Episode Transcript
[00:00:00] Speaker A: Foreign hello everyone and welcome to our podcast series where we bring you insights into the latest developments in the global tax policy and controversy space.
My name is Hang Vo and I'm a Senior Director in the International Tax practice of A and M Australia.
Joining me today is my colleague Jade Thompson. Welcome Jade.
[00:00:25] Speaker B: Thank you. Hi Hang.
[00:00:27] Speaker A: Jade is a Managing Director also from our international tax practice based out of Melbourne. On this episode we'll be discussing the latest developments in the treatment of tax incentives under the Globe Rules and the potential introduction of a simplified safe harbour. Let's start with tax incentives. Jade, would you like to give a brief background to set the scene?
[00:00:47] Speaker B: Yeah, sure.
So, earlier this year the US Secretary of the treasury expressed some concerns about the implementation of Pillar two. And and as a consequence, they propose retaliatory measures targeting foreign jurisdictions that impose what the US considers to be an unfair foreign tax to US entities or US owned foreign entities.
And following those discussions, the G7 released a statement on 28 June 2025 outlining a shared understanding between the US and G7 countries on a side by side framework.
And under that approach US parented groups would be exempt from the Globe Rules. And in return the proposed section 899 would be withdrawn. And this remains an active and evolving area of negotiation even as we sit here today. The proposed side by side arrangement is discussed in a previous podcast by our colleague Bruno Anacito da Silva. If you haven't already checked it out, recommend to go and do that. It's a good listen. But maybe as part of the shared understanding, the G7 statement included a commitment to pursue changes to the pillar 2 treatment of substance based non refundable tax incentives. The goal here is to achieve greater alignment with treatment of refundable tax credits. And that commitment was subsequently affirmed and broadened by the G20 on 18 July 2025 which emphasised the G20 support for fair treatment of substance based tax incentives. It's a bit of a tongue twister Hang. Yeah, thanks Jade.
[00:02:22] Speaker A: And to help level set our listeners understanding at their core, substance based tax incentives are reliefs that reduce a company's effective tax rate based on the level of genuine economic activity conducted within a jurisdiction. They serve as a proxy for measuring substance such as investment in people, infrastructure and operations. Examples include expenditure base or production based incentives like R and D tax credits, clean energy incentives, capital investment allowances, manufacturing incentives, benefits tied to a special economic zone or sector specific subsidies such as film production credits. We are seeing governments worldwide increasingly exploring these types of incentives for example, Malaysia and Singapore are already active in promoting substance based tax reliefs as part of their investment strategies.
[00:03:16] Speaker B: And I'd also add that these incentives differ fundamentally from profit shifting mechanisms like preferential regimes on passive income or patent box regimes. While profit shifting incentives often facilitate the booking of profits in a low tax jurisdiction without corresponding activity, substance based incentives are tied to tangible business operations. So the overarching goal is to encourage real investment, creating jobs, building infrastructure, and ultimately boosting production. To appreciate what this means, perhaps Hang let's take a step back and discuss the treatment of tax incentives under the existing GLOBE framework.
[00:03:57] Speaker A: Yes, sure, Jade. So under the OECD model rules, tax incentives are classified into several categories. The nature of the credit has an impact on the jurisdictional effective tax rate. The adjustment for the tax incentive is either an increase to globe income being the denominator of the effective tax rate calculation, or alternatively, a reduction to cover taxes being the numerator to the effective tax rate calculation. On the one hand, we have qualified refundable tax credits. These are broadly tax credits that are payable in cash or refundable within four years. Now, because they function more like government grants or subsidies, they result in an increased adjustment to globe income in the effective tax rate calculation instead of a reduction to cover taxes. This approach largely follows the treatment under financial accounting standards where the taxpayer's entitlement is not dependent on profitability, liability or income tax liability. Marketable transferable tax credits are treated similarly with adjustments made to globe income rather than cover taxes. And on the other hand, we have the other tax credits such as non qualified refundable credits, non refundable credits, or non marketable tax credits, all of which are treated as reduction to cover taxes which can materially lower the jurisdiction's effective tax rate. The value of these credit is effectively limited to the extent they can be used to offset actual tax liability.
[00:05:21] Speaker B: Another point to add hang is that in light of the G20's commitment to ensuring fair treatment of substance based incentives, there is growing momentum to level the playing field between these types of credits and qualified refundable tax credits. This reflects a broader policy shift as governments seek to attract real investment in economic activity, not just profit allocation, within their jurisdictions. Hang, what are some of the design considerations that would be relevant to achieving this fair treatment of substance based tax.
[00:05:52] Speaker A: Incentives to achieve alignment? J There are a number of potential options to explore. Certain substance based tax incentives could be treated as income in line with the current treatment of qualified refundable tax credits and marketable transferable tax credits, or as an alternative, perhaps a new safe harbor could be introduced for eligible substance based tax incentives. In terms of the scope, substance based tax incentives should include expenditure based and potentially also production based incentives. In principle, they should not extend to income based incentives. The key here is the connection with the substance within a particular jurisdiction in terms of the quantification or limitation of the amount of adjustment to the jurisdictional effective tax rate computation. Potentially this could be based on either the amount of the credits used in the period or introducing a substance cap. Jade, with all of this, what does this mean for in scope multinational enterprise groups?
[00:06:45] Speaker B: Good question. I think the potential expansion of qualified refundable tax credit treatment to include substance based incentives and effectively allows multinationals to enhance their jurisdictional effective tax rates. That's particularly relevant given that these incentives impact globe income. So the denominator of the effective tax rate calculation rather than the covered taxes component, which is the numerator and that's an important distinction under the Pillar 2 rules. I think what we're going to see is countries revisiting existing incentives. So as these rules evolve, we may see increased dialogue between multinational enterprises and local authorities such as Singapore's EDB regarding the structure of existing incentives. There's likely to be some strategic discussion on how jurisdictions like Singapore can ensure that their incentive offerings remain competitive and compliant under the revised Pillar 2 framework. I think historically the EDB has shown commercial pragmatism and I believe that we can expect them to remain flexible and open to recalibrating incentive structures to align with the international developments. Given the movement in this area, I think multinationals should be strategic in their consideration. At this stage, it may be prudent for companies to take a wait and watch approach as further guidance becomes available. I think jumping into restructuring incentives too early could result in unnecessary complexity or missed opportunities as the global consensus evolves. But perhaps let's shift gears. Hang now to talk about the proposed introduction of a simplified safe harbour.
[00:08:23] Speaker A: Sure. Thanks Jade. This is an important development.
It's anticipated that this safe harbour would be based on simplified taxes and simplified income to be determined based on the consolidated financial statements. This concept, as you may recall, was first flagged in the OECD Safe Harbour guidance release on 15th December 2022 where a possible permanent safe harbour framework was discussed. The aim of the simplified safe harbor is really to reduce the compliance burden on multinational enterprise groups either by minimizing the Number of Pillar 2 computations and adjustments required or by offering an alternative calculation to show that no top up tax arises in a particular jurisdiction. What's not yet clear at this stage yet is the basis for these simplified calculations. One question is whether they'll be linked to country by country report data or if they'll be more aligned to the simplified rules for non material constituent entities. Our current expectation is that the country by country report data won't form the basis, but we'll just have to wait and see.
[00:09:24] Speaker B: Yeah, and I think another issue is whether this safe harbour will be transitional or permanent. If it turns out to be permanent, which we think is likely to be the case, then we would expect the introduction of anti abuse measures, e.g. periodic retesting requirements to prevent groups from qualifying based on engineered data. Alternatively, specific events like M and A activity could trigger a reevaluation of safe harbour eligibility and status as well. So there's a couple of additional points there.
[00:09:53] Speaker A: And Jade, how does all this impact existing planning and financial and tax modelling for multinational enterprise groups?
[00:09:59] Speaker B: Yeah, in light of these evolving changes with tax incentives and the potential introduction of simplified safe harbors, it's important that multinationals are revisiting pillar two forecast modelling. That they're reassessing what updates are required to existing calculation tools and technology to configure the revised framework. That they're also evaluating incentive strategies with a forward looking lens and keeping a lookout for OECD updates and local changes that may impact planning. As I mentioned before, there also M and A implications. We can't forget that. So as simplified calculations and availability of tax incentives may affect deal competitiveness and pricing, so worth considering those points as well.
[00:10:41] Speaker A: Thanks Jay. That brings us to the end of our episode. Thank you for joining us today. Stay with us as we continue this journey in our upcoming podcast. Please also check out our monthly newsletter, which will bring you the latest key updates around selected editorial pieces from our global tax network. If you haven't already subscribed, please use the link in the description to receive the newsletter directly in your inbox. And don't forget to follow this channel. There will be regular insights and updates through podcasts coming your way.
[00:11:11] Speaker B: Thanks everyone.
