What BEPS 2.0 means for family enterprises
Family enterprises should follow BEPS 2.0 developments and pivot their business model and legal structure appropriately.
Base erosion and profit shifting (BEPS) 2.0 is all over the media and seems to dominate tax webcasts and conferences. What is it and how would it impact family enterprises that falls outside of the radar?
Understanding BEPS 2.0
To address the tax challenges arising from digitalisation, BEPS 2.0 is introducing a two-pillar solution, which is endorsed by 137 countries.
Pillar One proposes to revise how profits are allocated based on a nexus rule that prioritises profit allocation to market jurisdictions, where goods or services are used or consumed, regardless of physical presence, as opposed to current tax rules that focus on locations where income- or asset-producing activities are conducted.
Multinational enterprises (MNEs) (except those in the business of extractives and regulated financial services) with a global turnover of above €20b and with profitability of above 10% will be required to reallocate 25% of their residual profit to market jurisdictions where they derive at least €1m (or €250,000 for smaller jurisdictions with gross domestic product lower than €40b) in revenue. The global revenue will be reviewed after seven years to access if it should be reduced to €10b.
With the implementation of Pillar One, the unilaterally digital services taxes and other relevant similar measures are to be removed.
Pillar Two looks to set a global minimum tax rate of 15% that countries are to adopt to protect their tax bases and put an end to competition for foreign direct investment (FDI) via lowering corporate income tax rates.
Most MNEs (with certain exceptions) with a prescribed annual consolidated group revenue of more than €750m will be subject to Pillar Two, which comprises two general rules that essentially require a top-up tax at a parent entity level (Income Inclusion Rule) or imposes adjustments (Undertaxed Payment Rule). Notwithstanding the €750m revenue threshold, countries are free to apply the Income Inclusion Rule to MNEs headquartered in their country even if they do not meet the threshold.
For example, if the tax incentive is given at the subsidiary location, this benefit could be negated in the parent entity jurisdiction where the parent entity has to top up the tax burden to 15%. In the context of Singapore, any Singapore tax savings from tax incentives granted to MNEs (covered by Pillar Two) would be “clawed back” due to top-up taxes.
Three potential impacts on family enterprises
Many family enterprises may not fall within the scope of Pillars One and Two and may feel they will not be directly impacted. As it is often said, no man is an island. It is important to consider how family enterprises may be indirectly impacted by the two Pillars.
Implications for ecosystem
For the past three decades, many MNEs base part of their supply chain operations in jurisdictions that offer lower income tax rates, along with other factors such as land and labour, which are not necessarily where their consumer markets are.
Pillars One and Two collectively shift the goalposts and MNEs may re-evaluate whether to make a structural shift towards aligning jurisdictions. Consequentially, it is anticipated that MNEs’ capital, trade and talent flows will be affected, especially for ASEAN countries that have depended on FDI.
Family enterprises should anticipate how their MNE customers may be impacted by BEPS 2.0, along with their decisions around future investments, factories, procurement or principal hubs, raw materials and products trade flows, services (including contract manufacturing) and their employees, in order to prepare for and adapt to such changes.
For family enterprises that have extensive legal entity structure layered onto their business operations, they should consider the efficiency (i.e., tax costs on cross-border payments and compliance costs with maintaining the entity) of the structure and whether restructuring should be done.
Impact to tax regimes
Amongst the leading Asian economies, Singapore and Hong Kong are often the preferred locations for corporates – both MNEs and family enterprises alike – to house global or regional headquarters and their operations. This is due to favourable factors such as geographical location, stable environment, connectivity (physical and digital), free flow of information, capital, talent and information, robust legal regime, a competent workforce, as well as competitive corporate income tax regimes.
While Singapore and Hong Kong are similar in many aspects, Singapore has relied more on tax incentives to create substance, activities and value creation within the country and attract FDI, as compared to Hong Kong. Hence, Singapore will likely be more impacted as a result of Pillar Two blunting the effectiveness of tax incentives to attract FDI.
To remain competitive, Singapore is doubling down on reinforcing its non-tax advantages, including improving cost efficiencies, to defend its position as one of the top host locations for MNEs, and this may equally benefit the family enterprises.
Given that both Pillar One and Two targets MNEs with group revenue of €2b and €750m respectively, governments could well shift their focus to supporting family enterprises more and refine their tax regimes to facilitate the growth of family enterprises.
Tax transparency and reporting
Pillar One reporting will require the accurate attribution of profits to market jurisdictions and mitigate any double taxation that may arise on the profit reallocation. This is expected to lead to an increase in tax controversies and interaction with tax authorities especially in the earlier years. It also places a demand on the competency and resources available to deal with the issues.
Family enterprises that are in scope should review and ensure that they have the appropriate data infrastructures, software, systems and processes in place to accurately collect and manage extensive amounts of data. They should be prepared that their stakeholders will expect more reporting or inputs from them, to meet the increased compliance and reporting burden in the coming years. This ability for family enterprises to support their MNE customers in these aspects could become an essential part of engagement with them.
What next for family enterprises
BEPS 2.0 is a reality today and here to stay, with the rules expected to come into force in 2023 and 2024. Staggered implementation timeline, increased tax reporting and varying interpretation of the BEPS 2.0 guidelines leading to heightened levels of tax controversy can be expected. It is vital that family enterprises have a good understanding of BEPS and plan their strategy and resources early, so as to adapt nimbly to the changes in due course.
The co-authors of this article are Desmond Teo, EY Asia-Pacific Family Enterprise Leader and Asean EY Private Tax Leader, and Wong Hsin Yee, Partner, International Tax and Transaction Services from Ernst & Young Solutions LLP.