In February 2021, Rwanda adopted a new law on promotion and facilitation of investments (the investment code) providing for various tax incentives for investors meeting the requirements specified under the same law.

Tax incentives provided for under the investment code include preferential corporate income tax rates of 0% and 3%, corporate income tax holidays and preferential withholding tax rates on passive income between 0% and 10%. The investment code also permits the executive arm of the government to grant other tax incentives than those provided for by the investment code.

During the same year (October 8, 2021) a two-pillar global tax deal, representing a paradigm shift in the way that large multinational enterprises (MNEs) are taxed by allocating the right to tax certain excess profits of very large MNEs (with annual turnover above EUR 20 billion) to "market” jurisdictions (under pillar one) and creating a global minimum corporate tax of 15% for MNEs with annual turnover above EUR 750 million (under pillar two), was reached.

The deal was brokered by the Organisation for Economic Cooperation and Development (OECD) and joined by 137 countries that are members of the OECD/G-20 Inclusive Framework (IF) on Base Erosion and Profit Shifting (BEPS); Rwanda is not a member of the IF.

Given that the two-pillar solution was more or less a non-self-executing political agreement and required domestic-enabling legislation, in December 2021, the OECD released model rules for domestic implementation of 15% global minimum tax—dubbed Global Anti-Base Erosion (GloBE) rules.

Ever since, many countries have been signing up for pillar two initiative, and it seems to be having universal acceptance outside the United States. For instance, in December 2022, the European Union Member States adopted a directive implementing pillar two that is largely aligned with the OECD’s model rules and Member States will have to transpose the same directive into their national laws before December 31, 2023.

Countries like the UK, Switzerland, Canada, New Zealand, Australia, Japan, South Korea, Malaysia and Indonesia are also implementing pillar two, with Japan and South Korea having already enacted domestic laws to give effect to pillar two. In Africa, the African Tax Administration Forum (ATAF) has released draft domestic minimum tax legislation and Mauritius is also implementing qualified domestic top-up tax.

It is clear from the above developments regarding the implementation of pillar two that the latter is gaining traction and global minimum tax may go live in 2024 at least in the Global North. We consider how the pillar will work, the impact of its implementation on Rwanda's tax incentives regime and what it (Rwanda) needs to do to respond to that.

How will pillar two work?

The purpose of pillar two is to ensure that each entity controlled by an in-scope MNE (constituent entity) is subject to the minimum effective tax rate (ETR) of 15%. ETR is equal to the sum of the adjusted covered taxes of each constituent entity located in the jurisdiction divided by the net GloBE income of the jurisdiction for a given fiscal year.

Unlike sparing provisions in some double taxation avoidance agreements (DTAAs) that deem paid the amount of tax which would have been paid if the tax had not been reduced in accordance with investment promotion laws, ETR does not take into consideration taxes that would have been paid based on statutory corporate income tax rate in the jurisdiction. Only taxes actually paid or accrued on the GloBE income of the constituent entity in its host country are considered.

Where the constituent entity is subject to an ETR that is below 15% in the source country because it is for instance entitled to a preferential corporate income tax rate of 5% under the investment promotion laws of the source country, the GloBE rules provide for three rules that would be used to ensure the GloBE income of the constituent entity is taxed at the ETR of 15%.

Those are income inclusion rule (IIR), qualified domestic minimum top-up tax (QDMTT) and undertaxed profits rule (UTPR). One deliberately decided not to cover the subject to tax rule (STTR) given its implementation will require amendment of relevant DTAAs.

Under IIR, the country of residence of the ultimate parent entity or intermediary holding company, as the case may be, will (using the example above) be entitled to charge a top-up tax of 10%. QDMTT allows the country of residence of the constituent entity to thwart the application of IIR by preserving the first right of taxation to the source country. Using the example above, the source country would collect domestic tax of 5% plus a qualified domestic top up tax of 10%. It should be noted however that the introduction of QDMTT may give rise to investor protection issues which will be discussed under part two of this article.

UTPR will be used as a backstop, and will apply when the constituent entity does not pay at least a 15% ETR (taking into consideration any QDMTT imposed by the source country) and there is no top-up tax paid under the IIR in another jurisdiction.

GloBE rules also provide for substance-based income exclusion (SBIE) which excludes from GloBE income subject to top-up tax under IIR, UTPR or QDMTT, 8% of the carrying value of tangible assets and 10% of payroll costs of the constituent entity during a transition period of 10 years— to be respectively reduced to 5% after 10 years.

How does the implementation of pillar two in other jurisdictions affect Rwanda’s incentives regime?

Rwanda has not yet joined the IF, but some of the entities enjoying preferential tax regime (subject to less than 15% ETR) under the investment code or investor-state agreements with the Government of Rwanda may be constituent entities for the purposes of GloBE rules, and their GloBE income less SBIE may be subject to top-up tax in other jurisdictions under IIR or UTPR as the case may be, given that Rwanda has not yet expressed any intention to introduce QDMTT.

In this vein, Rwanda will lose twice in that the tax revenue foregone by Rwanda, as a natural outcome of the decision to offer tax incentives, will under pillar two be effectively collected by another country under IIR or UTPR, if such incentives have led to the constituent entity in Rwanda being subject to ETR below 15%.

Second, the tax incentives intended policy objective, such as supporting local employment, innovation and tangible investments, will be undermined at Rwanda’s expense as the tax benefit accorded to the investor would be taken away through the top-up tax collected by another country, likely to be a developed country.

In the next edition, one will consider what actions Rwanda should undertake (if any is needed) to respond to the implications of pillar two on its tax incentives regime and legal challenges that may be potentially associated with such actions, notwithstanding the fact that it (Rwanda) has not yet joined the IF.

The writer is a Partner in the ENSafrica Rwanda tax and corporate Commercial practices. The views contained herein are those of the author.