The STTR rule, part of the Inclusive Framework on BEPS, helps countries fairly tax multinational companies. It’s one of the rules under Pillar Two, which allows countries to tax certain payments when other countries don’t tax them enough. The STTR focuses on preventing companies from dodging taxes by moving their profits to countries with very low tax rates. This rule helps developing countries protect their tax income.
STTR applies to specific types of payments, like interest and royalties, between companies in different countries. If the country receiving the payment has very low taxes, the country where the payment originates can add extra tax. Some companies are exempt from this rule based on their characteristics or functions.
Countries with low corporate tax rates in the Inclusive Framework agreed to use STTR in their tax treaties with developing countries when requested. A multilateral agreement makes it easier to consistently apply this rule in these treaties.
Design of STTR
First, STTR is designed as a clear and easy-to-understand treaty article that aligns with the structure and terminology of the OECD Model Tax Convention. It uses defined terms such as “interest” and “royalties” that are consistent with the OECD Model. However, countries can choose to use their own definitions in their treaties if they prefer.
Secondly, STTR is presented as a separate treaty article and is not integrated into existing tax treaty articles. It does not change the allocation of taxing rights between countries but instead operates independently to address specific income types. It can be included in bilateral tax treaties based on the OECD Model or the UN Model Double Taxation Convention with appropriate adaptations.
Thirdly, STTR applies to income items that have nominal tax rates below a 9% minimum rate and are not already subject to a source state taxing right at or above this minimum rate under the treaty.
Fourth, The STTR is part of a broader initiative known as the “Two-Pillar Solution,” which addresses tax challenges arising from the digitalization of the economy. The STTR is implemented in bilateral treaties when requested by developing countries, and it focuses on countries with low-income thresholds.
Lastly, A multilateral convention is available as an option for implementing the STTR. This convention can be used to adapt the provision for existing treaties, making it more versatile and accommodating different treaty structures. Alternatively, countries can choose to include the STTR provision in their tax treaties on a bilateral basis.
Understanding the Key Provisions: Review of STTR Articles One and Two
Article One of the STTR provision explains how income taxing rights work, mainly focusing on “covered income,” which includes interest, royalties, distribution rights payments, insurance premiums, financial guarantee fees, rent for equipment, and service income. However, there are certain exceptions where specific rules don’t apply. These exceptions involve cases where people or organizations in different countries are receiving income or payments. Some of the exceptions include:
- If the recipient is an individual.
- If the recipient has no significant connection with the person or organization making the payment.
- If the income is related to pension funds or similar financial plans.
- If it’s received by non-profit organizations working for charitable, educational, or similar purposes.
- If the payer is a government or related entity.
- If it involves an international organization
- If the money is managed by an entity that invests funds for others and is properly regulated.
- If the entity’s taxation ensures that income is only taxed once and meets certain conditions.
- If it’s owned or created by other organizations falling into the above categories and is primarily focused on holding assets or managing funds for their benefit
The STTR grants the source state (where income is generated) the right to tax covered income, deviating from typical international tax agreements. This right applies only when a treaty limits the source state’s taxing rights for specific income. However, this taxing right is subject to certain restrictions.
The source state’s right to tax is limited under the STTR. It can be exercised when the residence state (where the income recipient resides) taxes the income at a rate lower than an agreed minimum rate of 9%. The specific tax rate is defined in paragraph 5 and further clarified in paragraphs 6 and 7.
Article Two of the STTR provision outlines the limitations on the source state’s taxing rights. Paragraph 2 sets a maximum limit on the tax imposed by the source state, determined as the difference between the agreed minimum rate of 9% and the tax rate in the residence state. The specified rate varies based on the residence state’s tax rate and specific circumstances, not a fixed numerical rate. An example illustrates this: if the agreed minimum rate is 9%, the calculated tax rate is 5%, and the gross covered income is $100, the specified rate is 4%, limiting the source state’s tax to $4.
However, paragraph 2 doesn’t mandate the source state to apply this tax in full or to tax the entire gross income. The specific application depends on the source state’s domestic tax laws. If these laws allow taxing the net income and apply a 20% rate, but the net income is $15, the tax would be $3, which doesn’t exceed the specified rate. But if the rate applied to the net income in the source state was 30%, paragraph 2 would limit the tax to $4.
The STTR provision permits the source state to tax certain income types, but only when the residence state taxes the income below a specified rate. It sets a maximum tax limit based on the residence state’s tax rate, ensuring a balanced approach to international income taxation.
Author: Eddie Opiyo