On October 3, the OECD published a new super tax treaty (known as a multilateral instrument or MLI) that should increase tax revenues for countries that want them. Strangely, it seems Israel isn’t interested in those extra tax revenues, although it is an OECD member.
The OECD is progressing with various international tax reform initiatives, especially Pillar 2, the OECD initiative calling for a 15% minimum rate of corporate income tax. Pillar 2 is expected to be adopted in 2024-2025 in around 140 countries.
The standard rate of company tax in Israel is 23%, but Pillar 2 may affect Israeli companies that use offshore companies and foreign multinationals investing in Israeli privileged enterprises that pay 5% – 7.5% company tax.If any country fails to adopt Pillar 2, its share of the international tax cake will be immediately reallocated to other countries.
This is because the OECD has dreamt up two cake re-allocation rules: (1) UTPR Undertaxed profits rule, (2) STTR Subject to Tax Rule. Double taxation is also possible.
About the Subject: To Tax Rule (STTR)
The Subject To Tax Rule (STTR) would generally apply to countries that sign the new STTR multilateral instrument (MLI). The MLI rapidly revises existing tax treaties between the countries signed up to it. In brief:
The STTR proposes to let payer countries collect 9% tax on payments of “covered income” not taxed at a rate of at least 9% in the recipient country.
Covered income includes: service income, interest, royalties, use of distribution (=franchise) rights, insurance and reinsurance premiums, financial guarantee or other financing fees, and rent of equipment.
The 9% statutory tax rate in the recipient country is after taking account any preferential adjustment in respect of income, but not in respect of expenditure or capital (e.g. UK R&D credits, Cyprus notional income adjustments regarding capital).
Some payments are excluded from the STTR, including those to: an individual, an unconnected party, a non-profit organization, governmental bodies not in business, regulated investment funds, widely held real estate investment funds which achieve a single level of taxation, and entities or arrangements owned or established or created by the above.
Also possibly excluded from the STTR are payments compensated on cost plus 8.5% basis or more, other than interest or royalties.
Connected means more than 50% of voting rights and value of a company’s shares.
About the Under-Taxed Payments Rule (UTPR)
The OECD also approved on July 6, a new “Under-Taxed Profit Rule” (UTPR).
Under the OECD’s Pillar 2 rules, a Parent Entity of a group with annual revenues over €750 million is supposed to apply an Income Inclusion Rule (IIR) to group income in over 140 Inclusive Framework countries. This involves topping up corporate income tax in the Parent Entity’s home country to 15% on its share of profit (per detailed rules) in each country where they have a low-tax constituent entity (i.e. offshore subsidiary).
If for any reason the Parent Entity doesn’t collect all the 15% top-up tax, the remainder is allocated to other Constituent Entities according to a “substance” formula under the Under-Taxed Profit Rule (UTPR).
The substance formula is basically 50% prorated to the number of employees in all UTPR jurisdictions, 50% prorated to the value of tangible assets in all UTPR jurisdictions.
Where UTPR tax is allocated to a jurisdiction, this is done by denying an expense deduction or equivalent adjustment.
Nothing to report. The government has issued proposals to collect 23% from Israeli parent companies with 30+% affiliated companies that derive certain types of “mobile income” taxed abroad below 15%. But the proposed rules are expressly narrower than Pillar 2.
Foreign multinationals with low taxed preferred industrial/tech enterprises in Israel are likely to pay foreign top up taxes elsewhere instead. So, other countries may get Israel’s share of taxes, starting perhaps as soon as 2024.
As always, consult experienced professional advisers in each country at an early stage in specific cases.The writer firstname.lastname@example.org is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.