In 2023, the OECD/G20’s Inclusive Framework released a series of documents addressing the tax challenges of a digital economy, dubbed BEPS 2.0. One of these concerned the subject to tax rule (STTR), a key component under pillar two that primarily targets cross-border payments between related parties, which are often structured to minimise the overall tax burden on multinationals.
Purpose and scope – the STTR allows jurisdictions to ‘tax back’ where other jurisdictions have not exercised their primary taxing rights or where payments are subject to low levels of, or no, taxation. It is designed to ensure a minimum level of taxation on certain cross-border payments, particularly those subject to tax rates below 9% in the payee’s jurisdiction.
Design and function – the STTR is a treaty-based rule applicable to specific intragroup payments that are taxed at low nominal rates in the payee’s state. It restores the taxing rights to the source state when the income is taxed below 9% in the residence state.
The STTR is an important plank in the narrative of how the two-pillar project leans towards emerging and developing markets. Its introduction was a significant step towards creating a more equitable global tax system by ensuring these countries receive their fair share of tax revenues from cross-border economic activities. Because of this, the STTR presents opportunities for Egypt but also opens the door for challenges in safeguarding tax revenues and ensuring fair taxation of multinational enterprises (MNEs).
The STTR and its upsides for Egypt
The benefits of the STTR for Egypt are as follows:
Reducing tax avoidance – by ensuring a minimum tax rate of 9% on covered income, the STTR allows Egypt to address tax avoidance strategies such as profit shifting and base erosion that are used by MNEs, which often exploit low-tax jurisdictions to minimise tax liabilities;
Revenue generation – by allowing Egypt to reclaim taxing rights on certain cross-border payments currently taxed at low rates, or not at all, the STTR could boost tax revenues needed to fund public services and economic development projects;
Supporting local businesses – the rule minimises MNEs’ aggressive tax planning strategies, which have long put local players at a disadvantage; and
Encouraging compliance – by making it harder for MNEs to implement these aggressive, and often complex, tax structures, the tax environment in Egypt becomes more predictable and transparent.
Challenges and considerations
Egypt faces the following challenges in applying the STTR:
Administrative complexity – implementing the STTR requires an update to Egypt's existing domestic tax laws, which can be administratively burdensome, and requires significant resources and capacity building, such as modernising IT systems and training personnel.
Complex negotiation – the effective implementation of the STTR necessitates coordination with other jurisdictions, particularly those with which Egypt has bilateral tax treaties. Negotiating and incorporating the STTR provisions into these treaties can be a lengthy and complex process, and there may be resistance from some countries that benefit from low-tax regimes, which could complicate the STTR negotiation process.
Dampening foreign direct investment – MNEs may reconsider their investment strategies in Egypt if the STTR significantly increases their tax liabilities, which could, in turn, affect foreign direct investment inflows.
Operational cost considerations – the augmented tax burden resulting from the STTR could elevate operational costs for MNEs in Egypt. This may lead to adjustments in the pricing of goods and services in the market and contribute to inflationary pressure.
Navigating the impact of the STTR on businesses
With Egypt having established 61 double tax conventions, the STTR is poised to bring significant modifications to these treaties. The changes are likely to have implications for businesses, necessitating heightened awareness and proactive adaptation.
Implications for cross-border payments – Egyptian enterprises engaged in cross-border transactions with related entities in low-tax jurisdictions may encounter increased tax liabilities, potentially impacting their profitability. This is particularly important for businesses with intricate international operations and financial frameworks.
Strategic reassessment for MNEs – MNEs operating in Egypt will need to undertake a comprehensive reassessment of their tax planning strategies to ensure alignment with the STTR. This may entail restructuring intercompany transactions and revising transfer pricing policies to maintain compliance.
Balancing fair taxation and investment appeal
Egypt faces the critical task of balancing fair tax collection with maintaining an attractive investment climate. As the government seeks to bolster foreign currency reserves and foster a competitive, export-driven economy, it is essential to ensure that new tax regulations do not deter investment.
Reviewing tax incentive programmes – in response to the STTR, a thorough reassessment of existing tax incentive schemes, such as free zones, is necessary. This review aims to ensure these programmes remain effective and compliant with international tax standards, thereby preserving their benefits while aligning with the new regulatory framework.
Simplified compliance – streamlining the ease of doing business, including tax compliance processes, can reduce the administrative burden on businesses overall, making it easier for them to operate in Egypt and counterbalance the impact of the STTR on investment.
Key takeaways on the adoption of the STTR in Egypt
The STTR presents a significant opportunity for Egypt to enhance tax revenues and safeguard its tax base amid the challenges posed by increasing digitalisation and globalisation. By effectively navigating implementation challenges and strategically capitalising on the benefits, Egypt can fortify its tax system and foster a more equitable international taxation framework. However, it is crucial for Egypt to weigh the potential revenue gains against the possible effects on its investment appeal. This necessitates a thorough evaluation of the broader economic impacts associated with the STTR’s adoption.
For businesses, engaging with tax professionals is essential to comprehend the evolving global tax environment and its implications. It is imperative for businesses to stay informed and proactive in understanding these new regulations to ensure compliance and optimise their tax strategies.
