On 17 July 2023 the OECD published details of the subject to tax rule (STTR) developed by the Inclusive Framework on BEPS as part of Pillar Two of the two-pillar proposals on international tax. The STTR gives jurisdictions the right to “tax back” in situations where other jurisdictions have not taxed a payment or where the payment is subject to low levels of taxation.

The STTR is a treaty-based rule applicable to certain intragroup payments from source States where the income is subject to low nominal tax rates. The STTR applies to interest, royalties, and a defined set of other payments made between connected companies.

An STTR model treaty provision and commentary have been developed. The provision is based on the principle that where, under a tax treaty, a source State has ceded taxing rights on certain outbound intragroup payments, it should be able to recover some of those rights where the income in question is taxed in the jurisdiction of the payee (the residence State) at a rate below 9%. A binding request can therefore be made by developing countries to include the provision in tax treaties with jurisdictions that have nominal tax rates below 9%. The restoration of source state taxing rights in these circumstances can assist developing countries to protect their tax base. This is particularly helpful for countries with low administrative capacity.

A multilateral instrument has been developed to enable countries to quickly include the provision in their tax treaties. The instrument will be open for signature from 2 October 2023.

Some entities are excluded from the scope of the rule on the basis of their characteristics or functions. The STTR will not apply to a payment where the recipient is an individual; a non-profit organisation; a State or part of a State; an international organisation; an investment fund that meets certain conditions (including pension funds); or a holding vehicle wholly, or almost wholly, owned by an excluded recipient.

A targeted anti-avoidance rule will combat the avoidance of the STTR by the use of intermediaries.