factors and interventions to attract greater inbound investment flows.
In terms of enforcement, Chawla noted the sophistication and ingenuity of the Indian tax office, where the regulator does not hesitate to scrutinise transactions, even where no approval is required. He observed that there are three main trends in tax enforcement in India: (1) adding strategic value to accelerate business model transformation; (2) the rapid shift in operational transformation due to digital tax administration; and (3) prioritising data simplification and low-cost resourcing as a foundation.
Chawla also noted the role of digitisation in tax administration and the ease with which enforcement agencies can enforce, leading to increased voluntary tax compliance.
Brincker explained that South Africa is aiming to broaden its tax base by minimising tax incentives (which encourage certain activities and behaviour) while reducing the tax rate from 28 per cent to 27 per cent. On the reduction of the tax rate, the interest limitation rules pursuant to base erosion and profit shifting (BEPS) Action Plan 4 will be strengthened and introduced. In this context, a 30 per cent of tax earnings before interest, tax, depreciation and amortisation (EBITDA) principle was adopted on the basis that the concept of interest includes interest rate swap agreements, the finance cost element in finance lease payments and foreign exchange differences, thus being very wide. At the same time, rules are being implemented such that one can only make use of and carry forward 80 per cent of assessed tax losses, and there is no group taxation.
With respect to enforcement, South Africa is introducing a high-net-worth unit and anti-avoidance unit, and a number of assessments are being issued by these units.
Brincker and Weisner then briefly explored South Africa's approach to 'round-tripping' or 'looping' as it is called in South Africa. Brincker noted that, while the exchange control rules have been relaxed in relation to looping, the tax rules have been strengthened in this regard so that the minimum applicable taxes equal roughly 20 per cent on income returns.
The statistics demonstrate that, despite the impact of Covid-19 in 2020 and 2021, there is gradual growth in net inbound investment. However, there is not much attraction in terms of tax in Korea, especially given that certain tax incentives were phased out post-blacklisting by the European Union. Ahn submitted that the attraction for inbound investment is more likely to be the automobile, infrastructure and entertainment industries, and due to the intelligent workforce and market in young people.
Notably, however, Ahn commented that as a result of the pandemic and the presidential election, the tax authorities have been lenient with tax audits since 2019, which is unprecedented, and this may be an attraction factor.
Trends in tax treaty negotiations and BEPS action plans
Korea supports the OECD initiatives in relation to base erosion, treaty shopping, anti-avoidance and earning stripping. Ahn commented that the aggressive, intelligent and creative Korean tax authorities will welcome the introduction of these rules into legislation, which provide more certainty than the use of broader domestic tax law principles used presently, such as substance over form. This is especially so as Korea is not known to be a low-tax jurisdiction and has a stringent CFC regime, as well as other high tax rates such as estate and gift tax.
Korea was an early adopter of the multilateral instrument (MLI), however, the Mandatory Arbitration Provision and Permanent Establishment Provision were reserved. Ahn suggested that neither of these provisions are likely to be reserved for much longer.
It was noted that the likely result of treaty negotiations between developing and developed nations is that the developing nation accepts constraints on its ability to tax inward investors usually under withholding tax rates, permanent establishment and other provisions. The developed country then agrees to bear the cost of eliminating any remaining double taxation incurred by its outward investors by making allowances for the taxes they pay in the developing country.
Particularly in relation to mandatory arbitration provisions, Chawla noted that it is unlikely that these will be accepted, given that there is tremendous confidence in the judicial process and belief in tax sovereignty.
Looking forward: the tax horizon
Budget spending during the pandemic and the 8.9 per cent increase in the budget from 2021 have placed an immense amount of pressure on the tax authorities of Korea to collect tax. This may have an impact on IP companies in particular, whose operational structure from a tax perspective has been a point of contention.
Chawla discussed two general resonating themes while looking to the future. The first was data nationalism, which he suggested may, in the future, be incorporated into tax and policy laws as this has many implications for market jurisdictions. The second was deglobalisation, where emerging nations may feel vindicated when looking at issues pertaining to cross-border investment and the way that multinational enterprises (MNEs) do business. While India favours a consensus-based solution, Chawla posited that there is a balancing act that must be performed with preserving source-based taxation.
The South African economy recovered from the pandemic much faster than expected, with in excess of an estimated ZAR 120bn in collections over budget. In the shorter term, an advance pricing agreement (APA) system will be implemented. However Brincker noted there should be room to amend APAs on the basis that it will take three to four years to implement such a programme.
In the longer term, pursuant to the African free trade zone agreement, 90 per cent of goods will be exempt from tariffs, and Brincker observed that this will have a positive impact, depending on the extent to which it is implemented.