OECD members beware: Global tax might be on the way

What should a taxpayer company do if Israel adopts a 15% minimum tax?

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)

 A 15% minimum global corporate tax income tax rate will probably arrive in 2024, thanks to an initiative of the OECD called Pillar Two. To support this, US President Joe Biden told the UN on September 21: “We’re working to build a new economic ecosystem… where every nation gets a fair shot….That’s why the United States has championed a global minimum tax.” 

OECD members are required to apply OECD recommendations. Israel joined the OECD in 2010. Over 140 countries are expected to apply Pillar Two. So after the election, the new Israeli government, once formed, will need to consider amending the famous Law for the Encouragement of Capital Investments, 1959, which prescribes low tax rates, many below 15%, for Israeli industry, hi-tech, hotels and agriculture.

Israeli implications

At present, preferred income derived by preferred industrial and tech enterprises is liable to company tax of 7.5% in development area A, 16% elsewhere in Israel, without time limit. Dividends are generally taxed at 20%. The resulting combined tax burden on distributed profits is generally 26% - 32.8%, subject to any tax treaty. An even lower company tax rate of 5% is possible for large groups with annual revenues over NIS 10 billion.

What the OECD proposes

In a nutshell, the OECD proposes that 15% minimum tax would apply to most multinational groups with global annual revenues over EUR 750 million in countries where they operate, e.g. Israel. The calculations would be based on financial statements, not tax returns.

To discourage offshore planning, there would be a reward for “substance” – an extra annual deduction of 5%-10% of payroll costs and 5%-8% of the average carrying value of tangible fixed assets that year.

Accelerated depreciation should not change much as deferred taxation that crystallizes within 4-5 years should count as tax payable.

Who gets the 15% tax? First, each country is free to impose its own 15% qualified minimum domestic tax (QMDT). Second, the home country of the ultimate parent entity (UPE) would get a top-up tax of 15% minus income tax paid elsewhere by the group. Third, if the UPE’s home country doesn’t impose the top-up tax, a lower down country may do so.

Fourth, failing all that, expense payments taxed below 15% in the recipient country may be taxed in the payer country.

Accelerated depreciation should generally be okay as deferred taxation that crystallizes within 4-5 years would count as tax payable.

Some countries don’t reduce tax on income, they incentivize desirable expenditure e.g. the UK R&D tax credit. The OECD would treat such R&D credits advantageously as income, not a tax reduction, provided they are paid out in cash if not credited against tax within 4-5 years.

What will Israel have to consider soon?

If Israel does nothing, other countries such as the US may soon impose top-up taxes on their multinationals that invest in Israel. Imagine groups like Intel paying only 5% tax in Israel and a 10% top-up tax in the US (and the US is offering substantial cash support for new chip plants in the US). How can Israel avoid a tax drain abroad?

First, Israel might consider imposing its own 15% QDMT tax, at least for groups with annual revenues over EUR 750m. It seems dividend withholding tax may instead be reduced. Second, Israel might consider granting qualifying tax credits for R&D and patent expenditure. Third Israel may expressly allow payroll and tangible fixed asset “substance” deductions for equipment etc. where relevant (many hi-tech firms have geeky employees but little equipment beyond a few laptops). Fourth, Israel might consider enhancing accelerated depreciation and cash grants for fixed assets, labor and marketing. Fifth, Israel might consider abolishing the lower tax rates in development area A. Instead, the government might invest more in education and commercial infrastructure.

Who’s off the hook? We assume that gas drilling companies in the Mediterranean may be exempted from the 15% minimum tax, but face substantial other Israeli taxes.

Tentative action plan?

What should a taxpayer company do if Israel adopts a 15% minimum tax? Possibilities to consider might include: investing in labor and equipment where possible; minimizing annual depreciation charges; accruing salary bonuses (rather than stock options), and US multinational groups should check whether they can blend lower Israeli taxes with higher taxes elsewhere.

Note that it remains to be seen what will be enacted, how it will be administered and how appeals would be handled.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

[email protected] The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd