Adapting Investment Incentives to the Global Minimum Tax

For decades, many developing countries have relied on tax incentives to attract foreign investment. These incentives include tax holidays, reduced corporate tax rates, exemptions from import duties, and other fiscal benefits offered to investors.

However, research consistently shows that tax incentives are often not the decisive factor in investment decisions. Investors typically prioritize market access, infrastructure quality, political stability, regulatory certainty, and the availability of skilled labor. In many cases, incentives are granted to investments that would have occurred even without them, resulting in substantial revenue losses for governments.

The global tax environment is now undergoing a structural shift. In 2021, more than 135 jurisdictions participating in the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting agreed on a two-pillar solution to modernize international tax rules.

Pillar Two, which is particularly relevant for tax incentive policy, establishes a global minimum effective tax rate of 15 percent for MNE groups with consolidated annual revenues above €750 million (about $871.5 million). These rules primarily affect the largest multinational companies, while smaller firms and domestic businesses remain outside their scope.

The global minimum tax is implemented through the Global Anti-Base Erosion (GloBE) Rules, which apply a “top-up tax” where the effective tax rate of a multination enterprise group in a particular jurisdiction falls below 15 percent.

Three mechanisms determine how this tax is collected:

1. Qualified Domestic Minimum Top-Up Tax: Allows the jurisdiction where the income is earned to collect the top-up tax itself, provided the regime meets OECD qualification requirements and follows the GloBE methodology.
2. Income Inclusion Rule (IIR): If the source jurisdiction does not collect the top-up tax, the parent jurisdiction may apply it.
3. Undertaxed Profits Rule (UTPR): Serves as a backstop, allowing other jurisdictions within the multination enterprise group to collect the remaining top-up tax if neither a QDMTT nor IIR fully captures it.

For countries hosting MNE activities, this structure creates a critical policy implication: if they do not collect the top-up tax themselves, other countries may do so instead.

How the Global Minimum Tax Changes Investment Incentives

Source: Authors.

The global minimum tax fundamentally changes the effectiveness of traditional tax incentives.

Many commonly used incentives, such as tax holidays or reduced corporate tax rates, lower the effective tax rate of an investor below 15 percent. Under Pillar Two, this benefit may be partially or fully neutralized by a top-up tax applied in another jurisdiction. As a result, the incentive no longer reduces the overall tax burden of the multinational group.

However, Pillar Two does not eliminate all policy space for governments. Several design features preserve room for development-oriented policies.

One important element is the Substance-Based Income Exclusion (SBIE). This rule excludes a portion of profits linked to real economic activity from the minimum tax calculation. After a transitional period, the SBIE permanently excludes:

• 5 percent of eligible payroll, and
• 5 percent of the carrying value of tangible assets.

This means that profits associated with genuine economic activity, such as employment and investment in physical assets, are partly shielded from top-up taxation.

Other features of the GloBE rules also influence how incentives operate. Effective tax rates are calculated on a jurisdictional blending basis, meaning that high-tax and low-tax entities within the same country may offset each other. In addition, qualified refundable tax credits can retain their value under the GloBE framework. Timing differences and deferred tax treatment can also affect measured effective tax rates.

The international framework continues to evolve. The 2026 Side-by-Side package introduces additional rules and simplifications designed to address specific implementation challenges.

Among its key elements are new Side-by-Side and Ultimate Parent Entity safe harbours, which may exempt qualifying MNE groups—most notably U.S.-parented groups—from the application of the IIR and UTPR while leaving QDMTTs in place.

The package also introduces additional simplifications, including:

• a permanent simplified effective tax rate safe harbour,
• extensions of transitional country-by-country reporting relief, and
• a substance-based tax-incentive (SBTI) safe harbour.

The SBTI safe harbour provides more favorable treatment for certain Qualified Tax Incentives, including:

• expenditure-based incentives directly linked to eligible spending, and
• certain production-based incentives tied to the volume of physical output.

These incentives remain subject to a substance cap but reinforce the broader policy direction of Pillar Two: shifting incentives away from purely rate-based reductions toward those linked to real economic activity.

In this new environment, governments must adopt a more evidence-based approach to tax policy.

Economic and revenue impact assessments allow policymakers to evaluate:

• the fiscal cost of existing incentives,
• whether incentives genuinely influence investment decisions, and
• how incentives interact with the global minimum tax.

Such analysis helps identify incentives that remain effective and those that may become redundant under Pillar Two. It also supports better alignment between tax policy, investment promotion strategies, and broader development objectives.

For countries hosting large MNE operations, implementing a Qualified Domestic Minimum Top-Up Tax is an important tool for protecting domestic revenue.

Without a QDMTT, any top-up tax resulting from low effective tax rates may be collected by other jurisdictions through the IIR or UTPR. A QDMTT ensures that the source country retains the right to collect this revenue itself.

Before implementing a QDMTT, governments should analyze:

• how existing incentives affect effective tax rates,
• which sectors or firms may fall below the 15 percent threshold, and
• how investors may respond to changes in the tax regime.

Across the Asia-Pacific region, several jurisdictions—including Australia; Japan; Republic of Korea; Singapore; Hong Kong, China; Malaysia; Thailand; and Viet Nam—are already moving forward with implementation, indicating strong regional momentum.

Early experience suggests that successful implementation requires:

• close alignment with the technical requirements of the GloBE rules,
• effective use of available safe harbours,
• robust data systems and administrative capacity,
• coordination across government agencies, and
• clear communication with investors.

To adapt to the new global tax environment, developing countries should consider several strategic actions.

Review existing incentive regimes: Evaluate current tax incentives to determine which remain effective under the global minimum tax and which may be neutralized by top-up taxation.

Strengthen tax administration: Build the administrative capacity needed to implement Pillar Two rules, including improved data systems and analytical capabilities.

Shift toward substance-based incentives: Prioritize incentives that promote real economic activity, such as employment, capital investment, research and development, or infrastructure development.

Improve policy coordination: Ensure close collaboration between ministries of finance, tax authorities, and investment promotion agencies so that tax policy aligns with broader economic development strategies.

Stay engaged in international policy discussions: Global tax rules continue to evolve. Active participation in international dialogue helps countries anticipate changes and protect their policy interests.