Israel’s Ministry of Finance has announced that it will apply the Qualified Domestic Minimum Top-up Tax (QDMTT) from 2026, as part of the OECD Pillar 2 international tax reform.
This is a plan to change the existing corporate taxation system, to allow countries to collect more taxes from international companies that sell products or services to their citizens. The purpose of the program is to update taxation laws and allow them to deal with the digital economy and with companies that report their profits in countries that collect less taxes from them, regardless of the countries in which their profits are generated. The change will affect the multinational tech companies, including Facebook, Apple, Amazon and Google.
Israel’s Minister of Finance Bezalel Smotrich said, "Israel's joining the implementation of the international standard that has been formulated on taxation of multinational corporations, will help preserve the attractiveness of the Israeli tax regime in the new global taxation reality, and will ensure the prevention of tax leakage from Israel on local activity. Compliance with advanced international standards is a necessary condition for creating a free and global market economy that leads to growth and improves our quality of life. I am grateful to the Ministry of Finance and Tax Authority officials, who worked in cooperation with the industry, investors, and other interested parties. As I have done from the outset as Minister of Finance, I will continue to work to strengthen and improve the attractiveness of the State of Israel for investment in the field of innovation and high-tech.'
Over the past decade, the OECD has been promoting the BEPS (Base Erosion and Profit Shifting) project to prevent the erosion of the tax base and the diversion of profits by multinational corporations between countries, among other things by shifting activity to countries where the effective tax rate on corporations is low. 140 countries are participating in the project, including the State of Israel.
The OECD plan for the taxation of the digital economy is built on two levels: the first level (Pillar 1) deals with the taxation of the profits of the giant international corporations by the countries to whose residents they provide services or deliver products, when according to the emerging outline, it will be possible to tax part of the profits of these giant corporations in the countries where they operate, even if there is no physical presence in the country.
The second layer (Pillar 2) seeks to prevent tax plans aimed at eroding the tax base or diverting profits to tax havens of multinational corporations, putting an end to the "race to the bottom" of tax rates. According to the outline plan, a minimum tax rate will be determined that will apply to the members of these corporations. Pillar 2 will apply to multinational corporations with annual turnover of €750 million.
According to Pillar 2, countries participating in the program must apply an effective corporate tax rate that will not be less than the minimum effective tax rate of 15% (QDMTT). The company's country of residence will have the first right to collect tax at a rate of 15% for the revenue attributed to the company resident in that country and this tax will not be collected by a country where another company in the group is resident.
Supplement to the minimum tax
Participating countries will not be required to increase the tax rate applicable to the companies within their jurisdiction to the minimum tax rate, but the parent companies, or other companies in the group, will be required to supplement the tax to the minimum tax to the tax authority in their country of residence (IIR and UTPR).
Back in June 2021, Israel, through then Minister of Finance Avigdor Liberman, declared Israel's accession to the digital economy taxation outline plan, and its two-pillar framework plan. In accordance with the OECD rules, a country may choose the scope and manner of adopting Pillar 2 mechanisms for its internal law, including partially. Many countries in the world already began fully or partially adopting the Pillar 2 mechanism earlier this year.
Smotrich’s decision to adopt the Pillar 2 mechanism from 2026 is based on the recommendation of the Ministry of Finance chief economist who is responsible for state revenues, the head of the budget division, and the head of the Israel Tax Authority.
The Ministry of Finance said that the decision had been adopted, among other things, to prevent Israeli resident companies from paying tax in foreign countries for income generated in Israel. At the same time, it was recommended that at this stage no additional tax collection mechanism be adopted in Israel for the income of companies in the group that are not residents of Israel (IIR and UTPR). This issue will be examined again after a period of implementation of the QDMTT mechanism in Israel has passed.
Agreeing on a flat tax is a huge change for small economies. For years some of them have acted as a tax havens for global companies since they offered them low to zero tax rates.
This is also a significant change for Israel, since some multinational companies enjoy extremely low tax rates, which can be as low as 6%, within the framework of capital investment encouragement laws. If the plan is adopted, companies like Intel, which are taxed at rates lower than 10% for setting up factories in the periphery, will be required to pay tax at the minimum rate (15%).
Published by Globes, Israel business news - en.globes.co.il - on July 28, 2024.
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