One of the most important skills of a tax professional is to stay well-informed not only about developments in tax, but also geopolitical and economic developments which have implications for tax policies. Tax and legal professionals from KPMG member firm have identified interconnected trends that are likely to reshape the global business landscape and which are creating uncertainty and risk.
Geopolitical factors: Companies can no longer rely on globalization to drive efficiency
The move to focus more on security of supply chains began during the pandemic and has continued in response to geopolitical tensions. Amid a climate of uncertainty, both governments and businesses are increasingly focused on security. KPMG analysts have identified five factors affecting geopolitical risks:
Climate change and the energy transition — Addressing climate change has become a top priority for many countries and the transition to clean energy is clearly underway. However, we can expect geopolitical tension between developed and developing countries over who should bear the burden of emissions reduction. Moreover, in the longer term, the effects of climate change have the potential to displace large numbers of people, straining government resources and creating significant economic disruption.
Artificial intelligence —Generative AI has caught the world’s attention, and has potential to do much to drive growth and efficiency. But this depends on quality data and effective measures to manage risk.
War in Ukraine and the Israel-Hamas conflict — The war in Ukraine seems likely to continue for some time and the evolution of the Israel-Hamas conflict is uncertain. It appears likely that war will continue to stir volatility in global energy and commodity markets for some time to come.
China’s domestic economy —China’s domestic economy is undergoing a structural slowdown driven by inflated property and credit markets. While the government is taking steps to encourage new growth, China’s economy will likely remain soft for the near term.
China’s changing role in the world — Strategic competition between China and the US seems likely to intensify. Even as the two countries work to keep their relationship stable, tensions will continue to simmer over trade, tariffs and export controls. China’s domestic vulnerability on the economic front will likely diminish its appetite for escalating trade disputes any further.
Continuing international cooperation on global tax
In spite of geopolitical uncertainty, we see continuing international efforts to cooperate on international tax, mainly through the OECD/G20 Inclusive Framework, which now includes over 140 jurisdictions. Governments are keen to ensure that tax is paid fairly in the countries where income is earned, and that major multinationals should not escape their responsibilities. Pillar One aims to make it easier for countries to tax companies which make profits without physical presence, while Pillar Two has introduced the Global Minimum Tax for large companies.
Nevertheless, there are a number of difficulties which need to be overcome. Some developing countries do not think the framework is inclusive enough or that the two-pillar solution fully addresses their issues. Such countries, which are keen to attract investment, may face challenges such as no longer being able to offer tax holidays. They are likely to have to focus on other ways to be competitive, such as quality of infrastructure.
Moreover, the whole issue of tax incentives has not been settled, and is quite complex. Some tax incentives can be beneficial to wider positive developments, such as incentives to encourage renewables. But incentives can distort the true tax rate, While Pillar Two is aimed primarily at eliminating tax benefits on profits earned in low-tax jurisdictions, according to an OECD report released in November 2023, more than half of global profits now taxed below 15 percent are being earned in jurisdictions with high headline tax rates, such as the US and many Latin American countries, due to the generous incentives and concessions that these jurisdictions offer. So there is still a need for a lot of discussion about the detail to ensure the Framework is effective and fair to all governments and taxpayers.
Nevertheless, the changes under the OECD/G20 Inclusive Framework would have been unimaginable 10 years ago, and the fact that a critical mass of countries have agreed to adopt these game-changing principles is one of the greatest achievements of multilateralism in the past decades.
Income inequalities are a continuing challenge
The pandemic, high inflation and supply chain insecurities have had a negative effect on many of those at the lower end of the income scale. But the picture in terms of global inequality is complicated.
Between countries, research shows that significant global inequalities exist but have declined over the last two decades. The gap between the average incomes of the richest 10 percent and poorest 50 percent of countries peaked in 1980 at over 50 times more income, but fell to a little less than 40 times in 2021.
Within most countries however, the average income gap between the top 10 percent and bottom 50 percent of individuals almost doubled during that time. As income gaps widen, loss of trust in governments can become a problem, with potentially destabilising political consequences. Ensuring that the tax system functions fairly and that all pay the correct taxes is a powerful tool by which governments can address inequality and regain the confidence of citizens.
In Romania, one important step should be to reduce the VAT gap. The EU’s 2023 VAT Gap Report shows that between 2013 and 2021, Romania’s estimated VAT gap ranged between 33.2% and 39.7% of VAT Total Tax Liability (VTTL). There are signs of progress- large companies are now required to submit their tax information through the SAF-T system, and this will be extended to cover medium-sized and small companies. According to the EU report, fast estimates suggest a possible decrease of Romania’s VAT gap by 1.5% in 2022. Nevertheless, there is still a lot of potential to combat VAT fraud, which is unfair on honest taxpayers.
Takeaways for Tax Leaders and the need for geopolitical risk management
Tax leaders have a critical role to play in guiding businesses through a time of change and uncertainty. Above all, they need to communicate effectively. They should connect with other parts of their organization, customers and suppliers to understand what is happening in the business and what tax impacts might be on the horizon. They should connect with their professional peers, advisers, academics and non-governmental organizations to keep up with and engage on emerging issues, social currents and political trends. They should connect with tax authorities and policy makers to take part in tax policy debates and make sure business issues are heard. They should also connect with the C-suite and senior management across the company to explain the sources of tax risk and highlight opportunities.
Moreover, a well developed risk governance framework, in which geopolitical risks are analysed, is essential for organizations to be able to plan to achieve their goals across a range of possible future developments. Tax professionals should play a key role in such a framework.
