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The three GCC countries which have introduced VAT so far, UAE, KSA and Bahrain, have based themselves on the GCC VAT Treaty to draft their laws. The next country to do so, Oman, has done the same.
There is a special group of VAT payers, which fulfill a particular role as stakeholders in the VAT system. They sit on the fringes of the VAT system, not being a full on taxable person, and neither simply a payer, like private persons would be.
In the EU, this special group is sometimes called the “group of four”, or the “persons benefiting from a special regime”. These are the non taxable legal persons, the exempt tax payers, the small business and the farmers.
Together with the capital assets scheme, it is one of the more technical matters in VAT, and its status under GCC VAT is lacking clarification. Below, we explore the status of the non taxable legal persons. In the upcoming articles, we will be covering the other categories of special taxable persons in the GCC, which are listed below. Going forward we will refer to them as “special tax payers”.
GCC VAT and its origins
While not explicitly stated, the origin of the GCC VAT Framework (or “Common VAT Agreement of the States of the Gulf Cooperation Council” in full) lies in the EU VAT directive 2006/112/EC. More specifically it corresponds to the version applicable after 2011 and before 2013. The reasons for drawing inspiration from the EU VAT directive are obvious. The GCC had ambitions to copy the EU model.
For example, the Economic Agreements between the GCC States of 1981 and 2001 read like the Treaty of Rome, which established the European Union.
The GCC had ambitions to form a similar trade bloc like the EU. While it indeed negotiates free trade agreements together, internally it works in a different way. It tried to establish a currency union as well, but was unsuccessful, although given that the countries have pegged their currency (relatively closely to) the US dollar, in practice they may have implemented certain elements of the monetary union. One of the more eye catching provisions of the Economic Agreements is that GCC citizens are allowed free circulation within the GCC. Such free circulation is again exactly the same principle which applies to EU citizens.
In addition to wanting to follow in the footsteps of the EU politically, there is another good reason to incorporate EU VAT provisions. The EU has the oldest VAT systems, and has the oldest VAT systems integrated in a customs union (see https://aurifer.tax/news/the-challenges-of-drafting-tax-legislation-and-implementing-a-vat-in-the-gcc/?lid=482&p=15 for a discussion on the genesis of the laws).
The copy is never better than the original
Like VHS tapes, the copy is never better than the original. This holds even more true when the copy is made from an old original. The GCC VAT Treaty does not incorporate the important changes to the EU VAT directive entered into force in 2013, 2015 and now in 2021.
At the same time, that does not necessarily need to mean that adverse consequences are triggered for the GCC States. The UAE has for example integrated the 2015 changes in its guidance and de facto applies them (see https://www.aurifer.tax/news/e-commerce-vat-rules-in-the-gcc-a-missed-opportunity-at-perfect-harmonization-with-the-eu/?lid=482). Bahrain has done the same in its guidance for the place of supply rules applicable to telecoms services.
A special group of tax payers
Like EU VAT, GCC VAT has two important main groups of stakeholders. They are the taxable persons on the hand and the private individuals on the other. The taxable persons are the businesses complying with VAT. That means they charge it, collect it and pay it to the tax authority. The private individuals are the consumers who carry the economic burden of the VAT and pay it to the businesses. They are the ones hit with the rise in cost.
Let us say that the taxable persons are “all in” and the private individuals “all out”. The private individuals (almost) have no obligation whatsoever. Although it may surprise, they have no legal obligations, except for their contractual obligations towards their contracting parties (and for imports made by private individuals).
There is another special group though. They often go by a special name even. In France, for example, they call them the persons benefiting from a special regime (“personnes beneficiant d’un regime derogatoire”). Elsewhere they may call them the “group of four”. In this article, we refer to them as the “special tax payers”.
Whether the special tax payers have VAT obligations or not, depends on their activity. The special tax payers in the EU are:
- Small businesses
- Exempt tax payers
- Non taxable legal persons (including government bodies and charities)
- Farmers and tax payers subject to a lump sum regime
Out of these four categories, the first two need to report VAT on services they receive from abroad. The last two need to report VAT on services they receive from abroad if they are already registered for VAT purposes because they have acquired goods from other EU Member States in excess of a threshold (between EUR 35,000 and EUR 100,000).
The special tax payers in the GCC are:
- Small businesses (i.e. businesses below the mandatory registration threshold)
- Exempt tax payers
- Non taxable legal persons
- Government bodies
- Charities and Public Benefit Establishments
- Companies exempt under international event hosting agreements
- Citizens constructing their own homes
- Farmers and fishermen
The taxable person concept in the GCC
The concept of taxable person in the GCC is where the GCC deviates from more mature VAT systems. In the EU, a taxable person is “any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity”. Economic activity is then “Any activity of producers, traders or persons supplying services, including mining and agricultural activities and activities of the professions…”.
Although at first sight only subtly different, a taxable person in the GCC is “A Person conducting an Economic Activity independently for the purpose of generating income, who is registered or obligated to registered”. The last bit of the phrase is crucial.
In the EU, the registration is a consequence of the fact that an economic activity is conducted, it is not a defining element of it. Note also that it is a global concept in the EU, i.e. anyone in the world can be a taxable person. In the GCC, anyone in the world can conduct an economic activity, a subtle difference.
As a comparison, the GCC inspired itself on the UK definition of a taxable person, which is “A person is a taxable person for the purposes of this Act while he is, or is required to be, registered under this Act.”
VAT registration requirements
A Person is required to register for VAT purposes when resident in a Member State and making annual supplies in that State above the Mandatory registration threshold of SAR 375,000 (USD 100,000 or its equivalent in local currency). Non resident businesses making taxable supplies in a Member State need to be registered as from the first cents made.
A person can voluntarily register when resident in a Member State and making annual supplies in that State above the Voluntary registration threshold of SAR 187,500 (USD 50,000 or its equivalent in local currency), or incurring taxable expenses for the same value.
The GCC Member States have not deviated from this principle yet, although the UAE has set the forward looking threshold for the next 30 days instead of the next year (mimicking the UK).
Calculating the thresholds
According to the GCC VAT Treaty, and the Omani VAT law, in order to calculate the threshold, the following elements need to be included:
- The value of taxable supplies, except for capital assets (category 1)
- Value of goods and services supplied to the Taxable Person who is obliged to pay Tax (category 2)
- The value of intra-GCC supplies which have a place of supply in another State but would have been taxable had they taken place in the State of residence (category 3)
The third category is not applicable right now, as none of the GCC Member States recognize each other as Implementing States.
The first category is straightforward, the second is much less so. The second category has been implemented in the UAE to take only into account imports of goods and services. In KSA, the receipt of reverse charged purchases are taken into account (which may include goods which are already in KSA when supplied by a non-resident and therefore not imported, contrary to the UAE). KSA and Bahrain also include deemed supplies in the calculation.
The second category mentions that the recipient must be a Taxable Person. It may be a Circular reasoning, since a business may not be a Taxable Person, but as a result of purchasing from abroad may become a Taxable Person and therefore may be required to register.
The first group of Special Tax Payers - the Non Taxable Legal Persons
In this series of articles, we will be covering the special tax payers in the GCC listed above, and their VAT obligations. We start with the Non Taxable Legal Persons.
This group of special tax payers is not explicitly mentioned in any of the GCC legislations so far. Its category is created following the application of the concepts of VAT law.
It is possible that a legal entity, such as, but not limited to, LLC’s, PJSC’s, … is simply not in scope of VAT. Even though a company is usually set up to conduct business, in a number of a cases, it might not actually be conducting business from a VAT perspective. Such an entity would not constitute a taxable person.
There are a number of other situations as well though, where legal entities are in business but are not making supplies in the material scope of VAT (we are not covering supplies which are in the material scope of VAT but outside the GCC based on the place of supply rules).
Conducting an economic activity, or its colloquial term, being in business, is defined as “An activity that is conducted in an ongoing and regular manner including commercial, industrial, agricultural or professional activities or services or any use of material and immaterial property and any similar activity”.
The definition of economic activity is as broad as possible, and intended to encompass a maximum number of situations. It generally includes all types of commercial activities.
In regards to non-taxable legal persons, we therefore distinguish:
- passive legal persons
- legal persons in business but making material out of scope supplies
We discuss these in further detail below.
Passive legal persons and legal persons not in business
The first category could be described as passive legal persons. Although they are a legal entity and therefore potentially (or presumably) set up to conduct business, they do not do so. An example is a holding company, such as JAFZA offshore companies which are set up simply to hold shares or an asset (see https://www.aurifer.tax/news/more-often-than-not-jafza-offshores-need-to-register-for-vat/?lid=482&p=12 for a discussion on the matter). Another such an example is a charity not conducting business, a dormant company, or an entity only receiving subsidies.
Given the fact that they are not in business (not conducting an economic activity), they cannot qualify as a taxable person and therefore, they remain outside of the remit of the scope of VAT.
This means that they are the equivalent of a final consumer, i.e. they pay the burden of VAT since they cannot recover any input VAT. Domestic input VAT incurred in the GCC is not deductible, and, importantly, they are not required to apply the reverse charge mechanism on any services they receive from abroad.
In regards to import VAT, they are considered the equivalent of a consumer (but cannot benefit from certain import exemptions). For imports of goods by non-registered persons, the UAE’s FTA has stated that the payment of VAT needs to be made directly to the FTA, separately from the payment of customs duties. Alternatively, a non-registered person can use a courier company, with the latter unable to recover the import VAT.
Note that this is different in the EU, where this type of entities would have the obligation to pay VAT on services received from abroad, when it is already registered for VAT purposes, for example because it made intra-community acquisitions of goods from other EU Member States. Such a registration is an obligation, even if the entity does not make any other taxable supplies, but makes purchases from other EU Member States.
Legal persons in business but having materially out of scope income
A company could be conducting an economic activity, but not be making taxable supplies. An example is a business making investments in futures (although the UAE considers these exempt from VAT), recording unrealized capital gains, recording an appreciation of the value of a portfolio, or collecting dues from borrowers after purchasing a non performing loan portfolio.
The question then begs what the VAT status is of such non taxable legal persons, if it is in business but not making taxable supplies.
When such an entity is conducting an economic activity, in order to calculate the registration threshold, this category would not have any income which counts towards taxable supplies (category 1 above).
However, one also needs to count the value of category 2. As mentioned above, there is some divergence between the approaches in the GCC States. Oman and Bahrain follow the GCC VAT Treaty, taking into accounts goods and services supplied to a Taxable Person who is obligated to pay VAT, whereas KSA takes into account the receipt of goods and services, and UAE only the “imports” of goods and services by Persons.
KSA confirmed its stance, and requires foreign businesses making supplies to non taxable persons (note it does not say “legal persons”) to register “where appropriate”. Presumably, GAZT means situations where the place of supply rules designate KSA as the appropriate jurisdiction to levy tax. GAZT confirms that if the recipient is carrying out an economic activity and the recipient is not registered for VAT purposes, the receipt of services will count towards the mandatory registration threshold.
In short, this category of legal persons, when it conducts an economic activity, needs to register for VAT purposes when it exceeds the registration threshold based on expenses or imports. It will then need to apply the reverse charge mechanism on services received from abroad, and be unable to recover that VAT.
With increasing globalization and the ease of conducting international financial transactions, the G20 countries requested the OECD to develop a transparent system that would allow jurisdictions to combat off-shore tax evasion and non-compliance effectively. Although exchange of information was not a foreign concept, CRS is one example of an international evolution towards automatic exchange of information (AEOI) based on pre-defined formats. Another such an example is country by country reporting.
Drawing inspiration from the Foreign Account Tax Compliance Act (FATCA) in the USA, the OECD Council approved the Common Reporting Standards ("CRS") in 2014, enabling the automatic exchange of financial information between jurisdictions.
How does it work?
A Financial Institution (e.g. a bank) in jurisdiction A collects select information and reports it to its local competent authority. Based on this information, the local competent authority of jurisdiction A will exchange the account information of persons who are tax resident in a different jurisdiction (e.g. jurisdiction B). This information will be exchanged directly with the competent authority of the jurisdiction B on an annual basis and it will include the following information:
- Name, address, TIN, date and place of birth of the Reportable Person
- Account number
- Name and identifying number of the Reporting Financial Institution
- The balance of the account at the end of the relevant calendar year
- Gains from sale of financial assets, if any.
Upon the receipt of the above information, the tax authority of the jurisdiction B will determine whether the taxpayer discloses his income accurately and if sufficient tax is paid. This process ensures that the taxpayer fairly discloses his income in jurisdiction B and jurisdiction B rightfully receives tax that is due from the taxpayer.
A country implementing CRS adopts certain legal instruments. It includes the Multilateral Competent Authority Agreement on Automatic Exchange of Financial Information ("MCAA") and the Multilateral Convention on Mutual Administrative Assistance in Tax Matters ("MAC").
The MCAA includes the rules of exchange of information between foreign jurisdictions and also provides the infrastructure to safeguard confidential information being exchanged. As on 25 November 2020, 105 countries are signatories of the MCAA with the first exchange of information having started in September 2017.
CRS in the UAE
The UAE has opted for the widest approach for CRS and the UAE Ministry of Finance ("UAE MoF") acts as the Competent Authority in charge of CRS implementation and ultimately enables the exchange of information with foreign jurisdictions. Moreover, it has ratified both the MCAA and MAC in 2018.
The UAE has appointed multiple Regulatory Authorities for implementing CRS in the UAE, these authorities are:
- The UAE Central Bank
- The Securities & Commodities Authority
- The Insurance Authority
- Financial Free Zone Authorities such as ADGM and DIFC.
- The Ministry of Finance
With the recent merger of the Insurance Authority with the UAE Central bank, the UAE may have at least five sets of Regulations for CRS purposes.
The first exchange of information between the UAE MoF and the participating reportable jurisdictions with UAE has taken place on 30 September 2018. The USA is excluded from the CRS as, as mentioned above, it adopted its own set of legislation.
Impact on Financial Institutions
Financial institutions hold a fundamental role in the effective implementation of CRS in the country. They are intermediaries through which the regulatory authorities collect information required for exchange of information purposes.
Reportable Financial Institutions include Custodial, Depository, Investment and Insurance Institutions.
In order to determine whether a pre-existing or new account is a Reportable Account, the Financial Institutions are required to put due diligence measures in place and collect relevant information from their clients (e.g. tax residency, TIN). These due diligence measures can be incorporated into existing AML measures, KYC policies, or by obtaining and validating self-certifications from account holders.
If an Account holder is a Passive Non-Financial Entities ("Passive NFE”), the Financial Institution must also identify the identity of the natural person(s) who exercise control of the legal person via a controlling ownership. The Financial Action Task Force (‘FATF’) recommendation determines that controlling ownership interest can be based on a threshold, for example, a natural person owning more than 25% of the legal entity would be identified as the Controlling Person. If no person can be determined through ownership, Financial Institutions must also determine if a person exerts control over the legal entity through other means.
Another aspect that Financial Institutions have to consider is OECD's analysis of high-risk CBI/RBI schemes when completing due diligence procedures. Citizen by Investment (‘CBI’) or Resident by Investment (‘RBI’) schemes allow individuals to obtain citizenship or resident status by making local investments. The OECD has established a list of countries that offer such schemes which includes the UAE and Bahrain.
Additionally, financial institutions are required to submit an annual report (by 30th June in the UAE) to their regulatory authorities describing the due diligence procedures in place, the number of reportable accounts, the amounts within these accounts (in USD), and other information.
Due to their important roles in the information collection processes, Financial Institutions may incur heavy compliance costs and spend more time on validation and reporting.
The UAE Cabinet recently published Cabinet Resolution No. 5/11 of 2020 Session No. (11) which imposes a penalty of AED 1,000 on any financial institution that opens a new account without obtaining a valid self-certification or for failing to validate such self-certification.
In recent times, the UAE has taken a stricter approach towards compliance, on the one hand reinforcing the penalty framework, and on the other hand enforcing stricter compliance on financial institutions.
Impact on account holders
New and/or pre-existing account holders are requested to provide a self-certification which contains information of the individual's name, place of birth and jurisdictions the customer is tax resident.
Entities have to provide a more comprehensive self-certification form with special emphasis on entities that are Passive NFEs (which helps identify Controlling Persons).
It is crucial for individuals to determine and inform their tax residency in the self-declaration form as in principle, the financial institutions are not permitted to assist the individual in this process.
The UAE has recently expanded the definition for being a tax residence in the UAE. In case of new individuals accounts, documentary evidence of a valid UAE residence visa must be available.
Enhanced Due Diligence procedures will be carried out by the respective Financial Institution for account holders with a valid residency visa of more than 5 years and if the Financial Institution cannot validate the self-certification provided by this individual.
To discourage account holders from providing inaccurate or insufficient self-certifications, a fine amounting to AED 20,000 may be imposed on the account holder (or the controlling person).
Despite the clear Common Reporting Standards, certain structures may still lead to non reporting of financial accounts. In addition, the tax residency criteria may differ from one jurisdiction to another, and unlike for international tax, there are no treaties providing tie breaker rules. This means amongst others that persons can have dual residences, and that for example a person who has acquired residency (or citizenship) by investment could be considered as a resident in the country of investment, whereas he is actually a tax resident in another country.
The UAE however, has recently updated its tax residency definition to to take into account these RBI/CBI schemes.
Despite the rules becoming stricter and the enforcement more intense, there are still a number of service providers which propose structures to avoid CRS reporting which will ultimately not reach their goal.
Ultimately, much confidence is placed in the due diligence process with the banks. Compliance is not always straightforward for financial institutions, who depend on the information disclosed to them and might not have much additional information to compare with. Amending submitted reports is also not an easy process.
Errors in CRS reporting may lead to incorrect exchange of information and affect account holders in the long run. A convenient and lenient correction process can encourage Financial Institutions to disclose errors without the fear of facing penalties.
Ultimately, the stricter enforcement of CRS is another step towards transparency taken by the UAE and individuals and businesses need to analyze their structures from this point of view, even more so today than when CRS was introduced in the UAE.
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