1. On July 1 2021, 130 countries approved a statement providing a framework for reform of the international tax rules. These countries are members of the OECD/G20 Inclusive Framework on BEPS (IF), comprising 139 countries.
2. The statement sets forth the key terms for an agreement of a two-pillar approach to reforms and calls for a comprehensive agreement by the October 2021 G20 Finance Ministers and Central Bank Governors meeting, with changes coming into effect in 2023.
3. Pillar one of the agreement is a significant departure from the standard international tax rules of the last 100 years, which largely require a physical presence in a country before that country has a right to tax.
4. Pillar two secures an unprecedented agreement on a global minimum level of taxation which has the effect of stipulating a floor for tax competition among jurisdictions.
5. The Multilateral Instrument (“MLI”) was signed in June 2017 by more than 70 jurisdictions, and represents one of the most important changes to-date to cross-border tax norms. Malaysia became a signatory to the MLI on 24 January 2018; and ratified the MLI on 4 August 2020 when the Malaysian MLI Order was gazetted. On 18 February 2021, Malaysia deposited the instrument of ratification with the OECD; and the MLI entered into force for Malaysia on 1 June 2021.
IMPACT ON HONG KONG SAR
1. Hong Kong SAR operates a simple and low tax system, characterised by a territorial taxation principle under which foreign sourced income of a company is exempt from Hong Kong SAR profits tax, capital gains are not taxed and there is a relatively low headline rate of corporation tax (i.e. currently 16.5%).
2. This may cause a considerable reduction in a company’s effective tax rate (ETR). Hong Kong SAR also currently offers some incentives which may also bring down a company's ETR to below 15%.
3. With a proposed global minimum tax rate of 15%, it is expected that a significant number of large multinational enterprise (MNE) groups (mainly groups with a total consolidated group revenue above €750 million although parent jurisdictions may choose to apply lower thresholds) with presence in Hong Kong SAR will be adversely affected by the pillar two proposals.
4. Many MNEs operating in Hong Kong SAR may also be taking advantage of incentives and tax breaks in other jurisdictions, and these will also need to be factored in to understand the overall impact of the proposals.
5. Hong Kong SAR entities could effectively end up being subject to ‘top up tax’ in the MNE parent entity jurisdiction on income that is exempt or subject to a reduced corporate tax rate in Hong Kong SAR where the combined ETR of the entities within Hong Kong SAR is less than the global minimum tax rate of 15%.
6. The subject-to-tax-rule (STTR) is also expected to impact many Hong Kong SAR entities on their cross-jurisdictional transactions. Where interest, royalties or certain services payments received from foreign related parties are subject to no or low tax in Hong Kong SAR, the source jurisdiction may apply withholding tax to bring the total up to the STTR minimum rate (proposed to be between 7.5% and 9%).
7. There is no jurisdictional blending for this rule, and it is applied on a transaction basis so it would need to be considered regardless whether the entity has an ETR of 15% or above.
8. Although no public commitments have been made by the Hong Kong SAR government, the Hong Kong SAR government has previously confirmed that it will actively implement the BEPS 2.0 proposals ‘according to international consensus’, whilst emphasising that it will work to maintain the simplicity, certainty, fairness and minimise the compliance burden of its tax regime.
9. Separately, the EU has expressed concern about foreign-sourced income exclusions. The combined impact of these initiatives may result in significant changes to Hong Kong SAR’s tax system, at least for large multinationals.
IMPACT ON MALAYSIA
1. The MLI contains both, mandatory and optional provisions. Malaysia has opted to adopt the following key modifications to Malaysian bilateral tax treaties.
2. Prevent of Treaty Abuse - Malaysia has opted to include a statement of intent that a bilateral tax treaty is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance. Malaysia has also chosen to adopt the Principal Purpose Test (“PPT”) to prevent treaty abuse, i.e. deny a benefit under a treaty (covering all benefits such as tax reduction, exemption, deferral, refund, and relief from double taxation) if it is reasonable to conclude that obtaining the treaty benefit (directly or indirectly) was one of the principal purposes of an arrangement or transaction unless it can be established that granting that benefit would be in accordance with the object and purpose of the relevant provisions of the bilateral tax treaty.
3. Widening the Scope Of Permanent Establishment ("PE") - Fixed place PE related provisions are broadened to prevent artificial PE avoidance strategies that have been used in the past to circumvent the PE definition and to shift profits out of a country where it should have rightfully been brought to tax. The specific activities exemption list (or the negative list) refers to the list of activities generally found in bilateral tax treaties which are specifically not taken into account in determining whether a non-resident has constituted a PE.
4. Where the warehousing activities are considered together with the operations of the subsidiary, the PE exemption would not likely apply. This is because the warehousing activities are seen as being a complementary function that is part of the cohesive business operation, which cannot be seen as being preparatory or auxiliary in nature, and could result in the existence of a PE for the parent entity in the jurisdiction of the subsidiary.
5. The MLI also introduced new anti-fragmentation rules to prevent strategies for avoiding a PE status by fragmenting a cohesive operating business into smaller operations which fit the description of items under the negative list in order to argue that each transaction should not constitute a PE. The anti-fragmentation rules take a holistic view of activities by closely related persons to determine the existence of a PE.
6. Agency PE rules are broadened to address the artificial avoidance of a PE status through commissionaire arrangements, sales support activities and similar strategies. The definition of a dependent agent is broadened to include a person who plays the principal role leading to the conclusion of contracts by the non-resident without material modification by the non-resident. The independent agent provision is tightened to exclude a person who acts exclusively or almost exclusively on behalf of one or more non-residents to which it is closely related.
7. The MLI provisions could affect new arrangements as well as existing structures. The introduction of the PPT to prevent tax treaty abuse - whereby bilateral tax treaty benefits will be denied if it can be “reasonably concluded” from the facts that the “principal purpose or one of the principal purposes” of entering into the transaction or arrangement was to obtain tax benefits - could have a significant impact on existing business arrangements. Businesses should look into their existing operating structures or intended new arrangements, and review the principal purpose behind entering into an arrangement.
8. The first step would be to check whether the relevant treaties are modified by the MLI. In other words, whether the country has a covered tax agreement with Malaysia, as the MLI provisions are effective only on covered tax agreements. The next step would be to assess when the MLI provisions are effective. There is a need to review the cross border transactions as to the effective date(s) and whether the positions Malaysia and the respective country opted for are the same. The MLI provisions adopted by Malaysia would only be effective where the corresponding country opted for the same interpretation/position on the relevant subject matter.
9. The anti-fragmentation rules would require an analysis of the value chain of activities (including activities of group of companies) as a whole, to assess whether a PE could arise as a result of a combination of activities. It is no longer sufficient to assess a tax impact of activities in isolation. Where a PE is found to exist, issues around profit allocation, which are often complex, would likely arise;
10. The expansion of the scope of Agency PE’s is likely to mean that the tax authorities may take a more aggressive view at determining whether an Agency PE exists. Marketing service company structures, purely related party sales support service companies and commissionaire arrangements are likely to be structures that will be most impacted. Such structures should be reviewed to mitigate any potential tax risks. It is not yet clear how the tax authorities will interpret this threshold in practice.
11. At the moment, businesses should review their cross border transactions and plan ahead while there is room to restructure these transactions such that the arrangement(s) would not be viewed to result in obtaining a benefit under a bilateral tax treaty. This would include aligning any discrepancy between the substance of what is being achieved under the arrangement and the legal form, or substantiating the character of payments (to mitigate mischaracterization of payments). There must always be a commercial decision behind every business arrangement or transaction, that is not led with an intention of obtaining a tax benefit;
Source:
https://www.roedl.com/insights/multilateral-instrument-malaysia-impact-business
https://www.internationaltaxreview.com/article/b1t8h4gpjyynn4/the-impact-of-the-oecds-beps-20-proposals-on-hong-kong-sar
