Pillar Two: Subject-To-Tax Rule (STTR)

  1. Overview
  2. Taxing Right
  3. Other Treaty Provisions
  4. Payments Subject to the STTR
  5. Calculating the Tax Rate
  6. Graduated Rates
  7. Provision of Information
  8. Preferential Adjustments
  9. Excluded Entities
  10. Mark-Up Exclusion
  11. Mark-Up Exclusion – Example
  12. Contractual Arrangements
  13. Contractual Arrangements – Example
  14. Connected Persons
  15. Connected Persons – TAAR
  16. Materiality Threshold 
  17. Administration

Pillar Two is comprised of two key rules, the GloBE Rules and the Subject-to-Tax Rule (STTR). 

The STTR is a key component of Pillar Two, and unlike the GloBE Rules focuses on source jurisdictions. 
On July 17, 2023, the OECD issued the model provision and commentary for the STTR.
This is a treaty provision to be inserted in certain double tax treaties with developing countries that allows a source State to recapture some of the taxing rights on intragroup payments, where the income is taxed in the residence State at a rate less than 9%.
The STTR will be included in bilateral double tax treaties with members of the Inclusive Framework (IF) when requested to do so by developing countries. IF jurisdictions considered as developing for this purpose are those with a Gross National Income per capita, calculated using the World Bank Atlas method, of USD 12,535 or less in 2019 (as updated).
STTR Multilateral Instrument
The Multilateral Instrument (MLI)  implementing the STTR was open for signature from 2 October 2023. 
The MLI applies to Covered Tax Agreements, which are existing bilateral tax treaties that are explicitly identified by each of the parties to those tax treaties, and directly amends Covered Tax Agreements in order to implement the STTR.
There are two new additions:
 – Annex IV to the MLI provides that jurisdictions can decide to adopt their specific definition of the term “recognised pension fund” for applying the STTR or use their existing treaty definition;
– Annex V includes an optional circuit-breaker provision that switches off STTR when a developing country becomes a developed country (and switches it on in a reverse case).
Jurisdictions are required to notify the OECD of double tax treaties that they wish to apply the STTR MIL to. In addition further notifications are required if:
– they apply a tax calculated other than on a net income basis (Article 4) (e.g. imposing tax on gross income as a resident jurisdiction or by reference to equity (e.g. a capital tax), or the tax base for which is calculated by reference to multiple components (e.g. income and equity such as zakat)); or
– they do not impose corporate income tax on items of covered income when that income is earned, but instead impose tax at the point of profit distribution (either a deemed profit distribution or an actual distribution) (Article 5).
Taxing Right

The STTR effectively claws back some of the taxing rights over certain forms of income that has been given to the residence jurisdiction under a double tax treaty. It only applies where the income is subject to a tax rate in the Country of residence below 9%.

STTR example
For example, if in this example the UPE was taxed on the royalty payments at 5%, Sub Co would have the right under the STTR to apply additional tax on the royalty payments at 4%. If the Sub Co was based in a regime that levied withholding tax at 15%, the STTR would not apply as it already applied tax at a rate above 9%. 
The tax that can be levied by the source-state is the:
specified rate * gross amount of covered income
The specified rate is the difference between 9% and the tax rate applied to the covered income in the residence State.
For instance, if the tax rate on income of 1M was 5% in the residence state, the source state could levy tax of up to (9%-5%) 4% * 1M = 40,000.
Note, that the source state isn’t required to tax this full amount, but it cannot exceed it.
Other Treaty Provisions
Paragraph 3 of the Model STTR Article provides specific treatment where another provision of a double tax treaty (DTT) taxes the income.
Where another DTT provision taxes the income at the specified rate (so that the total tax rate is at least 9%), as you’d expect, the STTR does not apply (as it is unnecessary).
If another provision of a double tax treaty allows the source State to tax income at a rate below the specified rate, the taxing right under the other provision is preserved and the STTR simply tops up the rate to 9%.
Payments Subject to the STTR
Under Paragraph 4(a) of the Model STTR Article, payments subject to the STTR (referred to as ‘Covered Income’ in the STTR Article) are:
– interest
– royalties
– payments made in consideration for the use of, or the right to use, distribution rights in respect of a product or service;
– insurance and reinsurance premiums;
– fees to provide a financial guarantee, or other financing fees;
– rent or any other payment for the use of, or the right to use, industrial, commercial or scientific equipment; or
– any income received in consideration for the provision of services.
It should be borne in mind that these definitions are based on applicable treaty definitions. As such when considering the scope of interest or royalties for instance, jurisdictions may have different interpretations. The OECD Model Tax Convention includes the observations and positions that jurisdiction have taken.
The following are not include in covered income under Paragraph 4(b) of the Model STTR Article:
– rent or other payment for the use of, or the right to use, a ship to be used for the transportation of passengers or cargo in international traffic on a bare boat charter basis; or
– items of income derived by a person whose domestic tax liability is determined by the tonnage of a ship.
The inclusion of services within the scope of the STTR list is likely to be of key interest to source jurisdictions, particularly as regards digital intermediation services.

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