Why traditional tax incentives fall short for large multinationals
Introduction
Mr. Suresh R.I. Perera
In an increasingly interconnected global economy, multinational enterprises (MNEs) with consolidated revenues exceeding 750 million face new fiscal realities under the OECD’s Pillar Two framework, also known as the Global Anti-Base Erosion (GloBE) rules. These rules impose a 15 per cent minimum effective tax rate (ETR) on profits in each jurisdiction where an MNE operates, fundamentally altering how countries compete for foreign direct investment (FDI). For developing economies like Sri Lanka, which have long relied on tax holidays and concessionary rates to lure investors, this shift poses significant challenges. However, innovative tools such as Qualified Refundable Tax Credits (QRTCs) and incentives linked to the Substance-Based Income Exclusion (SBIE) offer viable alternatives. This article explores why traditional incentives are losing their luster for large MNEs, delves into the mechanics of QRTCs and SBIE-linked incentives, provides international examples with a focus on Asia, and outlines how Sri Lanka can adapt to remain competitive.
Unattractiveness of tax holidays and concessionary rates for large MNEs
Tax holidays—periods of complete tax exemption—and concessionary tax rates have been staples in many countries’ FDI strategies, allowing MNEs to minimise liabilities in host jurisdictions. However, under Pillar Two, these profit based incentives become largely ineffective for MNEs surpassing the 750 million revenue threshold. The GloBE rules calculate an ETR per jurisdiction based on adjusted financial income and covered taxes.
If the ETR falls below 15 per cent due to a tax holiday or low rate, a “top-up tax” is imposed to bridge the gap, often collected by the MNE’s parent jurisdiction or another group entity via mechanisms like the Income Inclusion Rule (IIR) or Undertaxed Payments Rule (UTPR).
For instance, if an MNE invests in a jurisdiction offering a 0 per cent tax holiday, its ETR there would be zero, triggering a 15 per cent top-up tax elsewhere in the group. This neutralises the incentive’s benefit, as the MNE still pays the equivalent of 15 per cent globally. Concessionary rates below 15 per cent face similar issues, potentially leading to additional compliance burdens without net savings. This “no real benefit” dynamic discourages large MNEs from prioritising such jurisdictions, shifting focus toward locations offering Pillar Two-compatible incentives that preserve tax advantages without triggering top-ups.
Understanding Qualified Refundable Tax Credits (QRTCs)
QRTCs are a form of refundable tax credit designed to comply with GloBE rules, providing subsidies without reducing the ETR below 15 per cent. Under Article 10 of the OECD Model Rules, a QRTC is a refundable tax credit that must be payable in cash or cash equivalents within four years of the recipient meeting eligibility conditions.
Unlike traditional credits that offset taxes (potentially lowering the ETR), QRTCs are treated as additional GloBE income rather than a reduction in covered taxes.
This increases the denominator in the ETR calculation (GloBE income) without decreasing the numerator (covered taxes), maintaining or even enhancing the jurisdictional ETR.
For example, if an MNE qualifies for a 100 QRTC tied to R&D spending, this amount is added to its GloBE income, effectively acting like a government grant. Any unused portion is refunded in cash within four years, ensuring it’s not merely a tax offset. This structure minimises top-up tax risks, making QRTCs attractive for MNEs while allowing jurisdictions to subsidise targeted activities like innovation, job creation, or green investments. QRTCs differ from non-qualified refundable credits, which reduce covered taxes and could trigger top-ups if they push the ETR below 15 per cent.
Understanding Substance-Based Income Exclusion (SBIE) and Linked Incentives
The SBIE is a carve-out mechanism in the GloBE rules that excludes a portion of jurisdictional income from the top-up tax base, rewarding “substance” in the form of tangible assets and payroll.
Calculated as 5 per cent of eligible payroll costs plus 5 per cent of the carrying value of tangible assets (with transitional rates up to 10 per cent for payroll and 8 per cent for assets until 2032), the SBIE reduces the net GloBE income subject to the 15 per cent minimum. For instance, if an MNE has 1 million in payroll and 2 million in tangible assets in a jurisdiction, the SBIE could exclude 250,000 (50,000 from payroll + 100,000 from assets, plus transitional uplift) from the tax base, potentially eliminating top-up tax if the remaining ETR meets 15 per cent.
SBIE-linked incentives tie benefits to building substance, such as enhanced deductions or credits for investments in workforce training or fixed assets. These align with the GloBE’s emphasis on real economic activity, avoiding the pitfalls of pure rate reductions. The recent Substance-Based Tax Incentive Safe Harbour (SBTI SH), agreed in January 2026, further enhances this by allowing Qualifying Tax Incentives (QTIs)—expenditure- or production-based incentives capped by substance measures—to be added to covered taxes without inclusion in GloBE income, providing even more favorable treatment. This encourages jurisdictions to design incentives that promote genuine investment over profit-shifting.
International Examples of QRTCs and SBIE-Linked Incentives
Several countries have adapted their incentive regimes to Pillar Two, with Asian nations leading in innovative approaches to attract MNEs.
QRTC examples:
Singapore: The Refundable Investment Credit (RIC), introduced in 2024, offers refundable credits for qualifying activities like R&D and headquarters functions, designed as a QRTC to offset corporate tax or provide cash refunds within four years. This has helped Singapore maintain its appeal for tech and finance MNEs, with companies benefiting from aligned incentives. Thailand: The Board of Investment (BOI) is developing QRTCs as alternatives to traditional exemptions, tied to productivity-enhancing expenditures. This complements existing incentives for MNEs in electronics and automotive sectors, mitigating top-up tax impacts for firms. Other Asian Countries: Vietnam is exploring QRTC-like subsidies to compensate MNEs for potential top-ups, focusing on manufacturing hubs. Outside Asia, the UK’s creative industry credits and Ireland’s R&D schemes have been adapted similarly, providing models for refund timelines and eligibility.
SBIE-Linked Incentive examples:
Hong Kong: With a 16.5 per cent headline rate just above 15 per cent, Hong Kong leverages SBIE to preserve benefits from exemptions on offshore income and capital gains. Incentives for corporate treasury centres and R&D are tied to payroll and assets, allowing MNEs to reduce top-up exposure through substance-building.
Malaysia and Thailand: These countries use SBIE-compatible incentives via investment boards, offering enhanced allowances for tangible investments in S-Curve industries like EVs and digital tech. Malaysia’s Digital Incentive provides 0-15 per cent reduced rates linked to assets and jobs.
Non-Asian Examples: Switzerland offers QRTCs and SBIE-linked grants for cantonal investments, while the US pushes for QTI treatment of credits to optimize Pillar Two positions. The Substance-Based Tax Incentive Safe Harbour (SBTI SH) has spurred broader adoption, with incentives capped at 5.5 per cent of payroll or depreciation for stability.
How Sri Lanka Can Follow Suit to Attract Large MNEs
Sri Lanka, with its strategic Indian Ocean location and sectors like tourism, apparel, and IT, can pivot to QRTCs and SBIE-linked incentives to compete effectively. A dual-track approach—retaining traditional incentives for SMEs while introducing GloBE-compliant ones for large MNEs—would broaden appeal.
For QRTCs, Sri Lanka could introduce credits for investments in renewable energy, medical equipment, or export-oriented manufacturing, refundable within four years and tied to expenditures. This mirrors Singapore’s RIC, potentially attracting firms in logistics or BPO by subsidising upgrades without ETR dilution.
For SBIE-linked incentives, incentives could reward payroll expansions (e.g., skilled labor in IT) or asset investments (e.g., port infrastructure), using the SBTI SH to treat them as QTIs. The Board of Investment (BOI) could administer these, offering enhanced deductions capped by substance metrics, similar to Thailand’s model.
To implement, Sri Lanka should: reform legislation for QRTC compliance; prioritise non-fiscal enablers like infrastructure and skills development; and ensure transparency to build investor trust. By aligning with Pillar Two, Sri Lanka can position itself as a resilient hub for MNEs diversifying from China, fostering sustainable growth.
In conclusion, as Pillar Two reshapes global tax competition, QRTCs and SBIE-linked incentives provide a pathway for Sri Lanka to attract high-value MNEs, emphasising substance over mere rate cuts for long-term economic benefits.
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