Last month the European Commission launched its Anti Tax Avoidance Package, propelled by unprecedented political support for the fight against perceived tax avoidance by multinationals.
In it the European Union stresses its full support for recent recommendations of the Organisation for Economic Cooperation and Development's (OECD) BEPS project and it seems eager to show the world it can lead the pack in effectively curbing tax avoidance.
BEPS or Base Erosion and Profit Shifting refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low- or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. In the light of such practices by multinational enterprises, the OECD BEPS project provides governments with solutions for modernising international tax rules.
The EU package contains a wide range of concrete measures to prevent aggressive tax planning, boost tax transparency and create a level playing field for all businesses in the EU. The package addresses topical issues, such as non-taxation of foreign income, the abuse of tax treaties and country-by-country reporting. We focus below on two measures that are of most likely interest to Singapore.
Previous EU measures were typically confined to tax practices of the EU member states or the arrangements of multinationals within the EU, but the package contains two elements that will affect EU multinationals doing business in countries outside the EU, like Singapore. Will the package also influence how countries like Singapore design their tax systems? If so, this represents a serious challenge to Singapore's sovereignty.
Singapore should defend its sovereign right to design a tax system that complies with OECD norms, that is based on substance, embraces the arm's length principle, and prevents tax avoidance.
IMPACT ON S'PORE
One relevant element of the package is a proposal for a Tax Avoidance Directive. A rule of special interest to EU multinationals with operations outside the EU is a so-called "minimum tax rule", which would oblige EU member states to fully tax the profits that EU multinationals receive from operations in low-tax countries. The test for what is a "low tax" has been set at 40 per cent of the statutory rate of the relevant EU member state. With a statutory corporate tax rate of 17 per cent (higher than 40 per cent of the highest statutory corporate tax rate in the EU), Singapore should be outside its scope, even in respect of companies enjoying tax incentives.
Another relevant element of the package is a Communication, expressing the European Commission's aim for a common approach to third countries on tax good governance matters. According to the commission, there should be a new EU strategy to ensure the profits of EU multinationals in third countries are taxed effectively.
On fair tax competition, the Communication states that it is no longer sufficient to take into account only the EU's own Code of Conduct rules, but that the OECD BEPS recommendations must also be taken into account. This could significantly affect companies in Singapore.
The commission envisages two ways for enforcing the tax good governance rules on countries outside the EU. One is by including good governance clauses in agreements between the EU and third countries, or even regions, such as Asean. State aid provisions would become part of them, preventing countries from subsidising local companies through tax measures and making it difficult for EU companies to compete at a level playing field. If so, this would seriously challenge how Singapore uses tax incentives (as one of many reasons) to attract investments.
The second way ties in with the perceived need for stronger instruments if countries like Singapore are regarded as not respecting the EU's tax good governance standards. Presently, many EU member states have listed non-compliant countries, but they rely on different criteria and apply different counter-measures. In the commission's view, the end goal would be a common EU system for assessing, screening and listing third countries and taking counter-measures.
S'PORE NEEDS TO RESPOND
Although Singapore complies with the latest international standards on exchange of information, the Communication also refers to far-reaching EU rules on automatic exchange of tax rulings and pricing arrangements.
Furthermore, the Communication mentions the criteria for harmful tax measures under the EU's own Code of Conduct rules, and a lack of transparency is listed as one of them. As the precise conditions for Singapore's important incentive regimes are not officially published, it is vital to see how Singapore would be assessed by the commission against the EU's transparency standards.
The same uncertainties surround the notion of fair tax competition. Singapore's tax system seems EU Code of Conduct-proof, but the Communication also refers to specific EU state aid rules. These are stringent rules, which have a drastic effect on the discretion of member states in designing their tax systems. If the EU were to attempt to apply the state aid rules to Singapore's incentive regimes, there could be several practical issues. This is even though Singapore's incentives are subject to very stringent requirements around substance, commercial activity, real employment, quantitative criteria, etc. Although it is not fully clear which specific rules would apply to countries like Singapore, the commission recognises the different position of third countries (for instance, politically and economically), and it remains to be seen how this element will weigh in any external assessment of Singapore's tax system.
In our view, Singapore should not stand still but stand tall.
Singapore should defend its sovereign right to design a tax system that complies with OECD norms, that is based on substance, embraces the arm's length principle, and prevents tax avoidance. It should make the point that the EU's rules, which govern a group of member states that are uniquely integrated economically and politically, cannot easily be transposed across EU borders. EU multinationals, which have invested in Singapore and commercially benefit from real economic activities, should not be penalised for being here.
Finally, it is fair to say that the issues identified above confirm that deliberations over the design of Singapore's tax system must be very conscious of dynamic and fundamental changes happening outside Singapore.
• Liam Collins is an International Tax Partner with PwC Singapore, where he leads the Global Structuring team with overall responsibility for several major clients across the Asia-Pacific. Dr Frederik Boulogne is a Senior Manager with PwC Singapore and he is a specialist on the effect of European law on the tax systems of the EU member states. Chris Woo is the head of tax of PwC Singapore.