Corporate rate kept at 17% - but still competitive

By Andy Baik And Sandie Wun, For The Straits Times, 8 Mar 2012

GOVERNMENTS are under pressure to raise tax revenue to reduce budget deficits or fund social spending in a volatile economy. At the same time, their ability to raise taxes is limited by global competition which makes companies and labour highly mobile in their search for lower tax regimes.

Nations constantly pit themselves against their closest neighbour in tax competitiveness, fighting for a larger bite of the inbound investment pie. Asia-Pacific nations have been reducing corporate tax rates to that end. Hong Kong and Singapore currently lead the race to the bottom. Both have chosen to stick to their current headline corporate tax rates of 16.5 per cent and 17 per cent respectively during their recent Budget announcements.

Taiwan is the newest member of the low-tax-rate club, cutting its tax rate from 25 to 17 per cent in 2010. Indonesia, Thailand, New Zealand, South Korea and Malaysia are also implementing phased reductions. Even Japan, known for its traditionally high tax rate, has buckled.

With more hopping onto the 'cutting tax' bandwagon, will Singapore lose its sparkle as an investment destination?

Possibly so, if you take a cursory glance at Singapore's tax rates with a short-term perspective in mind. But dig deeper into the overall tax effectiveness, certainty and substance of Singapore's tax regime, and you will find that the race for Singapore in this global tax competition is far from over.

To begin with, the Asia-Pacific nations may not even be the most relevant benchmarks for Singapore, in terms of tax rate competitiveness and setting the headline tax rate. Singapore is at a different economic and developmental stage, compared to many Asia- Pacific countries. The country has successfully evolved from being primarily a manufacturing base for MNCs, to an attractive location for housing higher value-added activities such as services, procurement, supply chain management and financing.

It would be more meaningful to benchmark Singapore's tax regime with countries like the Netherlands and Switzerland, which have been attracting investments particularly from MNCs in Europe and globally. Their corporate tax rates are not particularly low, at 25 per cent for the Netherlands, and 12.7 to 25 per cent for Switzerland.

Singapore's relatively low corporate tax rate could have pushed it onto the list of potential hub location for MNCs to anchor their regional or global functions. However, the deal-breaker lies not just in the corporate tax rate. It is the effective tax rate that matters. This varies depending on the tax circumstances and other tax offsets that each company is subjected to. Countries are thus utilising tax strategies and policies in a targeted manner to bring effective tax rates to a level below the headline tax rates.

According to published data in 'Effective Corporate Tax Rates on New Investment, 2010' by the Cato Institute, effective tax rates of territories around the world were mostly higher than Singapore with the exception of Hong Kong. The effective tax rates were estimated at 8.5 per cent in Singapore, compared to 4 per cent in Hong Kong, 10.9 per cent in Taiwan, 16.8 per cent in the Netherlands, 17.6 per cent in Switzerland, 18 per cent in Malaysia and 29.1 per cent in Japan.

Ironically, too low a corporate tax rate can be a bad thing. For one thing, from an overall group perspective, anti-abuse tax rules (also known as foreign corporation rules) in the MNC's home country and other tax preferences may nullify the benefits that the low tax rate in Singapore confers. Countries may also put perceived tax havens - statutory tax rates being one of the conditions under scrutiny - on a tax blacklist, subjecting transactions from these countries to more onerous tax implications. Singapore is one of the 60 countries and territories currently on Brazil's tax blacklist. Under Brazilian legislation, tax havens are deemed to be jurisdictions that impose no income tax or levy such tax at a maximum rate lower than 20 per cent, or do not disclose information on the formal or economic ownership of corporate entities.

Further reducing the headline tax rate thus needs to be balanced with the overall policy objective of getting Singapore off such tax haven blacklists.

Many countries recognise the difference between an automatic access to a low statutory tax rate and a conditioned access to an incentive tax rate supported by substantive active economic activities. Rather than lower the headline corporate tax rate, it is more sound to grant substantive incentives tied to active functions performed in Singapore, and use this to lower the effective tax rate for MNCs.

Selective tax preferences and incentives can be given to MNCs from industries vital to the expansion and growth plans of Singapore. It is not surprising that neighbouring countries like Thailand and Malaysia have also been enhancing and actively promoting their tax incentives. Keeping a step ahead is crucial. Singapore must continue to refine, tweak and update its suite of tax preferences and incentives to reflect global business trends and lure the targeted sectors.

Other tax components can also lower the effective tax rates for investors. The Productivity and Innovation Credit (PIC) scheme, enhanced during the recent Budget announcement, is one example. The tax benefits may not be as evident as a blanket lowering of tax rates but it brings down the overall tax liability for MNCs that leverage on it.

Further, a low tax rate is meaningless if you cannot answer the age-old question of 'how much tax are we going to pay this year?' with confidence. In today's shifting tax landscape, certainty is a valued commodity.

The Netherlands and Switzerland have been popular with MNCs because of the tax certainty they provide.

Many tax regimes in the developing nations in the Asia-Pacific have yet to achieve the transparency in tax legislation and practice that are desired by investors. And with many countries wanting to broaden their tax base (albeit lowering tax rates) so as to ensure steady tax collection, one can expect more aggressive tax enforcement, audits and challenges from the authorities. What this means is that investors will want a higher level of assurance on how they will be taxed for cross-border transactions.

This is where Singapore is headed in the right direction. Over the years, tax policies have been shaped to reflect the need for tax certainty. Take, for example, the advanced ruling system that was introduced in 2005 where investors may ask for a binding response to clarify uncertain interpretations of the legislation in specific scenarios. And with this year's Budget announcement, there is now more clarity on the non-taxation of companies' gains on disposal of equity investments.

So without that cut in corporate tax rate, is Singapore less competitive?

We hesitate to think so. Direct tax rate, while an important indicator, is but just one aspect of a myriad of contributing elements to tax competitiveness. Singapore's tax regime is clearly not a bag of short-term, 'for now only' measures - the country is serious in competing for the long term.

The writers are Partner and Associate Director for International Tax at Ernst & Young Solutions respectively.

The perfect diet for fiscal health
By Andy Mukherjee, The Straits Times, 8 Mar 2012

WHAT to tax is a vexing question for nations, just as what to eat is one for diet aficionados.

It used to be that 'high protein/low carb' was the queen of weight-loss plans. It fell from grace as people grew wary about the amount of fat they were eating. Now it's seeing a revival.

Something similar has happened in the world of taxation where imposition of a levy on income, especially business profits, was once considered both socially progressive and a smart strategy for a country to build up its fiscal muscles. No longer. Taxing consumption is the protein shake that governments now prefer.

The change in thinking has been swift. Even a couple of decades ago, tax officials relished nothing more than helping themselves to a big chunk of corporate profits - typically 50 per cent, and in some jurisdictions, more. Those days are gone. Many nations now seem to agree with the view of the English philosopher Thomas Hobbes who asked some 350 years ago: 'For what reason is there, that he which laboureth much, and sparing the fruits of his labour, consumeth little, should be more charged, than he that living idlely getteth little, and spendeth all he gets?'

Research by accounting firm KPMG shows that the average corporate tax rate globally has declined every year for the last 11 years. The rate, which used to be 29 per cent in 2000, fell to 23 per cent last year. Taxing companies ever so lightly, lest they pull their investment dollars and jobs and go elsewhere, is the new orthodoxy among fiscal planners.

'To be competitive in the world today, you got to have a tax rate of about 24-25 per cent,' Mr Greg Wiebe, global tax head at KPMG International, said in an interview during a recent visit to Singapore. 'Business now is so global, so multinational and supply chain is so complicated that business can pick and choose where it wants to set up parts of its value chain. Tax is not the only driver, but certainly a significant driver in companies deciding where to set up their business.'

Apart from the threat from increasing mobility of capital, the other irritating thing about corporate taxation from policymakers' perspective is that revenue from it tends to collapse just when the government needs the money badly, for example, during recessions.

'Most governments find that corporate tax is not a good source of income' because of its high variability, Mr Wiebe said. Instead, governments have discovered that revenues from consumption levies - goods and services tax (GST), sales tax or value-added tax (VAT) - are 'pretty steady and solid', he said, adding that nations are increasing their reliance on such taxation.

India and Malaysia will, in all likelihood, be the next economies in Asia to embrace GST. Malaysia may do so after the next election, while India, which looks set to miss the April 1 deadline for implementing the tax, may announce a fresh timetable when the government presents its annual budget next week.

Lawmakers in Japan are debating a plan, which, if adopted, will see the sales tax rate in the country double to 10 per cent by 2016. Should Japan's creditors become jittery about financing its large public debt, the country may have to raise its consumption tax rate even further.

The consumption tax has also entered the presidential debate in the United States. Harvard University economics professor Gregory Mankiw, who is also an adviser to Republican presidential hopeful Mitt Romney, is advocating that the US government move towards taxing spending, rather than income.

Value-added taxes are a pain for accountants, though technical difficulties are not the main reason why governments tend to take time to jump on the GST bandwagon. The reasons for the dithering and the delay in countries like India are straightforward: Since GST is usually a centralised tax, sub-national governments see it as an assault by the federal authority on whatever little fiscal autonomy they still possess. Hobbes' argument notwithstanding, consumption taxes also tend to bite the poor more than they do the rich. In economics parlance, they are 'regressive'. Keeping corporate tax levels low and making up the revenue shortfall with GST can backfire with voters. As Mr Wiebe of KPMG explained, corporations don't vote, but people do.

Even that is not an insurmountable problem, as University of California law professor Susan Morse has documented in her study of how Australia got its GST.

In 1996, Mr John Howard, who had just been elected as Australia's prime minister, told a journalist that a GST would never be part of his government's policy. Never? The journalist persisted. 'Never ever. It's dead. It was killed by the voters in the last election,' was the prime minister's reply. Yet, as Prof Morse notes, not only did Mr Howard subsequently make the introduction of GST his party's priority, he even turned the 1998 snap election into a quasi-referendum on the issue. Mr Howard narrowly won the gamble, and Australia got its GST in 2000, six years after Singapore.

Even in Singapore, the GST, which was introduced when Mr Goh Chok Tong was prime minister, and was referred to as 'Goh Says Tax' in coffee shop talk, has been controversial. And the Government has had to use fiscal transfers, like the recently introduced GST Voucher Fund, to prevent the tax from further widening an already yawning income gap. As Finance Minister Tharman Shanmugaratnam told Parliament in his speech last week rounding up the Budget debate, low-income households that pay only GST get back more than $4 for every $1 they shell out. Middle-income families, which pay some income tax on top of GST, could get back $1.50, if they didn't own a car, and about half as much if they did.

GST collections in Singapore have jumped 120 per cent in the past five years, making the value-added tax a crucial component of the overall fiscal calculus. Of the Government's $50 billion operating revenue in fiscal year 2011, more than 17 per cent came from GST. It's already a more important source of revenue than personal income tax, which accounted for less than 13.5 per cent of operating revenue. In 2009, when the global financial crisis struck Singapore and corporate tax intake dropped $1 billion from the previous year, GST collections improved by $427 million, validating Mr Wiebe's point about their stability.

Will the worldwide move away from taxing business income and towards taxing consumption gain more momentum? Or has it run its course? It's hard to come up with easy answers. Like in deciding a diet plan, a balance is needed in selecting revenue policies that are 'investor friendly' (low levies on corporate profits and top personal incomes earned by company executives) and those that are 'voter friendly' (no or low consumption taxes). Countries that lean too much on any one side will face resistance from both within and without.

Israel, which wanted to lower its 24 per cent corporate tax rate to 23 per cent this year, and cut it all the way to 18 per cent by 2016, instead had to increase it back to 25 per cent this year after people took to the streets. Debt-laden Ireland, which has an extremely competitive corporate tax rate of 12.5 per cent is under pressure from Germany and France to increase the rate - and perhaps lose its dominance in attracting investments from large multinationals such as Microsoft and Google. Meanwhile, starting this year, Ireland has increased its VAT rate to 23 per cent, from 21 per cent.

The debate on what to tax won't end. Nor would, one suspect, the search for the perfect diet.