Online e-commerce traders of all sizes are starting to face income taxation in more countries than before due to the OECD Multilateral Instrument (MLI). Israel is an OECD member and Israeli exporters are affected by the MLI in many countries. What is the MLI and why does it matter to the Israeli small and medium enterprise (SME) sector?
What is the MLI?
The MLI is basically a super tax treaty intended to tighten up existing bilateral tax treaties between countries in one go, especially regarding digital enterprises and e-commerce. The MLI entered into force on July 1, 2018, and over 100 countries have signed up to the MLI since that date. As a result, the MLI now covers and amends nearly 2,000 tax treaties (“covered tax agreements”). So most tax treaties are now covered by the MLI. One notable exception concerns the USA which has not yet signed up to the MLI.
How the MLI Works:
The MLI has 39 Articles. Many Articles contain sub-articles. When countries sign up to the MLI they specify which Articles and Sub-Articles they select. When two countries select the same Sub-Article, there is a match, and that Sub-Article replaces the rules on that subject in the bilateral agreement between the two countries.
So a taxpayer – SME or large - needs to know what the bilateral treaty as amended by the MLI now says.
Israel has signed up to the MLI, so Israeli importers and exporters need to be aware of its rules.
MLI Anti-Commissionaire Article 12(1):
This rule aims to catch commissionaires who sell goods they don’t own as they are really just agents (secret agents!). But the rule is broader than that. The rule says that a taxable permanent establishment (PE) may exist where:
- a person (including company) in a treaty country
- habitually concludes
- OR plays the principal role leading to the conclusion
- OF contracts routinely without material modification
- In the name of the enterprise
- OR for the transfer of ownership or use or provision of services.
- The above catches commissionaires and online agreements – they are likely to trigger a taxable PE.
MLI Article 12(2) Anti-Subsidiaries??
Israeli exporters typically set up local sales or sales support subsidiaries staffed by personnel who speak the local language, understand the local culture and accepts local payments.
MLI Article 12(2) says the local subsidiary company will be considered a dependent agent and PE of the foreign (e.g. UK) supply company if:
- the local company acts exclusively or almost exclusively
- on behalf of one or more closely related enterprises.
- Closely related means: over 50% of the aggregate vote and value of the company’s shares.
- This rule turns local sales or sales support subsidiaries into taxable PEs and opens up the books of foreign (e.g.Israeli) affiliated suppliers to local tax scrutiny. This affects both e-commerce and traditional business operations.
MLI Article 13 – Anti-preparatory or auxiliary warehouses:
Most tax treaties rule that a PE will not exist regarding purely preparatory or auxiliary activities, such as warehousing. But in the e-commerce world, warehouses often serve as fulfillment houses – products are stored, packaged, shipped off and billed to customers (e.g. Amazon). MLI Article 13 gives countries two alternative Options -,A and B.
Under Option A, no PE should exist if the OVERALL ACTIVITY of a fixed place of business (e.g, a warehouse) have a preparatory or auxiliary character (MLI Article 13(1)).
Under Option B, no PE should exist if a SPECIFIC ACTIVITY OR a combination of activities have a preparatory or auxiliary character.
Clearly Option A makes a fulfillment house more likely to be a taxable PE.
For good measure, MLI Article 13(4) says a PE should not be avoided by splitting up cohesive complementary functions between closely related enterprises or locations.
The real issue:
Aside from the difficulty in knowing which MLI rules apply in a particular country/case, we anticipate double or triple taxation. The MLI deals with income taxation – referred to as direct taxation. On top of that most countries have indirect taxes such as VAT or GST (Goods and Service Tax e.g. Canada) or Sales Tax (most US states).
The result can be 60%-70% or more combined taxation on profit. It doesn’t leave much for the supplier.
What can you do?
First, check the nexus (presence) rules in the other country concerned. Second, try to pass on the VAT/GST/Sales Tax to the customer. Third, consider changing the business model.
As always, consult experienced professional advisors in each country at an early stage in specific cases.
Leon@hcat.co
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.