With Pillar Two rules weighing on Singapore’s tax incentives, we need new tools to attract investments and stay ahead of competitors
Ajay Kumar Sanganeria, Partner, Head of Tax, KPMG in Singapore
Harvey Koenig, Partner, R&D & Grants Consulting, KPMG in Singapore
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On 20 December 2021, the Organisation for Economic Cooperation and Development (OECD) released model rules to guide governments around the world with the implementation of a reform to the international tax system. Specifically, these rules define the scope and mechanism of the so-called “Global Anti-Base Erosion” (GloBE) rules under Pillar Two of the BEPS 2.0 project, which will ensure that multinational enterprises (MNEs) are subject to a minimum of 15 per cent effective tax rate from 2023.
Tax incentives have long been central to Singapore’s strategy of attracting large-scale investments into the country to drive economic growth and job creation. The tax incentives can mean that MNEs end up paying an effective tax rate in Singapore below the global minimum tax rate of 15 per cent.
However, even with the latest GloBE rules from OECD, it is not all gloom ahead. KPMG does not expect these tax rules to lead to an exodus of MNEs from Singapore. Firstly, Singapore's competitiveness goes beyond tax incentives, to include non-tax factors such as its strategic location, ease of doing business, rule of law, connectivity to key Asia-Pacific markets, and skilled workforce. Secondly, the GloBE rules will apply globally, so businesses will be subject to a minimum tax of at least 15 per cent, regardless of where the profits are being recognised. Thirdly, the GloBE rules only apply to MNEs with a revenue of 750 million euros (S$1.1 billion) and above, so the tax incentives will remain applicable for groups below the threshold. Fourthly, tax incentives will continue to remain relevant for certain “excluded entities”, such as specified investment funds, and activities that are out of scope, such as international shipping.
Nonetheless, the GloBE rules will inevitably have some impact on Singapore’s ability to attract investments, and tax incentives have traditionally also compensated for higher business costs in Singapore. Finance Minister Lawrence Wong previously stated that Singapore will have to work much harder to attract investments. Singapore has not provided any details on how the GloBE rules will be implemented here, but we expect these to be considered sooner rather than later. In this regard, we highlight 4 areas that we believe the country’s upcoming Budget 2022 should address:
1. Introduce flexibility into the tax incentive regime
For Singapore-based MNEs that belong to a larger corporate group where revenue is 750 million euros and above, tax incentives may still be beneficial if their overall effective tax rates (so-called jurisdictionally blended effective tax rate) is 15 per cent and above, taking into account the effective tax rates of other group entities operating in Singapore. For example, if Group Entity A has an effective tax rate of 10 per cent and Group Entity B has an effective tax rate of 20 per cent, then the blended aggregate effective tax rate in Singapore could be 15 per cent (assuming the same level of accounting profits).
To help these MNEs, relevant authorities could allow impacted businesses the flexibility to move to a higher tax incentive rate midway (for example, from 5 - 10 per cent) with lighter incentive requirements.
2. Offer grants and other benefits alongside tax incentives
Another way to help MNEs is for authorities to consider packaging grants as well as other nontax benefits, along with tax incentives to attract and anchor a range of activities to Singapore.
Various grants offered to date have been restricted to certain activities such as research and development (R&D) and are less transparent than tax incentives. This makes it harder for businesses to analyse the cost-benefits of making long-term investments.
It is important that the scope of these grant offerings is transparent so that it can be easily communicated to and understood by potential investors. For a start, the scope of the grants should be extended to a range of activities including helping MNEs transform their regional headquarters into digital and artificial intelligence-driven regional centres, upgrading their manufacturing facilities into Industry 4.0-enabled factories, and setting up Centres of Excellence for training and development of regional leaders. Other non-tax benefits could be related to accessing test-bedding facilities, training, and R&D resources.
3. Revise and enhance the R&D tax incentive
The pressure has increased in recent years to ensure that Singapore’s tax incentives are as attractive and as effective as those in other countries. Over 50 jurisdictions around the world offer some form of R&D incentives, underscoring the keen worldwide competition to attract R&D activities.
To date, Singapore’s R&D tax incentive, which offers a 250 per cent tax deduction on eligible R&D expenses, is one of the most attractive in the world. However, in the context of the GloBE rules, offering enhanced deductions for R&D could lead to lower effective tax rates. Singapore should look to countries such as UK and Ireland which offer so-called refundable R&D tax credits or “above-the-line” R&D tax credits to mitigate this impact. R&D tax credits typically allows the benefits to be encashed, unlike R&D tax deductions that can generally only be offset against taxable profits. The model rules have indicated that “Qualified Refundable Tax Credits” will be treated as income for purposes of computing the effective tax rate under the GloBE rules, and although companies may end up with higher taxes initially, the R&D tax credits that can be encashed will help soften the impact under the GloBE rules. Hence, changing Singapore’s R&D tax incentive to a refundable R&D tax credit is an elegant and easy solution to ensure that Singapore can maintain its attractiveness for R&D investments.
In addition to revising the incentive, the government should provide more certainty to the R&D regime by extending the R&D tax incentive beyond the Year of Assessment 2025 for another 10 years, as R&D investments are long term in nature.
The pandemic has also given a stark reminder that supply chains and labour networks are fragile, and as such, companies must ensure they have a robust framework to access goods, services and labour to ensure continuity of business. The R&D incentive is currently only restricted to R&D undertaken in Singapore. But with the pandemic, many R&D operations have depended on resources from overseas as demand for R&D and technology manpower has outstripped local resources. The R&D tax incentive in Singapore should therefore be enhanced to allow R&D done overseas for a Singapore company to also qualify for the R&D tax incentive, as long as the intellectual property (IP) or right to exploitation is owned by a Singapore entity.
4. Preserve hub activities by revising tax incentives
In a similar vein, there is another mechanism under Pillar Two that seeks to impose additional taxes on payments from other countries to Singapore under the “subject to tax” rule (STTR). This happens when non-resident companies make certain tax-deductible payments such as interest, royalties and other specified payments (also known as ‘covered payments’) to resident companies in the receiving jurisdiction. The top-up tax under the STTR will be triggered where a covered payment is subject to a nominal tax rate in the receiving jurisdiction that is below the rate of 9 per cent.
In this regard, subject to finalisation of the scope and model rules for the STTR (this is expected to be released in early 2022) companies enjoying incentives such as the Finance and Treasury Centre incentive and the Aircraft Leasing Scheme (both schemes offer a tax incentive rate of 8 per cent) could be adversely impacted by the STTR. There may be less reason for companies to want to set up financial and treasury centres or aircraft leasing businesses in Singapore if the payments they receive for work done will be taxed higher than what the incentives they receive can cover.
To this end, Singapore may consider introducing legislation to allow companies to opt for their incentive rates to be adjusted to 10 per cent to preserve the effectiveness of these incentives and thus increase the global competitiveness.
With Pillar Two rules weighing on Singapore’s tax incentives, it will be important to develop new tools to attract investments and stay ahead of competitors. While Singapore has a host of favourable non-tax factors to attract investors, calibrated strategies such as those highlighted above may be considered to ensure Singapore is prepared for the changes in the global tax landscape.