OECD shakes up global e-commerce and Israeli hi-tech

If you thought the difficulty in forming a government in Israel means no tax changes for a while, think again. The OECD has just published additional proposals for reforming international taxation. The latest proposals are known as Pillar 2 or GLoBE, they complement Pillar 1 published in September. The proposals are likely to be adopted in 2020 by more than 100 countries

Why is reform proposed? Until recently, multinational enterprises were generally only taxable if they did business IN another country. Now that people buy or use products or services over the Internet, suppliers no longer need a physical presence in each country, resulting in falling tax revenues in such countries.

Pillar 1 – reallocate profits

The OECD proposes in “Pillar 1” that profits of larger multinational enterprises in excess of a prescribed “base-line” may soon be re-allocated to countries where the customers or users are located, even if the enterprise has no physical presence there.

Pillar 2 – Minimum tax (top-up tax):

Pillar 2 is also known as the Global Anti-Base Erosion (GloBE) Proposal. Under the OECD Pillar 2 GLoBE proposal, several rules would aim to achieve a worldwide minimum income tax rate: An “income inclusion rule” would top up the tax on foreign income to a tax minimum rate. The rate remains to be determined.

An “undertaxed payments” rule would deny a deduction or impose a withholding tax on a payment to a related party if that payment is not subject to tax at the minimum rate; a “switch-over rule” in tax treaties to permit a country of residence to switch from an exemption to a credit method of double tax relief if the profits attributable to a permanent establishment or immovable property are not subject to the minimum tax rate; and a “subject to tax” rule that would complement the undertaxed payment rule by subjecting payments to withholding tax where the payment is not subject to tax as income at the minimum rate.

These proposals are loosely based on the UK diverted profits tax and the US tax known as GILTI (Global Intangible Low Tax Income). Under GILTI, the US minimum tax rate for US taxpayers on foreign income may be 13.125%.

Pillar 2 – further details

The US imposes uniform US earnings and profit rules for US tax purposes on the global profits of US multinationals. The OECD hints the US approach is easiest for taxpayers and tax administrations, but presents other alternatives for consultation. The OECD questions whether consolidated financial statements should be used. Or should a country-by-country approach be adopted? What about different principles governing income and expenses in different countries, e.g. different depreciation rates? Should there be any “carveouts” or exceptions? The OECD wants comments about these and other detailed aspects by December 9.

What about Israel?

Israel has a keen interest in the progress of Pillar 2 because of its lower tax rates on preferred enterprises and preferred technological enterprises (PTE), i.e. much Israeli hi-tech. If a PTE pays 6% Israeli company tax, should US investors have this rate topped up to 13.125% or to the OECD minimum rate for other investors? Can Israeli dividend withholding tax on PTE profit distributions also be taken into account?

Comments

The US GILTI tax sends shivers down the spine of many US taxpayers. GILTI may affect US immigrants in Israel with an Israeli company (although solutions may exist). GILTI can also reportedly apply even if the foreign tax rate is above the US intended rate of 13.125% because certain US expenses such as interest may be re-allocated against the foreign income, distorting the foreign tax rate.

We recommend that in the digital age where much is done from the home country, home country “earnings and profit” rules apply, for simplicity reasons (relatively speaking). And the minimum tax rate should apply to global blended earnings and profits with a carve-out for lower-taxed operations such as Israeli PTEs which meet OECD nexus rules for core income-generating activities. How much should the minimum tax rate be? How about 12.5% as in Ireland and Cyprus?

What should e-commerce and digital enterprises do? Such enterprises, wherever located, should follow the progress of these OECD proposals. Check what their home country adopts; which countries will start taxing them?; and where their core income generating activities are. That’s on the income tax side. Also check VAT/GST/Sales tax nexus rules which are rapidly evolving in US states, the EU and around the world. These changes may well affect your bottom line and the reporting procedures needed.

As always, consult experienced tax advisers in each country at an early stage in specific cases. The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. leon@h2cat.com.