Some months ago I wrote a piece on Twenty GloBe Points – Primer On The Minimum Corporate Tax Proposal. The EU has now taken the frontrunner position on 16 December 2022 when a press release announced the prior deadlock was overcome and the EU Council formally adopted the Pillar Two directive. The Official Journal publication will the next step followed by the transposition domestic law of each EU member state by the end of 2023, with the Income Inclusion Rule or IIR (which charges the groups parent entity) applying as from 2024 and the Undertaxed Profits Rule or UTPR as from 2025.
Let’s try to assess the potential impact of Globe Rules and Pillar Two Directive on tax incentives in place in Portugal.
Portugal is essentially capital-importing country with all adverse features that come along such as dependence on foreign capital, tendency to accumulate large amounts of debt and increase number of national champions held in foreign ownership (likely in-scope MNE).
Portuguese tax policy has historically relied heavily (like many capital-importing countries) on tax incentives to attract further foreign investment and stimulate economic growth. That has been the way forward for a country that stubbornly maintains one of the highest statutory CIT rates which for certain entities can reach 31.5%.
A 2019 governmental report on tax incentives, that received little or no track, summed-up very well the current mess: (i) there is more than 500 tax incentives (either tax credits, deductions, exemptions or deferrals); (ii) those incentives are spread over more than 60 different set of laws, (iii) those incentives are many times ambiguous; (iv) not always obvious (or absence) of extra-fiscal objectives on tax incentives; (v) difficulty in gathering adequate data to evaluate tax incentives or provide adequate tax expenditure reporting (estimated at 1.1 billion for corporate tax).
With Pillar Two directive coming into play in 2024, several tax incentives are no longer expected to be as meaningful for in-scope companies or groups with turnover in excess of €750 million since there is a requirement for the effective tax rate (ETR) to be at least 15% on a jurisdictional basis. It will not matter that a preferential tax rule in Portugal is harmful or if there is any meaningful economic substance, as GloBe rules apply to all low tax outcomes.
The qualification of tax incentives can be critical to the ETR outcome. For example, the OECD Blueprint identified a specific category of tax credits – Qualified Refundable Tax Credit or QRTC. Both OECD and EU definition require such tax credit to be paid as cash, or available as cash equivalents, within four years of the date on which the taxpayer is first entitled. A QRTC is then treated as income and not as a reduction in taxes paid in calculating the relevant group ETR (which generally is a worst outcome). This discussion may be particularly important for expenditure and R&D tax related incentives such as SIFIDE II, RFAI or patent box.
Another example that may require reassessment is the recent replacement in the 2023 Budget Law of the notional interest deduction and deduction for retained and reinvested profits for an expanded 4.5% allowance for corporate equity (ACE) leading to higher tax deduction. One should recall that for GloBE Income calculation, as the ACE is a tax fiction not recognised as a P&L expense it will result in lower covered taxes for in-scope MNEs. In some cases, the effect may end up being cancelled.
One may also mention that a reassessment would likely require to take other elements of the OECD GloBE rules, such as the potential impact of the Subject to Tax Rule (STTR) on the Portuguese Patent Box. The STTR (which is not covered on the EU Directive) is a treaty-based rule that will allow source jurisdictions to impose limited source taxation on certain related party payments subject to tax below a minimum rate of 9%. As STTR is not confined to large MNEs, the STTR will operate by restricting tax treaty benefits and either party to a tax treaty may request that the STTR be applied bilaterally since the current ETR of the Portuguese patent box can even reach 3.15%.
Finally, any analysis should cover if Portugal should use the EU Directive option to adopt a qualified minimum domestic top-up tax or QMDTT, allowing any top-up tax to be imposed to stay within Portuguese coffers.
In short, Portugal should be aware that GloBe tax rules are a game changer for both high-tax capital-exporting countries and low-tax capital-importing countries and going forward the limited ability to offer tax incentives to large MNEs is likely to change some factors on investment decisions.
Naturally one option could be stay as it is (multitude of tax incentives) and then the outcome is likely a higher asymmetry between GloBE in-scope entities and other entities operating in Portugal. Small or medium sized businesses tax reliefs will then remain unaffected. But with the dependence of foreign capital and exposure to subsidiaries of GloBe entities, not certain if such “no review needed” would be the correct policy. The new GloBE rules may the “perfect excuse” to re-valuate all corporate tax incentives and align nominal corporate tax rates with the 15% ETR.
Are we now in agreement that it is time to reassess?
Tiago Cassiano Neves
December 2022