Shifting Sands in MENA
By Guy Taylor & Kevin McManus
Posted: 26th August 2015 09:42An insight into the changing tax landscape in the Middle East as the region looks beyond its reliance on oil and gas exports and also starts to take stock of broader international focus on the level of taxes paid by corporate groups.
Ronald Regan once said “the government’s view of the economy could be summed up in a few short phrases: if it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidise it”. It is in this manner that many countries have sought to use tax policy to both bolster the pockets of the exchequer and, where political will so decrees, to incentivise investment.
Over the past several years the MENA region, or more specifically the resilient petro-dollar economies of the Gulf, have reaped the benefit of rising oil prices. In this context taxes have remained low and governments have been able to subsidise local commerce and pursue significant investment in domestic infrastructure.
However, with crude oil declining to six year lows and concern over a global slowdown gathering pace these same countries are now looking to broaden government revenue base. Contemplating wider government deficits it is inevitable that the Gulf economies are seizing this as an opportunity to re-visit their own tax policy.
At the same time, governments of western economies, struggling with their own budgetary issues, have also turned the spotlight on corporate taxes and are attempting to develop a coordinated response (through the OECD and G20) to address perceived international tax avoidance of high profile internationals.
Base Erosion and Profit Shifting
In 2013 the OECD outlined a total of 15 actions to combat areas of so-called Base Erosion and Profit Shifting (“BEPS”) in the global economy. The BEPS Action Plan is designed to address consistency, substance and transparency in international tax matters, through a series a formal recommendations to tax authorities across the OECD member states and beyond.
As with any such project one of the biggest challenges has been to garner consensus across the international community, and to prevent countries from rushing to implement unilateral actions. Unfortunately, while Pascal Saint-Amans and his team at the OECD were working double-shifts to complete their recommendations, tax legislators in the four corners of the earth have been equally busy re-writing their own tax laws, introducing new and more aggressive anti-avoidance rules, or making radical changes to tax administration.
As such, we must consider the outputs from the BEPS initiative in the broader sense and alongside those changes that are also being pushed through unilaterally. For example, Ministries of Finance and tax authorities across the Middle East have picked up on the themes and are increasingly focusing on taxation as a means of bridging the gap in their budget deficits. Major changes in the pipeline include the proposed rollout of VAT across the GCC, consideration of CIT in the UAE and a general increase in transfer pricing related activity.
Transfer pricing scrutiny is at the heart of the BEPS Action Plan and has already become a hot topic across the Middle East as countries look at alternative measures to protect their tax base. Egypt led the field in introducing transfer pricing rules in 2005 and issuing formal transfer pricing guidelines a few years later. Qatar has adopted transfer pricing legislation in both the State and QFC tax regimes, and the tax laws in Lebanon, Oman and Saudi Arabia apply the concept of the arm’s length principle to related party transactions. As transfer pricing controversy continues to be on the rise internationally, formal transfer pricing regulations could be introduced in several countries across the region within the next year or two.
With tax authorities in the region becoming increasingly sophisticated on transfer pricing, multi-nationals should ensure they have a robust approach to service recharges, and cost allocation models in particular. Increasingly a more pro-active approach to prepare and maintain contemporaneous transfer pricing documentation in line with internationally accepted principles appears to be the best defense against scrutiny and disallowances by tax authorities.
Many multi-nationals use a hub structure to invest into the region whereby a centralised hub (e.g. for procurement, distribution, marketing etc.) is located in a traditionally low or zero tax location such as the UAE or Bahrain. The focus of the international tax community and one of the key areas of the BEPS Action Plan is to more accurately align the level of profit in such structures with the actual substance of the activities performed. While this may present a problem for some multi-nationals with only limited presence in the region, from experience there are many multi-nationals which are also under-remunerating their hub entity with respect to the value of the people functions located there and the amount/value of support being provided to other parts of the business.
Permanent Establishment (PE)
PE controversy is on the rise in the Middle East with risks not only limited to PE assertion but the added risk of profit attribution. Saudi Arabia has recently started to assert virtual service PE’s such that services provided remotely to a client in Saudi Arabia would constitute a virtual service PE. Oman has both service PE and ‘place of sale’ PE concepts in its legislation, and there is an increased focus by the tax authorities in Kuwait, Oman, Qatar and Saudi Arabia to the existence of dependent agent PE’s, particularly in the retail and distribution sectors. Separately Kuwait and Iraq continue to employ broad ranging sourcing rules, whereby generally any income source in the country leads to a corporate income tax (CIT) exposure.
Against this backdrop we see that accidental PE’s in the region are commonplace, and as the rules and practices are constantly changing, multinationals are advised to review their people movements and authority matrices within the region to avoid any unwanted accidental PE exposure
To date MENA countries have not employed any specific measures to address the taxation challenges associated with the digital economy. Going forward this may become an increasing area of focus given the relatively limited amount of tax currently collected from digitally provided services and goods. The proposed introduction of VAT would partially address this, albeit the proposed VAT rate is understood to be low (i.e. 5%).
Limitation of Interest Deductions
Egypt, Jordan, Oman and Qatar (QFC) include thin capitalisation rules in their domestic tax legislation. In addition, Iraq and Saudi Arabia also include provisions which restrict the level of interest expense allowable. Some of these rules have been only recently introduced or have been tightened, which along with WHT, further limits the potential tax benefit of debt financing.
Withholding Tax (WHT)
Collectively Middle East countries have utilised a broad range of WHT’s to minimise compliance burden on business. WHT generally operates under an ‘apply and reclaim’ system such that relief under a tax treaty is not automatic. The WHT refund claim process is inherently slow and often leads to greater scrutiny (e.g. tax residency certificates are increasingly a necessity). Moreover, refund claims are increasingly being challenged by tax authorities on the basis that the source of income creates a PE and/or should be attributable to an existing PE in the relevant jurisdiction.
For some time there have been suggestions that a GCC tax treaty would be unveiled. However currently none exists which inevitably creates PE and WHT exposure for GCC centric groups or multi-nationals operating with a GCC hub. We are seeing many multi-nationals explore ways to reorganise their businesses in the region in order to mitigate these risks and manage their cash taxes.
Exchange of information (“EOI”)
The inclusion of Article 26 of the OECD Model Convention into new bilateral tax treaties has meant that many MENA countries have improved their EOI position, and the ability to meet such requests has been simplified by the adoption of e-filing in many countries (e.g. Kuwait, Qatar, Saudi Arabia). FATCA has found widespread support within the region with Qatar, Kuwait and Saudi Arabia signing IGA’s with the US. Furthermore Qatar, Saudi Arabia and the UAE have undertaken to comply with the OECD’s CRS by 2018.
The current most topical EOI item from a corporate perspective is country by country reporting (“CbC reporting”) with would require multinational groups to annually disclose a whole raft of data to tax authorities (including revenues, profits, taxes, headcount, assets etc.), for each tax jurisdiction in which they do business. While no MENA country has formally confirmed that they will implement CbC legislation, given that the CbC reporting requirements are designed to leverage off the OECD’s CRS, it is likely that at least Qatar, Saudi Arabia and the UAE will be supportive of CbC reporting.
Guy Taylor is a Partner at EY UAE and is EY’s Transfer Pricing Leader in MENA. Kevin McManus is a Director at EY Qatar specialising in International & Transaction Tax.
EY is the leading professional services firm in the Middle East with professional tax advisors and subject matters specialists in 15 countries across the Middle East and North Africa.
The opinions expressed in the article are the personal opinions of the authors and do not necessarily reflect the views of EY.