Developing countries could lose tax revenue due to capacity and legal constraints on implementing necessary reforms.
Geneva, June 9, 2022 – According to UNCTAD World Investment Report 2022 published on June 9.
The report titled “International Tax Reforms and Sustainable Investing“ provides a guide for policy makers to navigate complex new tax rules and to adjust their investment strategies.
The proposed reforms, scheduled for 2023 or 2024, aim to discourage multinationals from shifting their profits to low-tax countries. The main implications are:
- Increase in multinational tax revenue for most countries.
- Increase in taxes on foreign profits of multinationals.
- Potential downward pressure on new investment by multinationals.
- Reduced effectiveness of low tax rates and tax incentives to attract investment.
- Urgent need for Investment Promotion Agencies (IPAs) and Special Economic Zones (SEZs) to review investment attraction strategies.
“While tax reforms will increase revenue collection for developing countries, from the perspective of attracting investment, they present both opportunities and challenges,” said UNCTAD Secretary-General, Rebecca Grynspan.
She added: “Developing countries face constraints in their responses to reforms, due to a lack of technical capacity to deal with the complexity of tax changes, and due to investment treaty commitments that could hamper effective fiscal policy action. The international community has an obligation to help.
Impact in countries
Tax rates on foreign profits of multinationals will increase. Foreign affiliates that pay tax rates lower than the minimum on profits declared in the host countries will be subject to a top-up. In addition, multinationals will reduce profit shifting and pay host country rates on a broader profit basis.
The estimated increase in effective tax rates faced by multinationals is conservatively estimated at 2 percentage points. This corresponds to an increase in tax revenues paid by multinationals to host countries of around 15% – closer to 20% for large companies directly affected by the reforms.
Both developed and developing economies stand to benefit significantly from increased revenue collection. Offshore financial centers stand to lose a substantial share of the income received from foreign subsidiaries.
For smaller developing countries – which typically have lower rates – applying the top-up tax could make a big difference in raising revenue.
However, the flip side of the increased tax revenue is the potential downward pressure on the volume of investment that will be exerted by the increased tax on foreign direct investment activities. UNCTAD estimates that cross-border investment in productive assets could decline by 2%.
The planned reforms will have major implications for national investment policy makers and investment promotion institutions, as well as their standard tools. Tax incentives are widely used for investment promotion, including as part of the value proposition of most special economic zones.
International investment policymakers and negotiators of international investment agreements (IIAs) need to consider the potential constraints that IIA commitments may impose on the implementation of key reform provisions.
If IIA provisions prevent host (often developing) countries from applying additional taxes or removing incentives, the minimum tax increase will fall to the (mainly developed) home countries. Host countries would lose tax revenue without providing any benefit to investors.
“The tax revenue implications for developing countries of the constraints posed by international investment agreements are a major source of concern,” the report notes, adding that the international community, alongside or in the context of negotiations on the reforms taxes, should alleviate the constraints that disadvantage developing countries.
“We need to dramatically scale up technical assistance to support the implementation of reforms, and we need a multilateral solution to remove the implementation constraints posed by IIAs. As a stopgap measure, we need a mechanism to return the additional revenues collected by developed home countries that should have flowed back to developing host countries,” the report says.
Meanwhile, the report shows that global foreign direct investment has recovered to pre-pandemic levels in 2021, but uncertainty looms in 2022. (Please see attached press release UNCTAD/PRESS/PR/2022/ 008)
Explore Interactive visualization of UNCTAD data on FDI inflows and outflows in countries and regions over the past 30 years.
The United Nations Conference on Trade and Development (UNCTAD) is the principal United Nations agency responsible for trade and development. It is a permanent intergovernmental body created by the United Nations General Assembly in 1964.
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UNCTAD helps developing countries to access more equitably and more efficiently the benefits of a globalized economy. We provide economic and trade analysis, facilitate consensus building and offer technical assistance to help developing countries use trade, investment, finance and technology for inclusive and sustainable development.