Will Israel soon be expanding its tax net with OECD approval? The OECD has just published some draft model rules for “sourcing” taxable profits of large multinational corporations engaged in e-commerce (Pillar One – Amount A Model Rules for Nexus and Revenue Sourcing). The resulting new tax revenues in 137 countries, including Israel, could be many billions of dollars each year. However, the OECD proposals are complex and the public only has a two-week consultation period from February 4-18, 2022, to comment on them. A version of this article was submitted to the OECD.
Who is affected?
In theory, large multinational groups with annual revenues over £15 billion would be affected.
In practice, everyone living in the 137 participating countries, including Israel, the US and Europe stands to benefit, because if multinationals pay more tax, everyone else might pay less tax or receive bigger state benefits, starting in 2023 or 2024.
Until now, the old international tax rules said that income tax is generally only payable if in a country you do business physically in that country. That was before the internet made it easy to do business from outside that country, e.g. from an offshore internet server.
What does Israeli law currently say?
The Israeli tax law (Section 4A) merely says that taxable income arises in Israel if business activity is conducted there, or if services are performed there. Tax treaties require a permanent establishment, i.e. a fixed place of business or a dependent agent.
What does the OECD now propose?
The OECD proposes to prescribe new revenue source rules. If revenue is now sourced to a country, part of it may be taxed in that country (25% of profit exceeding 10% of revenues of large multinationals). Different source rules are specified for different activities. The OECD encourages sourcing on a transaction-by-transaction basis, meaning multinationals would generally need new data and compliance systems.
Proposed source rules include
- Finished goods – place of delivery, location of independent distributor.
- Components – final customer of finished goods into which the component is incorporated.
- Services connected to tangible property – where the service is performed.
- Online advertising services – location of the viewer.
- Other advertising services – place of display or reception.
- Online intermediation, i.e. platform linking buyers and sellers – 50% location of purchaser, 50% location of seller (or where resulting offline services are performed).
- B2B services – please of use or place of incorporation or headcount.
- B2C services – location of consumer.
- Digital goods, financing – as for B2B or B2C services.
- IP sale or licensing – place of use by the final customer.
- Sale or licensing user data – location of the user. Detailed rules are proposed. But a tug of war can easily develop between the tax authorities of different countries if groups claim they are not sure where their customers/users are. So the proposals call for multinationals to take reasonable steps to apply a “reliable method” of sourcing revenues between countries, according to the following hierarchy of priorities:
- Reliable indicators – used for commercial purposes, or verified by a third party, or confirmed by other indicators;
- Allocation key – using various statistics
- Global allocation key – using UN Conference on Trade & Development (UNCTAD) statistics regarding consumption and population around the world.
Our comments on OECD proposals
The OECD needs to go up the stairs one at a time, not in leaps and bounds that leave gaps. The OECD applies a “predominately” approach, but the devil is in the details.
We reviewed the UNCTAD handbook of statistics for 2021. There is apparently no breakdown of imports of digital goods or consumption.
Will double tax occur? There is zero guidance on the interaction and any credit mechanism between these proposals, Amount B (marketing and distribution), Pillar 2, VAT and sales taxes.
The US Treasury has announced a Digital Service Tax phase-out and credit against Pillar 1, not mentioned in these proposals.
Will there be a dispute resolution procedure binding on multinationals and governments, such as an international tax tribunal system?
Will these proposals override the OECD multinational instrument (MLI) and bilateral tax treaties?
In short, it remains to be seen whether the OECD will modify their proposed recommendations and how Israel and other countries will apply the final recommendations. Large multinationals must start adapting their systems and decide whether a UN statistical approach is appropriate. Other taxpayers would like to see their tax bill fall (don’t bet on it).
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. [email protected]