Following the release last month of the OECD's Public Consultation Document for a Unified Approach under Pillar One, aiming to adopt a harmonized approach to taxation of digital activities, which focused on new nexus and allocation rules (more on this proposal in our October Client Update here), the OECD has recently issued another Public Consultation Document titled Global Anti-Base Erosion Proposal ("GloBE") Pillar Two, which touches on technical issues relating to the structure of a proposed global minimum tax and seeking public input on the same. While the GloBE proposal addresses challenges relating to taxation of digital economy, it is intended to apply on a broader basis to other activities as well.
At its core, the GloBE proposal would adopt a new income inclusion rule that would tax the income of a foreign branch or controlled entity to the extent such income is subject to tax at an effective rate below a minimum rate (yet to be determined). To complement this rule and allow for its proper implementation, the GloBE proposal would adopt additional rules aimed at ensuring taxation at such minimum rate. The OECD is hoping to reach consensus by the end of 2020 on taxing profits of multinational groups at a worldwide minimum tax rate. The GloBE proposal expressly indicates that it represents a substantial change to the international tax architecture. The proposal would affect the way multinational groups are structuring their international tax planning, including their transfer pricing, value chain and supply chain.
While the Unified Approach focused on the substance and the methodology for allocation of taxing rights between jurisdictions and considered various proposals for new profit allocation and nexus rules, the GloBE proposal delves into technicalities, proposing a coordinated set of rules to address ongoing risks from structures that allow multinational groups to shift profits to jurisdictions where they are subject to no or very low taxation. The GloBE proposal is not set in stone and the OECD has requested comments relating to the use of financial accounts as a starting point for determining the tax base; the extent to which a multinational group can combine income and taxes from different sources in determining the effective (blended) tax rate on such income; and stakeholders' experience with, and views on, carveouts and thresholds that may be considered as part of the GloBE proposal.
Implementation of the GloBE proposal would require changes to domestic law and tax treaties to avoid the risk of double taxation in circumstances where one jurisdiction seeks to apply these rules to the same transaction or entity.
The GloBE proposal consists of the following four components:
- An income inclusion rule that would tax the income of a foreign branch or a controlled entity if that income was subject to tax at an effective rate that is below a minimum rate;
- An undertaxed payments rule that would operate by way of a denial of a tax deduction or imposition of source-based taxation (including withholding tax) for a payment to a related party if that payment was not subject to tax at or above a minimum rate;
- A switch-over rule to be introduced into tax treaties that would permit a residence jurisdiction to switch from an exemption to a credit method where the profits attributable to a permanent establishment (PE) or derived from immovable property (which is not part of a PE) are subject to an effective rate below the minimum rate; and
- A subject to tax rule that would complement the undertaxed payment rule by subjecting a payment to withholding or other taxes at source and adjusting eligibility for treaty benefits on certain items of income where the payment is not subject to tax at a minimum rate.
Depending on the minimum tax rate that will be set by the OECD, multinational groups with Israeli subsidiaries that are subject to preferred tax regimes in Israel (e.g., with respect to their so-called "preferred enterprise", "preferred technology enterprise" or "special preferred technology enterprise") may be subject to such rules.
The current draft of the GloBE proposal recognizes the potential impact on the effective tax rate in various jurisdictions that may result from temporary differences (that is, differences in the time for taking into account items of income and expense in the calculation of net income). In response, the GloBE proposal discusses the possibility of acknowledging (i) carry-forward of excess taxes (over the minimum tax rate) and tax attributes, (ii) deferred tax accounting and (iii) a multi-year average effective tax rate as a means for mitigating such potential impact on a transaction or entity.
Since the GloBE proposal is based on an effective tax rate test, it must include rules that stipulate the extent to which the taxpayer can "mix" (or "blend") low-tax and high-tax income within the same entity or across different entities within the same group, which have not yet been determined. However, the GloBE proposal considers whether blending should be allowed on a worldwide or a narrower, jurisdictional, basis. Regardless of the blending approach which will be adopted, it will be necessary to develop an agreed upon approach for allocating income between the corporation's office jurisdiction and its subsidiaries or branches, based on existing transfer pricing rules or otherwise.
Certain carve-outs as well as thresholds and exclusions to restrict application of the GloBE proposal are also contemplated. In particular, the GloBE rules would not apply to regimes compliant with the standards of BEPS Action 5 on harmful tax practices (Israel is currently considered as "not harmful" for this
purpose), and other substance-based carve-outs; a return on tangible assets; and controlled corporations with related party transactions below a certain threshold (not determined yet) or the size of the taxed group. An exclusion of transactions or entities with small amounts of profit is also being contemplated, albeit without any specific amounts at this stage.
It is yet to be seen how the GloBE proposal will affect the discussion on the subject matter and how various jurisdictions will respond, given that many items of the proposal and the means of its implementation remain unclear. Please feel free to contact us with any comments or reactions you may have with respect to the GloBE proposal by the end of the month, and we will communicate the same to the OECD. We will keep you updated on any new developments on this matter.