International taxation poses a challenge for multinational corporations, tax practitioners, and other professionals, as they must navigate an ever-changing economic and legal landscape.
In this context we would like to bring to your attention certain developments regarding the tax policy framework promoted by the OECD, of which Israel is a member.
The OECD’s BEPS project
For over a decade, the OECD has been promoting its BEPS (Base Erosion and Profit Shifting) project, which aims to prevent the erosion of the tax base and the diversion of profits and operations by multinational corporations to countries with low effective tax rates. Approximately 140 countries have joined this project, including many that are not members of the OECD.
As part of BEPS, 15 actions have been published, among them Action 1 – Addressing the Tax Challenges of the Digital Economy, which led to a policy model involving two “pillars”.
The two pillars
Pillar One – Allocation of an income amount (Amount A) to the market countries based on a new nexus rule, as well as guaranteeing a fixed reimbursement for marketing and distribution activities in the market countries (Amount B).
Pillar Two – Ensuring a minimum tax rate of 15% on multinational groups.
In 2021, Israel declared that it was joining the digital economy taxation outline and the two-pillar program. In the context of Pillar Two, the OECD allows each country to choose the scope and manner in which it adopts the mechanism into its domestic law. Many countries in the world – for example Austria, Belgium, Bulgaria, France, Germany, Italy and England – have already begun to fully or partially adopt the Pillar Two mechanism from the tax year 2024 or 2025. Israel recently announced that it will partially adopt the mechanism beginning in the tax year 2026.
Within Pillar Two there are two main mechanisms that result in the payment of an effective minimum tax rate of 15% on all the profits of a multinational corporation with a global revenue of 750 million euros or more, in each of the countries in which it operates.
These mechanisms are intended to prevent different jurisdictions from competing to attract corporations and business activity with low effective tax rates.
QDMTT
The first mechanism, Qualified Domestic Minimum Top-up Taxes (QDMTT) provides for an adjustment of the effective tax rate imposed on a company’s profits, to ensure a minimum tax rate of 15%. As part of this mechanism, the country of residence of the company will have the first right to collect the tax payment at a rate of 15% of the income attributed to that company, and this tax will not be collected by a country in which another company in the group is resident.
IIR and UTPR
The second mechanism, incorporating the Income Inclusion Rule (IIR) and Undertaxed Payments Rule (UTPR) states that an additional tax must be collected from the parent company, or another company in a multinational group (for example, in case where the parent company does not implement the IIR), for the income of a company in the group that pays an effective tax of less than 15%. The collection of tax at a rate lower than 15% by a country of residence of a company in the group will result in the completion of tax collection at a rate of 15% by a country in which another company in the group resides – the parent company or another company in the group.
Ministry of Finance announcement – to be implemented in 2026
The Ministry of Finance announced its intention to implement the local minimum tax regime, the QDMTT, with respect to the income of Israeli resident multinational companies with a group activity turnover of 750 million euros or more, starting from the tax year 2026[1]. The purpose of the Ministry of Finance is to prevent the payment of tax abroad by Israeli companies for income generated in Israel. For example, Israel is examining different ways to preserve the tax benefit provided through the Capital Investments Encouragement Law, and to prevent a situation in which the collection of the tax saved in Israel will spill over to other countries in a way that will nullify the benefits of the law. It is worth stressing that the adoption of Pillar Two seems to require the amendment of primary legislation in order for it to enter into force in Israel.
Application of the STTR rules to Israeli companies
On 14 August, 2024, the Israeli Tax Authority published a letter regarding the application of the Subject to Tax Rule (STTR), another component of Pillar Two. The STTR is a treaty provision that allows the source country– namely, the country where the income was generated – to impose an additional limited tax on transactions between “related parties”. This applies where the owner of the income is subject in its residence country to corporate tax rate that is lower than 9%, under certain conditions and for certain types of income that have been determined in advance.
The maximum tax rate that the source country will be able to impose is 9% of the income turnover, less the limited tax rate determined in the tax treaty with respect to such income and less the corporate tax rate applicable at the residence country of the recipient. This could be relevant, for example, to Israeli companies benefiting from the Capital Investments Encouragement Law.
Accordingly, countries with which Israel has signed a tax treaty will be entitled to request that the STTR provision be added to the treaty. The Israeli Tax Authority expects that there will be such requests by developing countries, and Israel will be obligated to agree and take action to amend the treaty. Such an amendment, and the entry into force of the provision, may have an impact on the tax of Israeli resident companies that may be required to complete the amount of tax paid in the developing country with respect to the relevant income. As of the date on which the letter was published, the provisions of the STTR had not yet implemented into any tax treaty to which Israel is a signatory.
The Tax Department of our office is at the forefront of activity in this area. As well as handling the tax aspects of the most significant merger and acquisition transactions in the Israeli economy, we provide regular and ongoing advice to both multinational and Israeli companies regarding their conduct in an everchanging tax environment across diverse contexts – such as preparation for tax audits, planning corporate restructuring before or after transactions, and the litigation of tax appeals in the courts.
This publication is provided as a service to our clients and colleagues, with explicit clarification that each specific case requires individual examination and discussion in writing.
The information presented here is of a general nature and is not intended to answer the unique circumstances of any individual or entity. Although we strive to provide accurate and available information, we cannot guarantee the accuracy of the information on the day it is received, nor that the information will continue to be accurate in the future. Do not act on the information presented without appropriate professional advice after a comprehensive and thorough examination of the specific situation.
