Tax challenges arising from the digitalisation of the world economy are currently top of mind for policy makers globally. To address these challenges, in October 2021, 137 jurisdictions (out of the 141 jurisdictions that are part of the so-called “Inclusive Framework” on “Base Erosion and Profit Shifting (BEPS)”) agreed on a “two pillar” solution.
In the OECD report on Tax Challenges Arising from Digitalisation which has proposed the “two pillar” approach, Pillar One is essentially a re-allocation of taxing rights whilst Pillar Two is a global anti-base erosion mechanism. Pillar One is not the focus of this article, but by way of overview its objective is to ensure a fairer distribution of profits and taxing rights among countries with respect to the largest multinational enterprises including digital companies. This would be achieved by a re-allocation of some taxing rights from the residence countries to the market jurisdictions from where the entities generate income regardless of whether they have a physical presence in those jurisdictions (which until now was a requirement for income tax to apply).
The second of these pillars, “Pillar Two”, sets out a global minimum tax designed to ensure that large multinational businesses pay a minimum effective tax rate of 15% on profits in all countries. The practical application of this is quite complex and there are still consultations ongoing as to how the rules will apply; however, a broad understanding has been provided and the expectation is that these rules will be applicable from 2023 or 2024.
A cursory look at the object of the Pillar Two rules might mislead people to think that it should have little relevance to Tanzania, considering that it is not a member of the Inclusive Framework on BEPS and that our corporate income tax (CIT) rate is 30%.
However, whilst the normal CIT rate is 30%, there are cases where this does not apply. As we are all aware, the Government has been focused to increase investment in the country. The major objective is development and value creation and creating employment and this should result in a multiplier effect. The investment strategy often includes the use of special economic zones (SEZs) (or export processing zones (EPZs)) and exemptions for strategic projects / investments. Assuming that conditions are met, SEZs have a corporate income tax holiday for 10 years. This effectively means that companies operating in a special economic zone are effectively subject to a corporate income tax rate of 0% and therefore would not meet the minimum global threshold of 15%.
Many companies in Tanzania will be subsidiaries of group companies that are based in a jurisdiction that is a member of the Inclusive Framework and which has agreed to implement the two pillar approach; in fact, most jurisdictions targeted for investments in Tanzania (such as the US, France, Egypt, Oman) are part of the Inclusive Framework. If the parent company is in a country which is a member of the Inclusive Framework, then a top up tax (known as income inclusion rule) will be levied by the tax authority of the parent company to bring the effective tax rate for its subsidiary to 15%. As Tanzania is not a member of the Inclusive Framework, it will not be able to use the tax treaty based rule which permits the source jurisdiction to make some adjustments and therefore any top up tax will be “enjoyed” / collected by the tax authority of the parent company tax jurisdiction.
Although these rules are expected to be implemented in 2023/2024, new (and some existing) investors are already asking questions regarding the implication of Pillar Two for their operations and the implication of the top up tax.
This also has an impact on decision making, as the tax is no longer nil but rather subject to a 15% effective tax rate. This is something that policymakers need to follow in terms of developments; for example, rather than have the 15% tax collected at the parent company level, would it be better to review the corporate income tax exemption for special economic zones and strategic investments (at least for those cases where the parent entity is in a country applying the two pillar approach) so as to amend the rate to 15% so that the tax is collected in Tanzania rather than the parent country jurisdiction.
As Her Excellency President Samia Suluhu Hassan has previously stated, we are not an island and therefore we need to be aware of changes happening in the world and how these impact us and adapt to withstand them.