The Global Tax Reform and Its Implications on Malaysia

Published on 30 Sep 2021

Introduction

A key development emerging from the G7 Finance Ministers meeting which took place on 5th June 2021 was a communiqué centred on principal design elements for international tax reform for the Organisation for Economic Co-operation Development’s (OECD) countries (Macdonald et al., 2021). The purpose of this move is to gain higher tax revenues by addressing the long-standing issue of multinational corporations (MNC) taking advantage of loopholes found in tax systems.

The communiqué proposes the introduction of two pillars to reshape the global tax system by addressing the digital economy and to ensure that companies pay taxes where they operate (Chan & McHugh, 2021)

 

The two pillars

Pillar One: Addressing the digital economy. Developments over the digital economy and tax regimes by individual countries towards digital companies have been much debated in recent times (Choo, 2020). At present, the Based Erosion and Profit Shifting (BEPS) framework by the OCED and G20 fail to address tax allocations among the resident country or the source country from which these tech companies are from. Here, Pillar One proposes that the larger, more profitable MNCs “…that generate revenue above a nominated profit threshold of 10% are expected to reallocate at least 20 percent of the profits to market jurisdictions where consumers are based” (Paddington, 2021). The proposal intends to close gaps in the international tax system that have allowed MNCs and tech giants in the likes of Facebook, Google, and Apple to “escape” tax payments due to the lack of a physical presence in countries they conduct business activities. These include online advertising and digital streaming services.

Pillar Two: Overcome tax-based erosion and profit shifting. The “race to the bottom” phenomenon took place in the 1980s with countries attempting to outdo each other by offering attractive corporate tax rates in an attempt to woo MNCs and their much desired FDIs. This resulted in average statutory rates declining from an estimated 50 percent to nearly 24 percent (Rodrik, 2021). A significant amount of MNCs shifted their profits to pure havens such as Bermuda, Cayman’s Island, Bahamas, and the British Virgin Islands to enjoy low-to-zero tax rates (Economist, 2021). According to Macdonald, Gray, and Marley (2021), while the BEPS is centred on preventing “stateless income” over time, the framework does not account for MNCs shifting their business interest to investment zones and other low-taxed jurisdictions. This is why companies like Google and Facebook once had holding companies in Ireland (Kollee, 2020).  Pillar Two’s introduction of a global minimum corporate tax rate of at least 15 percent is intended to curb such issues arising from domestic tax-based erosion and profit shifting which will allow countries to apply a minimum rate on MNCs operating within their borders regardless if the company is headquartered in a low-tax jurisdiction (Macdonald et al., 2021). This prevents MNCs from offsetting taxes paid in one market against obligations in another (EIU, 2021). Hence, this pillar provides national governments with the ability to increase domestic corporate tax rates while at the same time minimise the risks of MNCs transferring their operations to low-tax jurisdictions.

The Biden administration estimates that around 100 MNCs will fall within the scope of Pillar One and conversely, according to Janet Yellen, Pillar Two was anticipated up to 8,000 MNCs would be required to pay a minimum corporate tax under Pillar Two (Partington, 2021).

The OECD projects that a significant USD81billion in additional tax revenues would be raised each year under the proposed reforms assuming a global minimum rate of 12.5 percent is applied under Pillar Two (Chowdhury & Jomo, 2021). Concurrently, if the global minimum rate is set at 21 percent, the initial rate proposed by the Biden administration, tax advocacy groups estimate that governments can raise USD$640 billion in underpaid taxes.

 

Rationale and objections

The rationale for enforcing tax harmonisation is strongest when countries share similar interests and seek to avoid the prisoner’s dilemma where their primary motivation for lowering taxes to avoid capital outflows can be realised. However, when countries vary in levels of development and other characteristics such as their sources of income and political structure, what may seem appropriate in one context may be an obstacle to growth in another.

In effect, this tax proposal faces two contradicting objections. Tax-justice advocates argue that the global minimum of 15 percent is too low, while lower tax-rate countries would see it as an unjustified constraint that potentially restrict their capacity to attract investment (Ellyatt, 2021). Garnering support from countries which has consistently utilise tax incentives could be a challenge. Ireland, with a relatively low statutory rate of 12.5 percent, has signalled that a minimum 15 percent tax rate will disrupt its current economic model and cost them €2 billion or a reduction of approximately 2.4 percent per annum in government revenue (Economist, 2021). Similarly, havens like Paraguay, Hungary, and Cyprus which have used low corporate tax rates to lure investment would be particularly anxious with the possible loss of skilled labour and large capital outflows should this plan be implemented.

China has been giving tax breaks to promote its governmental objectives such as R&D to lure FDIs and would be reluctant to give up using such tax incentives due to “legitimate concerns” (Thomas, 2021). On the other hand, the Indonesian, South African, and Mexican finance ministers have shown support towards the deal as they would be able to gain additional tax revenues from MNCs (Nienaber, 2021). However, loopholes have been identified in Pillar One as it only applies to companies that exceed a 10 percent profit margin. With “clever accounting”, it is possible for a company with large profits to have low-profit margins. By definition, a company like Amazon does not fall under this scope as they only have a 6.3 percent profit margin (Jolly, 2021).

Critics of the G7’s tax proposal come even from within, with French finance minister Bruno Le Maire saying that they “will fight to ensure that this minimum corporate tax rate is as high as possible” (Myer & Walt, 2021). José Antonio Ocampo, Professor at Columbia University stated that: “it would not be enough to end the race to the bottom” while economist Gabriel Zucman said that a 15 percent rate was too low (Keane, 2021). Instead, a 21 percent rate would be a fairer rate to prevent MNCs from moving their profits offshore to a low-tax jurisdiction, according to the IPPR (2021) think tank report.

 

Effect on developing countries                                                                           

Developing countries may experience more significant effects from this tax reform as governments can rely more on corporate taxes (OECD, 2021). This is primarily due to their sizeable informal sectors that have posed difficulties in raising personal income tax.

Despite such possibilities, less developed countries would remain wary as this tax deal has been criticised for being too complicated, inflexible, and unfair (Economist, 2021b). As many developing countries are deemed as unfavourable investment environments due to the lack of infrastructure and skilled workers, lower tax rates have been used to compensate for the lack of appeal to attract MNCs. The implementation of a global tax floor could remove this advantage.

Development networks Oxfam and Eurodad argued that the proposal would only benefit developed countries while developing countries risk being “left with scraps” (O’Dennell, 201). It was also argued that 60 percent of revenues from this tax harmonisation exercise would return to the G7 countries, which only comprise a-tenth of the world’s population (Meyer & Walt, 2021). According to the OECD, reallocating taxation rights on selected corporations may improve corporate tax revenues in underdeveloped nations by only 1 percent (Economist, 2021b).

 

Impact on Malaysia

Some of the effects of the tax reform on Malaysia can be foreseen. For example, Pillar One’s requirement for countries to eliminate their Digital Service Tax (DST) will nullify Malaysia’s DST revenues from subscription-based electronic media, mobile applications and software, online training, and internet-based telecommunication from Malaysian-based consumers. DSTs have raised RM428 million in tax revenues for Malaysian public coffers in 2020 from services like Netflix and Spotify (Taxamo, 2021).

Pillar Two’s requirement for countries to set corporate tax rates to at least 15 percent could affect Malaysia’s appeal in the eyes of the numerous MNCs that have set up operations in Malaysia due to the tax incentives given to them. The immediate fear is if MNCs will take flight for countries with lower tax options. However, Malaysia maintains its appeal for its relatively affordable skilled workers and multilingual speaking populations. There may yet be reasons for MNCs to remain rather than move to another country, especially if these tax rules also apply elsewhere. Yet, the same can be said of other countries that offer better infrastructure and skilled workers that could be seen as more attractive venues. Malaysia will need to up its level of competitiveness to remain an attractive destination.

Another issue concerns Malaysian MNCs, some of which are government-linked (GLC), that have subsidiaries in tax havens and have operations in other countries. Companies like Petronas, Fortune Global 500’s 186th largest company (2020), fall under the scope of Pillar One. To note, more than 15 percent of the Malaysian government’s revenue is contributed by Petronas, according to Fitch Ratings (2020). Proceeding with this tax harmonisation exercise could reduce the country’s revenues significantly as a portion of total profits will be used to pay taxes in countries where such MNCs have a consumer base.

Government Linked CompaniesTax Haven Countries
Axiata Group BerhadSingapore
Sime Darby BerhadSingapore
Gamuda BerhadBritish Virgin Island
Genting BerhadSingapore, British Virgin Islands, China, Hong Kong

 Examples of Malaysian Companies That Could be Affected by G7 Tax Reform (Normah & Salwa, 2015)

 

Yet, if imposing a tax floor can potentially reallocate a greater amount of fiscal revenue back to Malaysia from companies that previously paid lesser taxes under the present global regime, the G7 plan could make the forgoing of the DST and the loss of revenues from Malaysian MNCs overseas quite worthwhile.

There is a need to determine the above side effects as a whole as there are bound to be positive and negative repercussions. This is key as Malaysia’s fiscal space has been overly stretched by the COVID-19 pandemic and the subsequent fallout on her economy.

 

Conclusion: The necessity of an international tax reform

Although many MNCs are expected to oppose this proposal, some companies such as Google and Facebook have shown support (Rappeport. 2021). Yet, the question remains if such reforms are necessary to begin with and if existing mechanisms can be used instead. Dani Rodrik, a Harvard professor argued that the present global regime allows individual countries the flexibility to design their own tax systems based on their needs and preferences, which is more robust and durable compared to the proposed tax deal (Rodrik, 2021).

Ultimately, if MNCs are willing to pay tax amounts that are satisfactory to countries they operate, such discussions would not even need to have taken place. However, the simple reality is that MNCs are rational entities attempting to maximise earnings for their shareholders and themselves by exploiting every possible loophole. Such “rational behaviour” can at times conflict with the will of sovereign governments merely wanting a fair share of MNC earnings for the development and administration of their countries and the people that live there.

The establishment of new tax rules on a global level is intended to mutually benefit all parties – the multiple countries involved, not just ones offering low tax rates, as well as the MNCs by meeting in the middle. Negotiations will be brought forward to the G20 in July 2021 before haggling among 135 member nations of the OECD/G20 Inclusive Framework on BEPS (Partington, 2021). Malaysia must carefully consider the implications such a reform before deciding on its adoption. There may be kinks to smoothen in the negotiations to come and countries like Malaysia must keep an eye on how these changes can affect its standing with these corporations (and the vast capital they hold in the country) while at the same time be a team player on the global stage.

 

References

Chan, K. & McHugh, D. (2021). G-7 backs steps to deter tax dodging by multinational firms. The Associated Press. Retrieved from https://apnews.com/article/europe-tax-reform-technology-government-and-politics-business-12736e0426f0898a1a3bc187e3c4dfc1

Choo, S. (2020). Grasping the Service Tax Amidst Digitalisation. Kingsley Strategic Institute for Asia Pacific. Retrieve from https://kasi.asia/publications/the-dawn-of-digital-service-tax-in-malaysia.

Chowdhury, A. & Jomo, K.S. (2021, June 24). My Say: Powerful state push tax race to the bottom. The Edge. Retrieved from https://www.theedgemarkets.com/article/my-say-powerful-states-push-tax-race-bottom

Economist. (2021a, June 5). Twilight of the tax haven. Retrieved from https://www.economist.com/finance-and-economics/2021/06/03/twilight-of-the-tax-haven

Economist. (2021b, June 5). Fighting for the scraps. Retrieved from https://www.economist.com/finance-and-economics/2021/06/05/will-poorer-countries-benefit-from-international-tax-reform

EIU – Economist Intelligent Unit. (2021, June 9). G7 backs global corporate tax, in first step towards reform. Retrieved from https://www.eiu.com/n/g7-backs-global-corporate-tax-in-first-step-towards-reform

Ellyatt, H. (2021). The beginning of a long road: Global tax reform will take sweat and tears to implement, expert say. CNBC. Retrieved from https://www.cnbc.com/2021/06/07/global-tax-reform-deal-will-take-time-negotiation-and-cooperation.html

Fitch Ratings. (2020). Rating Report: Petroliam Nasional Berhad (PETRONAS). Retrieve from https://www.fitchratings.com/research/corporate-finance/petroliam-nasional-berhad-petronas-11-12-2020#:~:text=PETRONAS%20accounted%20for%20more%20than,over%20the%20last%20five%20years&text=The%20government’s%20100%25%20ownership%20givesdriving%20the%20’Strong’%20assessment

IPPR. (2021). G7 Tax Agreement: IPPR says countries can still go further to end ‘race to the bottom’ on tax. Retrieved from https://www.ippr.org/news-and-media/press-releases/g7-tax-agreement-ippr-says-countries-can-still-go-further-to-end-race-to-the-bottom-on-tax

Jolly, J. (2021). Global G7 deal may let Amazon off hook on tax, say experts. The Guardian. Retrieved from https://www.theguardian.com/technology/2021/jun/06/global-g7-deal-may-let-amazon-off-hook-on-tax-say-experts

Keane, J. (2021, June 8). G7 tax deal: The questions hanging over Big Tch and Ireland. Silicon Republic. Retrieved from https://www.siliconrepublic.com/business/g7-tax-deal-big-tech-ireland

Kollee, J. (2020, December 27). Facebook to close Irish holding companies at centre of tax dispute. The Guardian. Retrieved from https://www.theguardian.com/technology/2020/dec/27/facebook-to-close-controversial-irish-holding-companies

Macdonald, P., Gray, K., & Marley, P. (2021). G7 Finance Ministers back international tax reform (Pillar One and Pillar Two), including introducing a global minimum tax of at least 15%. Osler Hoskin & Harcourt LLP. Retrieved from https://www.lexology.com/library/detail.aspx?g=8133374a-63ed-43d2-9f90-6c8182e5f942

Meyer, D. & Walt, V. (2021). Far too low: Tax justice campaigners push back against the G7’s 15% minimum tax-rate pact. Fortune. Retrieved from https://fortune.com/2021/06/07/global-minimum-corporate-tax-rate-g7-15-percent-pact

 Nienaber, M. (2021, June 10). Indonesia, South Africa, Mexico back G7 global tax reform proposal. Reuters. Retrieved from https://www.reuters.com/business/finance/indonesia-south-africa-mexico-back-g7-global-tax-reform-proposal-2021-06-10

Normah Omar & Salwa Zolkaflil. (2015). Profit Shifting and Earnings Management through Tax Haven Subsidiaries: an Exploratory Analysis of Multinational Companies. Procedia Economics and Finance, 28, 53–58. doi: 10.1016/S2212-5671(15)01081-3

OECD. (2021). Addressing the tax challenges arising from the digitalisation of the economy, OECD/G20 Base Erosion and Profit Shifting Project. OECD Publishing, Paris. Retrieved from https://www.oecd.org/tax/beps/brochure-addressing-the-tax-challenges-arising-from-the-digitalisation-of-the-economy-july-2021.pdf

O’Dennell, J. (2021). Anti-poverty groups criticise rich countries over G7 tax deal. Reuters. Retrieved from https://www.reuters.com/article/global-tax-poverty-idCNL2N2NP155

Partington R. (2021). G7 tax reform: what has been agreed and which companies will it affect? The Guardian.  Retrieved from https://www.theguardian.com/world/2021/jun/07/g7-tax-reform-what-has-been-agreed-and-which-companies-will-it-affect

Rappeport, A. (2021, June 5). Finance Leaders Reach Global Tax Deal Aimed at Ending Profit Shifting. New York Times. Retrieved from https://www.nytimes.com/2021/06/05/us/politics/g7-global-minimum-tax.html

Rodrik, D. (2021). The G7 Tax Clampdown and the End of Hyper-Globalization. Project Syndicate. Retrieved from https://www.project-syndicate.org/commentary/g7-corporate-tax-agreement-end-of-hyper-globalization-by-dani-rodrik-2021-06

Taxamo. (2021). Malaysia’s tax on digital service raises over RM400 million. Retrieved from https://blog.taxamo.com/insights/malaysia-digital-tax-annoucement

Thomas, L. (2021). Exception to the rule? G7 deal on tax triggers carve-out talk. Reuters. Retrieved from https://www.reuters.com/business/finance/exception-rule-g7-deal-tax-triggers-carve-out-talk-2021-06-10

 

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Date

30 Sep 2021


Category

Taxation