The Pillar Two model has started a new chapter for international taxation when dealing with the challenges of globalisation and digitalisation. As the world’s second-largest economy, China has actively participated in the discussion and implementation of the Pillar Two model.
By introducing a global minimum tax regime, the Pillar Two model has sent a clear message: MNEs shopping for tax benefits in lower-tax jurisdictions may end up bearing top-up taxes; it will make a dent in the tax advantages offered by some jurisdictions with low taxes.
For some years, China has been directing its investment attraction strategy away from the sole reliance on tax incentives. On the whole, China adopts a national standard CIT rate of 25%. Thus, most Chinese enterprises should not fall into the scope of the Pillar Two model, except some Chinese MNEs which may need to adapt to the new rules of the game.
Like their overseas counterparts, Chinese MNEs leveraging a global presence and region-specific privileges would also be affected by Pillar Two. They need to re-evaluate their situation per the core ideas of the model. If their tax burden in some jurisdictions falls under the minimum 15% level due to the use of tax incentives, they would also be taxed for the underpaid or saved tax sum in other jurisdictions.
By the same token, they need to assess whether they are covered by the Pillar Two model by measuring the breakpoint at which the minimum tax rule is applied and reviewing how Pillar Two would impact their multi-jurisdictional tax liabilities. Further, they need to evaluate whether any region-specific benefits or exemptions could backfire and result in a tax shortfall from the whole group’s perspective.
Some sector-specific and zone-specific tax incentives are still available in China. For example, a 15% CIT rate is offered to tech companies in software or integrated circuit business, encouraged sectors in the western regions, and to those companies based in Hainan Free Trade Port. In parallel, another CIT incentive is offered to R&D investments. With the tax incentives combined and enjoyed at the same time, some Chinese groups may see their effective CIT rate dropping below 15%. If so, they would end up bearing the top-up taxes using the Pillar Two model.
It is expected that some more guidance could be issued by the Chinese tax authority in due course regarding how to implement the Pillar Two model, as it will be effective globally in 2023. It is suggested that Chinese MNEs evaluate its impact and consider optimising the investment structure accordingly.
With this newsletter, we inform multinational companies on changes in international tax law and country-specific tax law developments with respect to cross-border transactions.
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