René Gayle | Rethinking tax incentives as an economic policy tool

AT THE recently held G7 Summit in the United Kingdom, global finance leaders agreed to endorse a global minimum corporate tax rate of 15 per cent, resulting in a wave of concern about the likely impact of this historic decision, particularly on developing countries.

Many developing countries, including Jamaica, utilise preferential tax regimes as a tool to better compete for and attract foreign investment. This has led to a ‘race to the bottom’ (nearly four decades of falling global corporate tax rates), which the global minimum aims to extinguish. It also aims to remove the lure for large multinational corporations (typically tax resident in developed countries) from migrating profits to no-tax or low-tax jurisdictions to reduce their tax liability. Recent economic events have made the calls for greater coordinated action against the erosion of the global tax base even stronger.

This article explores some of the key issues shaping the discussion and considers the potential impact on small island developing states, such as Jamaica. Part II will suggest some measures which regional policymakers can consider in mitigation.

What could the global minimum tax rate mean for Jamaica and other developing countries?

DEATH KNELL FOR TAX INCENTIVES AND TAX HAVENS

Jamaica is not a low-tax jurisdiction but does offer specialised low-tax regimes for qualifying investors, such as within Special Economic Zones (SEZs). SEZs offer a corporate income tax rate of 12.5 per cent. Jamaica has long utilised tax and other fiscal incentives as an economic policy tool for attracting internationally mobile capital. The global minimum corporate tax rate, if implemented, may ring the death knell for such incentives. It may also signal the potential sunset of tax havens, many of which operate in the offshore Caribbean. Many Caribbean corporations benefited from such tax havens by establishing tax-efficient international business companies as holding companies for their ventures. On the flip side, therefore, this could potentially mean greater tax revenue for governments within the Caribbean as this tax base repatriates. Additionally, governments may benefit from greater tax revenue where they opt to increase their corporate income tax rate to the global minimum.

What is without doubt is that there is growing momentum towards a seismic shift in global tax policy. Rethinking the ways in which we utilise tax incentives as part of our economic policy should therefore be top of the agenda for local and regional policymakers. Here’s why.

The likely major outcome of the proposed global minimum is that small island developing states (SIDS), like Jamaica and others in the Caribbean, will have to find other ways to compete for foreign direct investment (FDI) other than through tax competition. This will necessitate wide-scale infrastructure upgrades (both physical, digital and support services); upskilling and retooling the labour force to meet the demands of modern commerce, especially ICT skills; improving the environment for doing business; and providing grants for research and development in areas of innovation. While these are all worthwhile objectives in and of themselves, the reality remains that there are significant obstacles which impede smaller states from being able to achieve these aims, especially in the short term. For starters, cash-strapped, debt-ridden developing countries simply do not have the resources to channel to these objectives. Furthermore, even if these states were able to acquire and allocate such resources, their size and population mean that they are unlikely to achieve the level of scale needed to truly realise such investments in the short to medium term.

NEGATIVE IMPACT ON FDI FLOWS LIKELY

It is anticipated that the global minimum tax rate may negatively impact FDI flows to no/low tax countries within the Caribbean, by removing perhaps the only frontier by which such countries were ever able to truly compete for FDI with larger, more industrialised emerging and developed economies: that is, via tax competition. Simply put, islands such as Barbados, The Bahamas and the Cayman Islands would likely not enjoy their current economic strength without their favourable tax regimes.

RISK OF COMPENSATION CLAIMS BY FOREIGN INVESTORS

Additionally, if implemented, Caribbean countries might be forced to raise their tax floor, which might have serious implications for the relations between these countries and their investors, including potentially triggering investment arbitration claims under applicable bilateral investment treaties (BITs). BITs typically include stabilisation clauses, which limit the government’s ability to adopt adverse changes to the investment environment. Governments will thus be caught in a catch-22 in trying to ensure that any revisions to tax policy do not ultimately lead to breaches of contractual or treaty-based investor protections. Careful consideration should be given by the international community to these inherent risks and suitable safeguards provided. One suggestion is for a grandfathering period of at least five to 10 years for full implementation, like that introduced when the global community transitioned to the WTO regime less than three decades ago.

BROADENED INCOME GAP BETWEEN RICHER AND POORER COUNTRIES

While the move to address tax avoidance is a positive one, the current proposals will have unintended consequences for developing countries, which must be addressed if they are to take effect. As David Jessop aptly remarks in his June 27 Gleaner column: “the initiative potentially threatens to undercut Caribbean fiscal sovereignty” and “raises serious questions about future Caribbean growth, sustainability, job creation and the ability to fund education, healthcare and social provision”. Likely to be the most affected, small island developing states should therefore be highly engaged in the ongoing discussions at an international level. Part II will highlight some approaches regional policymakers can suggest to help mitigate the impact.

René Gayle is an attorney-at-law and legal consultant. She may be contacted at rene@beyondlegalja.com