Tirani Kulathunge 00:11 For decades, Sri Lanka competed for foreign investments through tax holidays, concessionary rates, but with OECD's Pillar Two global minimum tax, which is at the flow of 15% right now, those fighting for investments, that playbook does not appear to be more obsolete at this point. Hello, everyone. Welcome back to Advocata Studio, and today we have here mr. Suresh Pereira, the principal of KPMG. Hello, mr. Suresh. How are you today? Speaker 1 00:44 Hi. Tirani Kulathunge 00:45 Before we start with the complex questions, let's go back with the basics of it. So, what is the background of BEPS or bayes erosion? If you can explain. Profit shifting. Yeah. Speaker 1 00:56 So, actually, there are there are two points that led to this whole thing called the basically base erosion profit shifting. So first point is with regard to the capital of the European countries, the USS etc. Basically, their capital flow or the profits being shifted to low tax jurisdictions or the no tax jurisdictions. Right. So this is what, and of course, these other countries, developing countries, have been competing for these FDI's foreign direct investments by offering zero tax or very low tax rates. This is what we call race to the bottom. Tirani Kulathunge 01:35 Right, Speaker 1 01:35 competing for the FDI, reducing the taxes, and this result, this resulted in harmful effect to the countries as well as how do I say? Of course, the other countries also did not like the governments of the other countries also did not like the idea of profits being shifted to shifted out of their borders and being parked in other countries, right? So this is this was a major issue, and in addition to that, the second point is the the change of the way you do business. What we call the digital economy, development of the digital economy also resulted in the digital giants, the big companies operating in other countries without having any physical presence, deriving profits, earning income without also the physical presence, and therefore not being liable for income tax, because the traditional income tax systems, which are basically geared for brick and mortar economic activities, not this e-commerce type of things. So that also resulted in the, let's say, our countries, many countries losing revenue, giving income away out of their borders to other countries, and without getting any taxation in return, so this digital economy is the second second reason why OECD had to get involved in relation to resolving a how do I say resolving a trade war that was developing. So the say USA the digital country where basically most of the digital giants come from, had to reply to the developments that were taking in other countries because other countries, though their normal income tax systems are not developed to capture derived taxes from these other this kind of economic activities, digital activities, they started developing introducing unique taxes called DSIs, digital service tax. You must have seen these unique taxes being introduced in these countries, European countries, even other countries, and trying to impose taxes on this digital dance, though they were not physically present in the country, in their countries, and this had an impact on the USA. So USA threatened the countries if you impact if you impose taxes using these DST mechanisms on our companies, then we will also increase the import duties. There was a trade trade war that was developing. So to resolve this issue, OECD got involved. So OECD tried to create a harm harmony by coming up with a different mechanism. So this is this mechanism is the BIPS. So BIPS also has two stages: BIPS 1.0 and the BIPS 2.0. What are the Tirani Kulathunge 04:47 differences in between? Yes. Speaker 1 04:49 So in BIPS 1.0 there are for 15 action points, and in fact, the inclusive framework where Sri Lanka also joined over 140 countries joined. 01, but it did not address the digital economy properly. So that's why the BIPS 2.0 was developed with two pillars. The pillar one specifically addressing this digital economy issues, but still that has not been how do I say implemented, gone through, or the agreements reached. So it's the pillar two now, basically that is being implemented as of now. So this is in at this moment, the hot topic is the pillar two. Right. So pillar two also has two elements. Pillar two has what I call the globe rules, where we talk about this what you mentioned as the global minimum tax of 15% and of course there's another element called STTR subject to tax rule. That basically ensures when certain payments are being paid out of, let's say, a country like Sri Lanka to another country. If those payments are not subject to adequate taxes, that means at least 9% tax is not imposed in the recipient country. Then that permits the a country like Sri Lanka to using what is called a multilateral instrument to collect to impose taxes up to the 9% So that is a different mechanism. So today I think we are going to talk about the pillar two and the global minimum tax. So we'll take it from there. Tirani Kulathunge 06:20 So what is Globe rule to be specific? Could you explain more on that? Right. Speaker 1 06:24 So, first, let me tell me tell you what GMT, that is the Global Minimum Tax 15% is. So, there is an agreement that they have reached. Sri Lanka is not a party to this one. Sri Lanka is not a party to the Globe so called the Pillar One or the Pillar Two. Yeah. We have not endorsed this one, but nevertheless, we are also how do I say Tirani Kulathunge 06:46 we get the effects of it. We Speaker 1 06:47 get the effects of it. Just because that we are we have not endorsed that does not mean we are immune from this mechanism. So, question that you ask is what is globe rules? So, globe means global base erosion rules that has been introduced to give effect to this global minimum tax, 15% So global tax minimum 15% means the countries have agreed at anywhere where the profits are being generated, those profits should be subject to a minimum tax of 15% Minimum tax of 15% If the 15 15% is not being paid in countries where the profits are being generated. There is a mechanism to ensure that the that particular company will be paying 15% in some other country. Is this Tirani Kulathunge 07:34 the top up tax that's been referred to? Speaker 1 07:36 Yes, top of tax. I will come to the top up tax first. I will explain this mechanism. So when you say globe rules, there are three rules. One is IIR, we call it income inclusion rule. So I'll give an example. So in a particular jurisdiction in a particular country, if the 15% is not paid, so what is this 15% It's not just the statutory tax rate of 15% It's the effective tax rate of 15% So there is a formula given to calculate the 15% So what is this 15% in particular country? Let's say a company, let's say company A from let's say UK has three subsidiaries in Sri Lanka. So if these three subsidiaries are not contributing 15% tax to Sri Lankan government. Okay. 15% effective tax rate. This government, right? So how you do it is there's a formula. So basically, you aggregate the revenues and then deduct the expenses. You calculate the effective tax rate for a particular country, not just a company per se, right? To a country. So if you see that in Sri Lanka, from that group, that three companies are not paying 15% then we say the jurisdictional effective tax rate is below 15% So, how do you calculate this 15% It's basically covered taxes divided by the global income. That is the formula, and sorry, I think before going there, I have to explain this rules apply not to everyone to big MNE groups. Tirani Kulathunge 09:11 Yeah. Speaker 1 09:11 So most important thing is this MNE group should have more than 750 euro consolidated revenue in their global structure, so consolidated revenue of 750 million euro above companies, above groups are the ones that are getting subject to this concept of the global minimum tax, not the small companies, right? So if you don't have 15% then you calculate the effective tax rate. What is the effective tax rate? Let's say when you calculate, if all three companies have been given zero tax, that means effective tax rate ETR will be zero, of course. Then the difference between that actual tax effective tax rate and the 15% which is 15 in this example that I took, is. Referred to as the top of tax, so that top of tax is is collected in three ways. First is the parent company in some other country. Let's say in this case a UK government can collect that 15% from the parent company, ultimate parent company. Tirani Kulathunge 10:20 Okay. Speaker 1 10:20 If the ultimate parent company, if the for whatever reasons, let's say the UK does not collect the from that ultimate parent company the 15% then we check okay in this group in other countries. So in Singapore, there's another subsidiary. Then the Singapore government can step in if the UK government has not collected using the third second rule called the UTPR under tax profit rule and collect that 15% for the benefit of the Singapore government. Tirani Kulathunge 10:47 That's interesting. Speaker 1 10:48 Yeah, so that is what we call. If you don't collect it here, we are donating our taxes that are due to our treasury to foreign treasuries, right? So now, how do how do you come out of this one? The mechanism is, if the Sri Lankan government enact this third rule, we are talking about the Globe rules. So there are three rules here. If we enact this rule called the QDMTT, Qualified Domestic Minimum Top Up Tax, then though under the Income England Revenue Act there is no tax collected under this new tax to be this rule to be enacted and statute to be enacted. You can collect that 15% So in that case, the company has paid 15% minimum tax somehow in Sri Lanka. Then there is no donation to the UK government or the Singaporean government. Right. So you Tirani Kulathunge 11:37 describe continuing these tax holidays, let's say for large M and A's, as let's say effectively donating revenue to foreign governments. So is the real policy failure not pillar two but Sri Lanka's failure to implement this QD MTT? And if we don't implement this QD MTT, are we voluntarily surrendering revenue again? And let's say, is this delay more damaging than non-participation? Speaker 1 12:05 Yes, correct. So it's it's like for a country like Sri Lanka, we are not strong enough to carve out our own freedom and not be part of it. So whether we sign this two pillar two or not, basically we still have to go by the rules, and we how to say our taxes go to other countries if we don't have duty and tdt coming. So I think the question that you ask is: Should Sri Lanka sign this pillar two into pillar two? Tirani Kulathunge 12:34 Yeah. Speaker 1 12:35 If you want to safeguard our tax base, that is one way in which We can, how to say, ensure the ETR 15% is achieved via the QDMTT rule. But that is not that. That is a one way of doing it. That is the normal way of doing it. But there are other ways in which still we can look after our tax base, right? So the the thing is that we have to ensure somehow there is 15% ETR in Sri Lanka, Tirani Kulathunge 13:04 right? Speaker 1 13:05 Right. So there are ways in which we can do. So there. Okay, I come to this concept called the QRTs, qualified refundable tax credits. This is basically instead of giving. So this happens basically when you have profit-based incentives, tax holiday or low tax rate. Instead of offering low tax rates or the tax holidays to attract the FDI to the investors, the big M and E investors, we can still have incentive basket designed based on QRTCs and what is called substance based incentives linked to substance-based income inclusion exclusion rule. So let me explain little bit in relation to that. So what is this QRTC qualified refundable tax credit? This is basically where when the investor comes, the government has a package where the government promises to give credits. The government offers credits. Right. So these a particular amount. So these credits, depending on the investment contents. So these credits could be set off against the tax liabilities eventually. And if these tax tax credits that you have used, these tax credits within four years, according to the Article 10 of the OECD credits should be used within four years. That's a rule that is there, right? So there are so based on this based on this rule, we can be innovative and we can develop structure different types of qualified refundable tax credits in relation to the investors. So this is something very attractive to the MNIS going forward because of the pillar two. Because if we offer tax holidays or low tax rates, that's something that is unattractive to the investors because even if they don't pay taxes in Sri Lanka, the benefit that we are conferred. Via the tax holiday agreement to the investor is being absorbed by the tax office in another country, maybe in their parent company or in a country where they have another subsidiary via the IIR rule or the UTPR rule. Tirani Kulathunge 15:15 So basically, from what you're saying is that you basically pronounce, let's say, this QRTC is like a silver bullet, but are these fiscally sustainable for a country that's under IMF consolidation again? Like, if refundable credits become large cash outflows, does that shift fiscal risk? And then, how do we prevent this? It depends Speaker 1 15:36 according to the way in which you structure the QRTCs. QRTs does not mean always cash grants. These are credits that are given. So you have to design it innovatively to attract the bigger MNEs. It's possible. So other one is the SBI. That is basically a substance-based income exclusion rule. Now what is main substance here? Basically, in relation to the tangible properties and the payroll cost, government provides support to the investor because the whole purpose of this pillar two is not to punish real economic activities. So, real economic activities comes from the real investment. So, what are real insurance? Those are the investments made in payroll. That means the employees. The investments made in tangible property. So, if the investor really investing in these real economic activities and the government supporting in a pillar two compliant manner, the returns on that is basically carved out in calculation of the ETR. Tirani Kulathunge 16:42 Okay. Speaker 1 16:43 Carved out. So therefore, there is no top-up taxes that will accrue on account of this income stemming from this real economic activities. Tirani Kulathunge 16:52 Okay. Speaker 1 16:53 So based on these principles, Sri Lanka has to be policymakers have to be innovative and design another incentive basket to the big MNIS. So now what we have is the invest the investment basket that we have incentive basket that we have is appealing only to the non 700 the non how to say not the in scope in scope MNEs but the investors who are outside the 750 category, that means small investors. Right. So you look at the port city port city incentive package. What do we have? Tax holidays, both the primary BSI as well as the secondary BSI. So secondary BSIs we have 7.5% lower tax rate. Whereas we have a tax holiday for the primary BSI. Now you look at last week we had the regulations coming for the SDP. What do we have? Only the tax holidays. So these tax holidays are not attractive for the large MNIs. So if the dream of our policymakers is to attract large amenities. Our incentive package is not addressing that. So this is where basically I am saying that in Sri Lanka we need to go for the two basket strategy. We need investments from the small investors because of other economic constraints that we have, and also the big investors. Tirani Kulathunge 18:25 Right. Speaker 1 18:25 The background we have now is we are excluding the big investors. We don't have anything to offer the big investors. So, Tirani Kulathunge 18:33 what are these two basket strategy you mentioned? Correct. So Speaker 1 18:36 that's it. The first one is basically the profit-based incentives. That means the tax holidays and the low tax rates, which I already have, but that is not appealing to the large investors. So we need to design another basket, including covering incentives that are attractive to the large MNIs. That means the pillar two compliant incentives. So this will fall into two categories: the fiscal incentives and the non-fiscal incentives. So what are what are fiscal incentives like the credits that I refer to (QRTCs) and the incentives linked to the substance-based income exclusion rule type of ones. So this so that's where you target the real, giving support to the investors in relation to the real economic activity, that is the payroll and the tangible profits aspect, and of course the non-fiscal incentives. That means having proper infrastructure, doing ease of doing business, no corruption. You know, so that kind of stuff in relation to that, Tirani Kulathunge 19:41 I have this question. So now, this two basket system, of course, won't that now? Okay, there's a pillar that let's say with OECD you have the MNEs that are 750 million above or below. That's the one tier, and then below that you have another basket. I mean, group, right? I'm just thinking that wouldn't this, you know, risk creating distortions between large and medium-sized firms, and let's say could these firms artificial structure below 750 million that threshold, and with this, wouldn't this segmentation complicate tax administration, which is already complicated right now, but wouldn't add another layer then? Speaker 1 20:25 Okay, two different things. One is if you're asking about complication of tax administration, because we are trying to create a dual strategy, Tirani Kulathunge 20:33 yeah, Speaker 1 20:34 as opposed to the strategy that we have. That means to have two baskets as opposed to one basket, my answer is, what are we aiming at? If we are basically trying to get the investments from the big MNEs, we need to go for that. So that is, yeah, administration is a little bit inconvenient, but then that is a necessary evil that we will have to stay with. But at the same time, if when we implement, when we go and endorse the BIPS 2.0 pillar two, and we comply with the pillar two rules. The data gathering is not a joke. It's it's it's a little bit complicated. What does it look like Tirani Kulathunge 21:14 if you can give a surface level? So, for instance, basically Speaker 1 21:17 do the compute. The IRD should be in a position to do these computations for that the data is required, and for that the data also happened at this Tirani Kulathunge 21:25 point? Speaker 1 21:26 No, so we have not even thought about the called the BIPSA 2.0. No, so basically we have to go through that one and then enact the QDMTT and all that. So there are steps to be done, and also of course the administration. There will be costly administration measures that we we have to follow when we follow the BIPs 2.0, but for that we need to do our number crunching and get an idea. Okay, what is we have to do a cost benefit analysis. But to me, basically, I think there's a substantial amount of revenue that is that we are going to donate. When I say donation, donation, it's not just donation. Let's take one by one, first one is we have in the past we have been using tax holidays as the major tool for attracting FDI for anything Tirani Kulathunge 22:09 and everything. Speaker 1 22:09 Yeah, exactly. So basically, the existing investors fall into again two categories: the ones who are above 750, ones who are below 750. In relation to ones who are above 750, now itself we have started donating, right? So that is basically revenue due to our tax revenue due to our treasuries. We are basically permitting other countries to collect. So that has to immediately stop. And when you look at other countries, let's say Thailand in 2023, they introduced rules to ensure that donation won't happen in relation to the legendary tax holidays that have been granted by the Thai BOI. What did they do? They came up with a offering, a package for the existing tax holiday companies. You come forward voluntarily, pay 10% and then we will give you other incentives that are pillar two compliant incentives, so you really benefit because the tax legendary tax solid that has been granted, signed up for the investor, it's not a going forward. It's not an incentive for the existing investor because going forward they may not pay it in Thailand, but they end up paying it in some other country. So there is no incentive. So that's why they said, okay, you pay 10% and extend the holiday period and give certain other benefits also based on the QRTC SBI formulas, which means they get more benefits. So then you can get the voluntary buying of the investor to negotiate, renegotiate their tax holidays. So this is a strategy that Sri Lankan government should be looking at. The next point is again the existing investors, whose whose because of the pillar two impact, when their tax holidays get neutralised, there is no incentive to do business in Sri Lanka to continue business in Sri Lanka. They look at other countries. Okay, these countries offering us pillar two based incentives. Let's shift our existing investment from Sri Lanka to that country. They will be tempted going forward, so if we need to, if we are looking at retaining the these investors, again we need to look at rethink our investment strategy. So, so the third one is sorry, I'll take a little better. The third one is basically if we are trying to attract new investors, then we need to have that second bastard designed. Tirani Kulathunge 24:39 Right. Speaker 1 24:40 So this is why Sri Lankan government has to get going, and right now that I think the environment is also correct. We saw a few weeks back under the IMF influence, Sri Lanka has introduced a TPU tax policy unit. Now their job is to get going, do the number crunching, identify. Where the where we need to address, where we need to step in, so I think we have the infrastructure also now. We need to start moving, understanding. Tirani Kulathunge 25:10 In terms of incentives, let's say you were to list down some incentives for Sri Lanka that the policymakers can pick on. What are the top five? Speaker 1 25:20 Sorry, come again. Tirani Kulathunge 25:21 The incentives part of things. Speaker 1 25:23 QRTs, yeah. So it's like QRTs could be structured in different ways, right? So it depends. We look at a company, okay? We'll say that you give how it works. Basically, it's basically credits are given. So these credits could be used against your actual tax liability. So you don't pay tax; the company won't be paying tax because you set off these credits given against the tax liability. Right. It's almost like a tax holiday. Tirani Kulathunge 25:52 The Speaker 1 25:52 company is not going to pay tax because you can use these credits. So these credits could be structured in specific ways for specific sectors. Tirani Kulathunge 26:00 Okay. Speaker 1 26:01 When you say substance-based income exclusion incentives, again could be structured in different ways. So basically, if you are taking a, you have the payroll, the employees, cash grants could be given for trainings, employee training, research R and D Expenses, grants could be given. So these are the ways in which, for with regard to tangible assets acquisitions, specific one that all know basically is the enhanced capital allowances or accelerated depreciation could be given. So these are things that should come into this second basket. Right now, once upon it, now once upon time, up to recent, you take the post city. Post city had the mix. Post city had the enhanced capital allowances and tax holidays. Investor had the choice. Primary primary BSI investor had a choice, whether to go for the ECA or enhanced capital allowance or the tax holiday, but when this new regulation was enacted, ECA option, enhanced capital loans option was taken out. So that's fundamental ignorance of the global tax rules changing. So that's why I said basically Sri Lanka is little bit. We have done well recently with regard to reforming our STP, how the STP tax holidays and the port city tax holidays. But then I use this term, we do have a global disconnect because we are doing things without understanding what is happening globally. I Tirani Kulathunge 27:44 just want to add on to this now. QRTs definitely an incentive, but with that, let's say, are there any reform opportunities that you can see that can enhance with the QRTs? Let's say the business environment or how we can increase ease of doing business in as a whole. I think one example I could bring on, let's say, to have more rules-based, or let's say, avoid politicised BOI-style negotiations, things like that. Any thoughts on that? Speaker 1 28:14 Yeah. So this is what we call the non-fiscal incentives. So I said the incentives were divided in two categories: the fiscal incentives and the non-fiscal incentives. So, doing business easiness of doing business is one category. So that's a big thing. So when the investor comes, how you treat the investor, how you basically get things going, the speed of doing things, etc. So that comes from so so many other factors. Tirani Kulathunge 28:38 Right. Just I have this other question: Is that does Pillar Two, let's say, effectively cartelize global corporate taxation? And let's say, is tax competition a legitimate development tool for, let's say, for Sri Lanka again? And then, or was the race to the bottom again, is it unsustainable? I'm coming with this thought again because let's say harmful tax arbitrage. I have an understanding that it should end, but competition generally disciplines governments, and the thought about whether the danger is actually uniformity without again efficiency within us. Any thoughts on that? Speaker 1 29:23 Okay, it's like this concept of the pillar two. Yeah. It basically hinges on our sovereignty. Yeah. So there's another school of thought. This is something that is inappropriate. All. but but real fact is basically now this has been implemented. A country like Sri Lanka has no say in this. We need to know how to play with these existing rules rather than just criticising. Tirani Kulathunge 29:58 Right. Speaker 1 29:58 If we are strong enough, we can. We could have done things, but this is not option that is available. Unfortunately, for a country like Sri Lanka. Tirani Kulathunge 30:06 Okay. The next thing is that let's say I think it will be my last question. Let's say if you were advising cabinet tomorrow, and what should be the priority order? I have four. Give me a sec. One is that implement the QDMTT immediately, and second one reform incentives into let's say QRTCs. The third one is simplify corporate tax and reduce discretion if possible, and the fourth one is overhaul let's say non-tax business environment. Your thoughts? Speaker 1 30:43 So it's basically like this: immediately implementing a QDMTT. There is a certain timetable that we'll have to go through certain sequence of actions we have to take. So it's only little bit time. So immediate thing much we should be doing is renegotiating the existing tax holidays given to in scope companies, in in scope investors. Why? Because there is a from today onwards there is a tax donation that is taking place. But following the Thailand example, we can prevent that thing. In other words, first we need to gather the data, identify these companies, and we need to sit with the investors because what we have is a lose-lose situation. This we can turn into a win-win situation because the investor is also not happy about this pillar too. So both of us basically, so both parties should sit together and come to a compromise, renegotiate, pay some taxes, give some different types of concessions to these investors, and we can arrest this situation. That means we can arrest the donation that is taking place to the government of a foreign country, as opposed to both parties losing. So this is something that we can do immediately, that we should do immediately. So that I would say that is the priority number one. If I'm addressing the government to basically implement, do start renegotiating, or I'll first gather the data. That is the why we have the TPU now, the tax policy unit, and immediately start negotiating these tax holidays. That is the priority that I would say, and then parallel to that is the get the policymakers to sit and design the the second basket, because when we are going to negotiate, renegotiate as well as when we are trying to attract the new amenities to come here, we need to have this package redesigned based on the QRTCs and the incentives linked to the substance-based income inclusion rule, so redesigning this one also takes bit of time. Start doing that thing better. So that is what should happen. Then let's look at the QDMTT after that, because QDMTT also has a cost involved. It's not that easy. But what do you mean by Tirani Kulathunge 33:01 the cost involved? Speaker 1 33:02 Well, you need to have softwares. You need to gather data. You need to implement. You need to. There's a big job at the for the good job offices at the England department. Okay. So everything has a cost. Tirani Kulathunge 33:15 Definitely. Yeah. Okay, mr. Suresh. Thank you so much for the conversation and the dialogue that you brought into this topic. I'm pretty sure not a lot of us understand this topic. I'm pretty sure it will benefit the policymakers also if we definitely pick up on this. Thank you, mr. Suresh, once again. And please, if you want more deep, insightful conversations like this forward, please like and subscribe to our channel. Thank you. Transcribed by https://otter.ai