On 17 July 2023, the OECD / BEPS Inclusive Framework (IF) released new documents in relation to its Two-Pillar solution. Among others, this package contained the Subject-to-Tax Rule (STTR) model treaty provision. The STTR, which needs to be implemented in double tax treaties (DTT), is the third measure constituting the Pillar Two tax reform that aims at implementing global minimum effective taxation of 15% for large multinational groups. Importantly, its scope is not limited to taxpayers in scope of the GloBE rules, i.e., multinational groups with a consolidated turnover of at least EUR 750 million.
The STTR allows a source state that has ceded taxing rights on certain mobile intragroup payments under the normal allocation rules of a DTT, to reclaim taxing rights in certain circumstances where the intragroup payment is taxed at an (adjusted) nominal rate of less than 9%. The STTR would not apply if the source country can already sufficiently tax this payment under the normal allocation rules of the DTT. The STTR is a separate DTT provision that applies before the so-called GloBE Top-up Tax rules.
The STTR was originally proposed to be a withholding tax.
However, because the STTR heavily relies on information that is
only known after year-end, the STTR will be levied as an ex-post
annualised charge.
To facilitate the implementation of the STTR in DTTs, the OECD / IF
will make a multilateral instrument available for signature as from
2 October 2023.
Which payments are in scope?
The categories of income targeted by the STTR
The STTR applies to seven categories of income, which most
notably include interest and royalties. Other covered income under
the STTR is (i) insurance and reinsurance premiums, (ii) payments
for the (right to) use of distribution rights in respect of a
product or service, (iii) financial guarantees or financing fees,
(iv) payments for the (right to) use of industrial, commercial or
scientific equipment and (v) any income in relation to the
provision of services (the latter category is particularly
broad).
Specific items of income have been excluded for the shipping
industry.
Exclusions based on the recipient
The STTR does not apply to payments made by individuals nor to
payments made to individuals or other persons not connected to the
payor. There is an anti-abuse rule that aims to tackle structures
where entities are interposed to avoid the STTR.
In addition, payments made to certain entities are excluded from
the scope of the rule based, for example, on their characteristics
or functions. These entities often are not exposed to CIT to
preserve a specific intended policy outcome, e.g., recognized
pension funds, certain investment funds or non-profit
organizations. The types of excluded entities are defined by the
STTR model treaty provision, and the scope should therefore be
reviewed carefully.
Exclusions based on the amount
Moreover, as a general rule the STTR would not apply if the gross
amount of the covered income (not being interest or royalties) does
not exceed a cost +8.5% remuneration of the recipient for the
activity giving rise to such income, since it is considered that
these items present a more limited BEPS risk.
Exclusions based on materiality threshold
Contracting states should introduce a materiality threshold below
which the STTR will not apply. The materiality threshold operates
by reference to the total value of payments arising in the source
state and paid to connected recipients which are resident in the
other contracting state. For contracting states with a GDP ? EUR 40
billion, the threshold of covered income in a year should be set at
EUR 1 million. For contracting states with a GDP < EUR 40
billion, the threshold should be EUR 250,000. The applicable
threshold is determined by reference to the size of the smallest
economy of the two contracting states.
How is the amount of additional tax under the STTR computed?
The STTR allows the source state to apply additional tax on an
item of covered income that is subject to an adjusted tax rate
below 9% in the recipient state. When determining this additional
tax, the tax rate applying in the recipient state to the covered
income must be considered, as well as the tax rate that the source
state is allowed to apply pursuant to the normal allocation rules
of the DTT.
The additional tax that the source state can levy is determined as
follows:
In effect, the specific tax rate that may be applied under the
STTR is capped at the difference between 9% and the (adjusted)
nominal rate applicable in the recipient state. Such nominal rate
will in many cases be the main CIT rate.
An adjustment to the nominal rate in the recipient state must be
made to take into account preferential rates applicable in that
jurisdiction to the covered income, e.g., because of a permanent
partial exemption or exclusion of such income from the tax base
where such preferential treatment is "directly linked" to
the relevant covered income or "arises from a regime that
provides a tax preference for income from geographically mobile
activities". Specific rules are in place for the application
of the STTR in case of payments to permanent establishments.
Because the STTR applies after other taxing rights allocated to the
source state, the tax rate under the STTR is further reduced by the
rate at which the source state is already allowed to tax the gross
amount of covered income (regardless of whether the source state
exercises that right or not). Therefore, if the DTT already allows
the source state to tax the gross amount of covered income at a
higher rate than under the STTR, the STTR does not apply.
How the source state levies the additional tax under its domestic
tax law is not relevant, as long as the tax does not exceed the
amount resulting from the above-mentioned formula.
To facilitate tax certainty, the competent authorities must notify
each other of the applicable rates and other features of their tax
laws that are relevant to the application of the STTR.
STTR compliance
The details of the tax compliance process, e.g., as regards certifications or deadlines, are left to the parties to each relevant DTT but conceptually the OECD / IF proposes that the STTR liability is determined by means of self-assessment through the filing of an STTR tax return in the source country only if the recipient of the payment has an STTR liability. That determination is made after the end of the fiscal year, once all financial and tax data points relevant to the computation of a potential STTR tax liability are known.
Interaction with other DTT provisions and other Pillar Two measures
The OECD / IF also proposes to amend the DTT provision on the
elimination of double taxation in order to avoid that recipient
states unduly grant exemptions or credits in case the source state
levies tax solely based on the STTR.
The STTR should apply before the GloBE rules, i.e., any tax levied
pursuant to the STTR should be taken into account when computing
the GloBE effective tax rate.
Take-aways
Contrary to the GloBE rules, the STTR does not apply solely to
groups that have a consolidated turnover of at least EUR 750
million. Other thresholds and exclusions (outlined above) should,
however, limit the otherwise potentially very broad scope of the
rule.
Moreover, the STTR does not affect every DTT. Many jurisdictions
have a statutory tax rate of at least 9%, though specific
adjustments (e.g., due to specific tax exemptions or reductions
applicable to certain categories of covered income) need to be
factored in the assessment. However, where the STTR is implemented
into the DTT, the STTR appears more complex than originally
expected.
As regards implementation, the OECD / IF specifically mention that
members of the IF that apply nominal tax rates below 9% to the
defined set of payments have committed to implementing the STTR
into their DTTs with IF developing countries when requested to do
so. As mentioned above, to facilitate the implementation of the
STTR in DTT's, a multilateral instrument should be available
for signature as from 2 October 2023.
In parallel to the STTR model provision, the OECD also released additional administrative guidance (see our website article) and a revised GloBE Information Return for compliance with the GloBE Rules (see our website article).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.