How LER can help companies navigate the evolving global tax landscape

Businesses should leverage LER to manage issues and risks arising from changes in the business environment and global tax rules.

Legal entity rationalisation (LER) involves a review of an organisation’s legal and operational structure. The purpose is to prune away the unwieldy entities in a corporate group. 

Corporate groups are often quick to add legal entities as their businesses grow. However, few are diligent enough to regularly prune away legal entities that no longer serve the original purpose or have become a deadweight to the business.

Organisational complexity increases with each addition of new legal entities, at home and abroad. In turn, complexity brings inefficiency and ineffectiveness and heightens the likelihood of errors and business risks. A complex and tangled web of legal entities costs a lot to maintain; it also demands management’s attention on governance, accounting, audit, human resource and tax compliance.   

LER is a process. It achieves its purpose through methods such as elimination, consolidation, amalgamation, and other forms of mergers and acquisitions (M&A).

LER is particularly relevant now, given the demands for greater transparency, better governance and compliance, including an increased focus on complete and accurate tax compliance and a fast-changing tax landscape globally.   

Managing tax risk and reputational issues 

There is a global trend towards strong corporate governance, including tax compliance and tax risk management. The tax authorities are one of the key drivers of such movement.

The Australian Taxation Office, for example, has a “Justified Trust” regime that requires the taxpayer to have an established tax governance and control framework.

The Inland Revenue Authority of Singapore (IRAS) has also recently published its e-Tax guide Tax Risk Management and Control Framework for Corporate Income Tax on 17 February 2022.

Many countries, such as the UK’s HMRC^[1] and the Netherlands’ NTCA^[2] either already adopt similar frameworks or advocate for these.

There is thus increased pressure on corporate groups to institute a strong tax governance and control framework to identify, monitor, and mitigate tax risks and ensure complete and accurate tax compliance. With its increasing importance, a strong tax governance and control framework is no longer a “nice to have” for corporations.

What has this to do with LER?

A complex and tangled organisational web increases compliance and operational costs and makes it difficult to design and implement an effective tax governance and control framework. The reason is that redundant entities, duplicative processes, and structural misalignment tend to add repetitiveness and spawn convolutions to the framework design. The result is the framework’s questionable effectiveness.

We see LER as a key pre-step to implementing a robust governance structure. It seeks to eliminate redundancies and align business structures. A thorough LER offers the management a clearer view of what it wants of its risk architecture post-rationalisation.

Compliance with tax governance control framework typically requires a hefty one-off cost to implement the desired governance processes and controls throughout the organisation. In conjunction with LER, this one-off cost could be more than offset by the savings from ongoing maintenance costs of legal entities that no longer serve their original purpose and have become deadweight to the business.  

Gearing up for BEPS

Base Erosion and Profit Shifting (BEPS) 2.0: Pillar Two addresses the ongoing risks from structures used by multinational enterprises (MNEs) to shifting of profit to no tax or low tax jurisdictions. Pillar Two introduces the Global Anti-Base Erosion (GloBE) rules that require a minimum effective tax rate (METR) of 15%. The current proposed rules to achieve this minimum tax are complex and some say convoluted. Whatever the final rules may be, one impact is clear – the value of tax incentives that affected MNEs enjoy in jurisdictions such as Singapore and many developing countries is eroded.  

We expect countries affected by BEPS 2.0 to rethink and reimagine their investment incentives structures to restore their values to the investors with minimal “violation” of the 15% minimum standard.

Not much is known about the outcome of this rethinking and reimaging process. When concrete details are announced over time, the LER framework should play a role in rationalising an MNE’s legal structure when the organisation strategises for potential expansion or divestment of its global operations.

With the major reform of the international tax system, significant regulatory changes across the world are starting to kick in. This includes the potential implementation of the METR and changes in domestic or treaty provisions. Jurisdictions may also impose new reporting obligations on companies that have not been subject to country-by-country reporting (CbCR) obligations for income inclusion rule purposes. A rationalised legal structure ought to help enterprises navigate the rapidly evolving compliance and reporting requirements in jurisdictions. It will also potentially minimise compliance costs and the risk of non-compliance. This highlights the importance of LER for enterprises to review and restructure their legal structure on a timely basis to assess and reassess the impact on the group’s operations to capitalise on opportunities for tax efficiencies and manage the overall group’s effective tax rate.

Advancing the green transition

Corporations globally are embracing the environmental, social and governance (ESG) wave as they seek to deliver value in a sustainable way for their businesses. Countries such as Singapore, Sweden, Germany, Japan, Korea and Canada have set or are considering a net-zero emissions target by 2050. At the heart of this, the adoption of carbon pricing to reduce emissions is expected to be the universal norm. Singapore recently announced a carbon tax hike in its recent budget, seeing carbon tax rise from the current S$5 per tonne to S$80 per tonne by 2030. Singapore is also looking at high-quality carbon credits, such as offsets from nature-based climate solutions, which carbon-liable businesses may use to offset 5% of taxable emissions by 2024.

In general, advancing the green transition requires proper planning and execution effort in the organisations. This may entail various strategies and approaches, including tracking and monitoring compliance, strategising and planning carbon offsets to manage the increase in green taxes, investing in new and green technologies, stepping up innovation efforts and research and development (R&D), etc. In managing the implementation of green efforts and strategies, LER can be a valuable tax planning process for companies to advance their green transition.

For one, planning for carbon offsets is not a simple matter of addition and subtraction – the trading of carbon credits could take the form of various instruments, including derivatives and futures in the carbon market. LER could be an essential framework that corporations can use to evaluate how carbon credits should be purchased, traded and utilised within the group. It helps companies to identify entities with higher carbon emissions, decide which entities should purchase or trade in the required carbon credits, evaluate the type of carbon offsets to purchase, and optimise the group's best (or net-zero) result as a whole. In the transactions dealing with carbon credits or offsets, it is also essential for companies to consider tax costs involved, such as the taxability of potential gains and tax deductibility of potential costs or losses from dealing in carbon offset instruments. In doing so, the LER process helps to rationalise the group’s structure to be efficiently “green”.

There are benefits in applying the LER framework for companies when considering other green approaches. Having an efficient group structure achieved through the LER process also reduces compliance costs in general when tracking and monitoring carbon emissions. Investments in innovation and green technologies and R&D innovation efforts can also be properly and efficiently planned out using the LER framework to obtain any support or credits available. This includes enhanced tax allowances or deductions for qualifying R&D spending and tax incentives and grants for qualifying projects and activities.

Keeping up with global mobility trends

The COVID-19 pandemic has introduced disruptions in working arrangements globally. Companies have had to adapt to temporary work-from-home arrangements, which has recently evolved into the new normal. Post-pandemic, it remains to be seen how these trends and changes could be reshaping global mobility going forward.

Managing employee global mobility assignments henceforth can be complex. This depends on the size of the organisation and the number of assignments undertaken. There are various tax risks and issues to consider when structuring global mobility functions, including permanent establishment risks, double taxation risks, and tax residence and social security and pension complexities for the assignees. Coupled with cost pressures, relooking at an entity’s operational and legal structure in a LER exercise is relevant so that such risks can be countered or mitigated and costs can be contained.

A simpler and more efficient structure allows ease of compliance and optimises global mobility functions, e.g., ease of tracking of cross-border assignments, aligning of home and host locations, designing effective policies, etc. The LER framework can be useful to help companies plan their mobility strategy. In considering a centralised versus decentralised mobility function model, this may be complemented by an LER exercise, which seeks to arrive at an operationally optimised structure. The use of the LER process is, therefore, potentially beneficial to assist companies to optimise the global mobility function.

Relevance of LER will remain

LER remains a relevant framework to help companies tackle issues and manage risks, especially in navigating through the evolving global tax landscape. The effects of emerging trends and changing landscapes require corporations globally to have to rethink the way they do business, how they structure operations, who they deal with, and where they should expand into.

The co-authors of this article are Rachel Kok, Partner, International Tax and Transaction Services from Ernst & Young Solutions LLP and Wendy Wong, Senior Manager, International Tax and Transaction Services from EY Corporate Advisors Pte. Ltd.