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

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


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. It effectively allows source jurisdictions to tax the gross amount of interest, royalties and a defined list of other payments received by a connected company, up to a globally agreed 9% minimum rate. 
This applies even if a relevant tax treaty only permits the source country to impose withholding tax on the payment at a rate below 9% or allocates exclusive taxing rights over the payment to the recipient’s country of residence.
Where a jurisdiction applies a tax rate on the receipt of relevant payments that is less than the globally agreed 9% minimum rate, the payer jurisdiction has the right to “top up” the tax payable with a withholding tax.

Guidance To Date

The STTR is much less developed than the GloBE Rules. Most of the detail for the STTR is contained in the October 2020 Blueprint on Pillar Two (OECD Blueprint).
The GloBE provisions contained in the 2020 Blueprint changed in a number of respects in the eventual Model Rules issued (eg the use of deferred tax accounting). As such, it is likely that the application of the STTR would also change when the final treaty articles and accompanying notes are issued. 
The 9% nominal rate for the STTR was stated by the OECD in an October 2021 Statement.

When does the STTR apply?

The effect of Article 9.3.2 of the OECD Blueprint is that the STTR applies where covered payments between connected persons are not taxed either in the source country or the residence country at the 9% agreed rate. 
This can arise for a number of reasons, eg:
  • There is no tax on the income in the residence country and the source country does not levy withholding tax;
  • The source jurisdiction levies withholding tax at a rate less than 9% and the income is taxed in the residence jurisdiction at a rate less than 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. 

Nominal Payments

Unlike the GloBE Rules, the STTR applies to each payment and the tax rate on the income in the residence jurisdiction would need to be determined on a payment-by-payment basis. 
The nominal rate of tax in the residence jurisdiction is not simply the statutory rate, given that the actual tax rate on the income may be much less. For instance, the residence jurisdiction may apply a territorial basis and not tax the income or there could be an exemption or other credit in the residence jurisdiction that reduces the tax on the income. 
It should be noted that this is different to the effective tax rate determined for the purposes of the GloBE Rules which is based on the income and taxes of the entity for the accounting period, unlike the STTR which looks at the particular payment. 
The OECD Blueprint refers to the tax rate in the residence jurisdiction as the ‘adjusted nominal rate’. This is determined by:
1 – ascertaining the statutory tax rate
2 – identifying the proportion of the payment that is subject to tax after taking into account any exclusions or deduction. 
For instance, if a jurisdiction exempted 80% of royalty income from corporate income tax, and the general corporate income tax rate was 20%, the adjusted nominal rate on the royalty income would be 4%. 
Note that deductions and credits that are not directly attributable to the payment, but rather impact on the income of the entity are not taken into account when calculating the adjusted nominal rate.
For example, super-deductions that provide for a double deduction for qualifying IP expenses would be taken into account when calculating taxable income (and GloBE income), but not the adjusted nominal rate for STTR purposes. 

Covered Payments

The STTR doesn’t apply to all payments. The OECD proposes to restrict it to payments where there is the highest risk tax motivated base erosion. As such Article 9.2.3 of the OECD Blueprint restricts the STTR to the following payments:
  • Interest
  • Royalties
  • Franchise fees or other payments for the use of or right to use intangibles in combination with services;
  • Insurance or reinsurance premiums;
  • Guarantees, brokerage or financing fees;
  • Rent or other payments for the use of or the right to use moveable property; and
  • Amounts paid for marketing, procurement, agency or other intermediary services.
The inclusion of services in this list is likely to be of key interest to source jurisdictions, particularly as regards digital intermediation services.

Connected Parties

The STTR only applies to payments between connected parties. The OECD Blueprint follows the definitions of closely related parties in Article 5(8) and 5(9) respectively of the OECD and UN Model Tax Conventions.
In general, this treats parties as connected where one has control over the other and includes cases where one party directly or indirectly holds more than 50% of the beneficial interest in the other or where another person possesses directly or indirectly more than 50% of the beneficial interest in each person.
It’s worth noting that this does not tie in with the related party definition for transfer pricing purposes under many domestic tax regimes.
For instance, Peru in Article 24° of Supreme Decree N° 122 -94 -EF generally applies a 30% requirement. Similarly, Section 33 of Cyprus’s Income Tax Law applies a 25% requirement.  This is likely to require separate analysis of the related party definitions for domestic transfer pricing requirements and the STTR. 


The OECD Blueprint includes a number of exclusions where the STTR does not apply:
Firstly, it does not apply to payments that form part of the income of a permanent establishment. This is because the right to tax the income would be attributed to the source state anyway under a double tax treaty. 
Secondly, Article 9.2.3 of the OECD Blueprint excludes low-return payments partly to ease compliance and partly to ensure the STTR is focused on the most material cross-border planning arrangements. 
Low-return payments are calculated by reference to the costs incurred by the payee in earning the payment, or can be calculated on a cost-plus basis, and where the margin is no higher than an agreed percentage. The agreed percentage has not yet been determined. 
The practical effect of this is that in most cases, where an agreed transfer pricing methodology has been used, the payment may satisfy the requirement to be a low-return payment. 
Thirdly, Article 9.2.4 of the OECD Blueprint exempts certain excluded entities from the STTR. It states that investment funds, pension funds, governmental entities (including sovereign wealth funds), international organisations, and non-profit organisations are excluded entities for the purposes of the GloBE Rules and the same treatment would apply for the STTR. The GloBE Rules have other classes of excluded entity (including investment funds and real estate investment vehicles that are the UPE), however, there is no mention as to whether they will be similarly excluded from the STTR. 
Finally, Article 9.2.5 of the OECD Blueprint includes a materiality threshold. The design of this rule is not yet determined. The Blueprint provides a few possibilities, including:
  • Threshold based on the size of the MNE. Where the MNE exceeded a certain size or revenue threshold, the STTR would apply. 
  • Threshold based on a tiered value of covered payments made to connected persons in other contracting state. Where the value of covered payments made to connected persons in the other contracting jurisdiction exceeded a fixed amount in a year, the STTR would apply.
  • Threshold based on a ratio.  The STTR would not apply where the total amount of covered payments made over the course of the payer’s financial year, expressed as a proportion of total expenditures, were below a certain ratio.
Each of these is being looked at by the OECD and Inclusive Framework members.

Interaction with the GloBE Rules

The STTR applies in priority to the GloBE Rules, and STTR tax would be a covered tax for the purpose of calculating the effective tax rate under the GloBE Rules.
An MNE Group consists of 3 companies, the UPE and two wholly owned subsidiaries, Company 1 and Company 2.
Company 1 pays interest of 100 million to Company 2. Company 2 has other non-taxable income of 100 million. 
Company 2 is resident in a jurisdiction that has a corporate income tax rate of 25% but exempts 80% of the interest receipt from tax. 
Company 2 is subject to tax on the interest at an adjusted nominal rate of (20% * 25%) 5%.
As this is below the 9% STTR rate, Company 1 can withhold additional tax at a 4% rate (ie 4 million).  
When calculating the impact of the GloBE Rules on Company 2, covered taxes are the 4 million withheld tax, and domestic tax on the income (5% * 100 million) 5 million. This totals 9 million. GloBE Income would be 200 million and the GloBE ETR is therefore 4.5%. The top-up tax percentage is 10.5% which leads to top-up tax of 21 Million.

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