Abstract
The current international tax system, designed over a century ago, struggles to address the challenges of the modern economy. While in the past it was relatively easy to define where income was generated and where business activity took place, today's digital and global economy presents new challenges arising from the fact that business activity occurs largely in the virtual space, without the need for physical presence, fundamentally different from the world for which the international tax rules were originally designed. This paper aims to contribute to the understanding of current trends in international taxation and their impact on Israel, by outlining key issues in the design of the contemporary international tax system and its trajectory. In particular, the paper presents and analyzes the emerging reform in international taxation led by the Organization for Economic Cooperation and Development (OECD), known as the "Two-Pillar Reform," assuming it progresses based on its current status. This is against the backdrop of the critical intersection between the Two-Pillar Reform and Israel's system of tax incentives and investment policy.
136 member countries signed the Statement on the Two-Pillar Reform in 2021, as part of the OECD's inclusive framework (featuring 147 countries in 2024). The two pillars of the reform focus on different yet complementary aspects related to the development of the international tax system over the past few decades and are intended to address tax shortcomings emblematic of the digital age of the global economy. Against this backdrop, the first pillar centers on taxing large and highly profitable multinational corporations. It creates a new taxing right, transferring part of the profit generated by these corporations to the destination or market countries where goods and services are provided or where the final consumer is located. In this way, the first pillar expands the tax bite of destination or market countries, allowing them to increase their tax collection. The economic impact of the first pillar is expected to be small in most countries, and accordingly also in Israel. In contrast, the second pillar establishes a global mechanism for effective minimum taxation of multinational corporations at a rate of 15%. Thus, the second pillar focuses on the phenomenon of profit shifting and base erosion that has greatly intensified in recent decades, by setting a limit to international tax competition. The scope of the second pillar is broader than that of the first pillar, it applies to a larger number of companies, and may accordingly have a more significant effect on the global economy in general and the Israeli economy in particular.
Specifically, the paper analyzes the impact of the Two-Pillar Reform on the tax incentives system and the policy required to maintain Israel's appeal for foreign investments in the new international tax-economic reality. In this context, the paper outlines and discusses three main scenarios regarding the implications of the Two-Pillar Reform for Israel’s policy, from which it emerges that the reform poses unique challenges as well as opportunities, especially in the field of tax incentives and investments. The challenges are the required changes in the tax system, resulting from the emerging reform, and their potential consequences for corporate incentives to invest in Israel. The opportunities, on the other hand, include the potential to increase revenue collection alongside possibly cutting back on the provision of tax benefits in light of the declining international tax competition and increasing international tax cooperation.
The paper's recommendations include examining the corporate tax incentive system to identify which incentives should be maintained, which should be canceled, and which should be converted into grants or benefits external to the corporate tax system, in order to protect Israel's relative advantage in attracting international investments/corporations. Furthermore, in light of the expected reduced capacity to attract international investments/corporations by means of tax benefits, the paper also recommends examining alternative investment incentives that comply with the rules of the reform, such as tax credits that turn into grants and regulatory simplification. These incentives should target companies that contribute significantly to the Israeli economy, such as investments that generate considerably more value than is reflected in corporate profits (“positive externalities”), or those that are particularly important to the economy, and have the capacity to relocate from Israel. More importantly, and more than ever, in light of the reform, it is essential to improve fundamental factors, such as education and other infrastructure, in order to strengthen Israel's position as an international business center. These steps will support Israel's economic growth and fiscal resilience.
Keywords: International corporate taxation, Profit shifting, BEPS, Multinational corporations, Tax compatition.