What Is the Subject to Tax Rule Under Pillar Two?

The Subject to Tax Rule (STTR) is a component of the international tax reform initiative known as Pillar Two. Its primary function is to grant developing countries a mechanism to tax specific payments made between related companies when the recipient is in a country with a very low corporate tax rate. The STTR is designed to address situations where a country, through a tax treaty, has given up its right to tax certain income that is then taxed at a low rate elsewhere. It allows the country where the payment originates, the source jurisdiction, to reclaim a portion of those taxing rights, helping developing nations protect their tax base.

Scope and Applicability of the Rule

The Subject to Tax Rule applies to large multinational enterprise (MNE) groups with a consolidated annual revenue of €750 million or more, aligning with the broader Pillar Two Global anti-Base Erosion (GloBE) rules. The rule targets payments made between “connected persons,” which are entities within the same MNE group under common control. This connection exists if one entity has a direct or indirect ownership interest of more than 50% in the other.

A specific set of payment types, categorized as “covered income,” falls within the scope of the STTR. These are mobile, intra-group payments often used in tax planning and include:

• Interest payments on loans between related companies
• Royalties paid for the use of intellectual property
• Insurance and reinsurance premiums
• Various financing fees
• Rental payments for the use of movable property and equipment
• Payments for services rendered between connected entities

The STTR Mechanism

The STTR is triggered when covered income is paid to a connected entity in a jurisdiction where the income is taxed below a minimum rate of 9%. To determine if this threshold is met, the rule starts with the recipient country’s nominal corporate tax rate but adjusts it for any permanent tax reductions, such as an exemption for that specific income. If this adjusted rate is below 9% and a tax treaty limits the source country’s right to tax the payment, the STTR applies.

Once triggered, the source country can charge an additional tax on the gross amount of the covered income. The calculation for this top-up tax is the difference between the 9% STTR minimum rate and the adjusted tax rate of the recipient’s jurisdiction. Any existing withholding tax that the source country is already permitted to levy under the tax treaty is subtracted from this amount.

For example, consider a $100,000 royalty payment to a connected company in a jurisdiction with a 3% tax rate on that income. The initial calculation would be 9% minus 3%, resulting in a 6% rate. If the existing tax treaty allows the source country to impose a 2% withholding tax on royalties, this is subtracted from the 6%, leaving a 4% STTR top-up tax. The source country could then levy an additional tax of $4,000 on that payment.

Interaction with Tax Treaties and GloBE Rules

The STTR is not a unilateral measure; its implementation depends on its inclusion within bilateral tax treaties. To facilitate this, the Organisation for Economic Co-operation and Development (OECD) has developed a model treaty provision and a multilateral instrument to allow countries to simultaneously amend their treaty networks to include the STTR.

The STTR’s relationship with the main Pillar Two GloBE rules—the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR)—is important. The STTR is designed to apply first, meaning the source country applies it to any applicable payments before any GloBE rule calculations are made.

Any tax paid under the STTR in the source country is then recognized as a “covered tax” in the GloBE rule calculations for the entity in the recipient jurisdiction. This coordination prevents the same low-taxed income from being taxed twice under Pillar Two. The STTR tax increases the total taxes paid on that income, which increases the entity’s Effective Tax Rate (ETR) and makes it less likely that additional top-up tax will be due under the IIR or UTPR.