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Customs & Trade Int'l Tax & Transfer Pricing Tax Updates UAE VAT

Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors

UAE publishes long awaited Cabinet Decisions on Free Zones and Medical Supplies

Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors

Explore the complexities of real estate investment taxation in the UAE with the article “Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors.”

This piece, authored by our very own Thomas Vanhee, Priyanka Naik, and Giorgio Beretta, and featured in Tax Notes International on December 18, 2023, offers a detailed look at the new corporate tax landscape effective June 1, 2023.

It provides valuable insights for both local and international investors navigating the UAE’s real estate market.

Click to read the full article and stay informed about these essential tax developments.

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Customs & Trade Int'l Tax & Transfer Pricing Tax Updates UAE VAT

Understanding the Business Response to the OECD/G20’s Pillar Two Initiative: A Survey Analysis

UAE publishes long awaited Cabinet Decisions on Free Zones and Medical Supplies

Understanding the Business Response to the OECD/G20’s Pillar Two Initiative: A Survey Analysis

Our business survey shows how ready businesses are about the OECD/G20’s Pillar Two Initiative.

Aurifer Middle East had the privilege of representing the business community at the UNCTAD’s 8th World Investment Forum held in Abu Dhabi, a reason it conducted a survey for MNE’s operating in the UAE and the Gulf to gauge where businesses stand and their readiness to adapt to the impending changes of the OECD/G20’s Pillar Two Initiative. The data and sentiments captured in this survey were shared in the forum, bringing the GCC business perspective to a global stage.

 Read our survey.

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GCC Tax Int'l Tax & Transfer Pricing

Overview Draft KSA Income Tax Law and Draft Tax Procedures Law

Overview Draft KSA Income Tax Law and Draft Tax Procedures Law

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On 25 October 2023, the Zakat, Tax and Customs Authority (“ZATCA”) in the Kingdom of Saudi Arabia (“KSA”) published the Income Tax Law Draft (“proposed Law” or “new ITL”) in the Istitlaa Portal, which aims to update the KSA’s income tax system, currently governed by the Income Tax Law (Royal Decree No. M/1 dated 1/15/1425 AH) (“current Law”). At the same time, ZATCA also published a draft of the Zakat and Tax Procedural Law on the same platform (“draft Procedural Law”).

ZATCA proposes replacing the existing Income Tax Law with a new draft that aligns with the KSA’s evolving tax landscape, embraces global best practices to stimulate investment, and streamlines compliance and transparency. In addition, it implements defensive measures against transactions with tax havens. We summarise below the main changes to the application of corporate income tax in KSA if the proposed Law comes into force.

 

Tax haven blacklist

The proposed Law provides several provisions aimed at tackling profit shifting and tax avoidance. The proposed Law introduces the concept of a preferential tax regime, which is not present in the current Law. According to the proposed Article 10(2), any transaction involving a resident or permanent establishment in a jurisdiction that employs a preferential tax regime will have special provisions applicable, which are less favourable than the normal regime. These special provisions pertain to how expenses, depreciation, WHT rates, and TP regulations are applied.

A tax regime qualifies as preferential if it meets one of the conditions outlined in the proposed Article 10(3). Likely, the most prominent situation is the one where a country applies a statutory income tax rate of less than 15%. Further, a country will also be considered to have a Preferential Tax Regime if it has no information exchange agreement or if it does not have substance requirements applicable in its jurisdiction.

The jurisdictions that fall under this preferential tax regime will be determined through a decision made jointly by the ZATCA Board and the Ministry of Foreign Affairs. In other words, they will draw up a blacklist. In the region, these provisions will impact UAE, Bahrain, Qatar and Kuwait, all countries that either tax below 15% or exempt GCC-held businesses. KSA may essentially be blacklisting those countries, and policy responses will be expected from those countries.

The WHT rate for payments to such preferential regimes will always be 20%, irrespective of the type of payment. Where there is no Double Tax Treaty (“DTT”) available with the residency country, this impact is profound. In the GCC, KSA currently only has a DTT with the UAE, although negotiations for a DTT with Qatar are underway.

Other consequences include that the participation exemption may not apply when the investee is in a jurisdiction regarded as a preferential tax regime. Further, the deductibility of expenses for payments made to preferential tax regimes may be impaired, and depreciation may not be available for the purchases of assets from preferential tax regimes.

 

Withholding taxes

The proposed Law makes a clearer division for the application of withholding taxes. Withholding taxes will be applicable for the following payments:

  • Dividends, rental payments, and interest payments: 5%
  • Payments for Services: 10%
  • Royalties: 15%

Currently, a more detailed analysis of the nature of the services is required to identify the applicable WHT rate. The amendment is a surprise given that a recent reform has already taken place. Since 12 September 2023, the WHT rate for technical and consultancy services between related parties was reduced to 5% from 15%. The draft Law would now bring all services to 10%. This is not a positive evolution, given the expansion of the economy and current interactions with non-resident suppliers. Companies in jurisdictions that have DTTs with KSA may seek shelter under those treaties unless they have a Permanent Establishment in KSA.

 

Special incentives

Article 33 of the proposed Law foresees that special tax regulations may apply. This prefaces different tax regulations related to the SEZs in KSA, the ILBZ and potentially for the RHQ in accordance with the Regional Head Quarter Regime and other potential regimes.

In the same vein, there will be deductions for R&D and incentives for Green Investments. The design of those deductions and incentives may be in line with a Qualifying Refundable Tax Credit under the Pillar Two rules. Further, the creation of an investment reserve will encourage investment in assets.

 

Updated Residency rules and Service Permanent Establishment

In comparison to the current Law, the residency Article in the proposed Law (Article 2) gives extended details to the residence criteria of the natural person and sets rules to count the days in this regard. According to the Article, less time is required for natural persons to meet the residency criteria. Most crucial is that a natural person will be a tax resident for Income Tax purposes where they conduct business-related activities, and their length of stay exceeds 90 days during a tax year and 270 days over the course of three years.

In relation to the concept of Permanent Establishment (“PE”), the current Law provides two forms of PE: the Fixed PE and Agency PE. However, since the KSA, in practice, has also been enforcing a Services PE based on its sourcing rules, the proposed Law explicitly adds the Service PE in Article 6(3) with a threshold period of 30 days in any 12 months. This is a low threshold, which is likely easily to be crossed. The OECD’s Model Tax Convention has no Services PE, and the UN Model Tax Convention which puts the threshold at 183 days in any 12 months. Where KSA has DTT’s, the provisions of the DTT will prevail.

 

Binding nature of rulings and guide and Zakat penalties

 Amongst others, the draft Procedural Law imposes penalties on non-compliant Zakat payers. It also would bind ZATCA to its own administrative guidance and rulings. This removes any ambiguity for all taxpayers as they are assured they can place reliance on the Law when in force.

 

Non-GCC national resident persons clarified to be in scope

 These provisions have caused some concern amongst expats in KSA. It was already part of the law but has been clarified. It does not constitute Personal Income Tax but rather a business tax applicable to non-GCC nationals conducting a business in KSA.

 

Adoption BEPS standards

 In the proposed Law, Article 19 includes interest deductibility limitations different from the current rules. As per these proposed rules, the net loan charges are tax-deductible only in the tax year they arise and are capped at a maximum of 30% of the adjusted earnings. This approach is considered best practice by the OECD, recommended under BEPS Action 4 and is in line with numerous other jurisdictions.

Further, the proposed Law tackles the issue of the hybrid mismatch of financial instruments between the KSA and other jurisdictions. It rejects any discounts or tax exemptions on the financial instrument if the tax is not appropriately imposed in the other country due to varying tax treatments between the KSA and that other country. Therefore, the application of such instruments will depend on the tax regime in the corresponding country. This provision is an implementation of the recommended norms under BEPS Action 2.

Further, KSA domestically also adopts a Principal Purpose Test, a norm prescribed under BEPS Action 6.

 

Consistency terms and clarifications

To ensure that the proposed Law is interpreted consistently and in a unified manner, the Law provides detailed definitions for existing terms in the current Law and consolidates them into one article rather than adding them to different articles in the proposed Law.

Furthermore, the proposed Law took a further step and included interpretation rules for undefined terms in the Law, where it has a hierarchy for different legal references starting with the meaning included in the Income Tax By-Laws through to the Accounting Standard adopted in the KSA that do not contradict to the proposed Law. There are a range of other provisions also included where their impact under the current Law is unclear.

 

Other provisions

The proposed Law treats the Partnership as fiscally non-transparent (opaque) for Tax purposes. In the current Law, the unlimited Partnership is treated as fiscally transparent.

The proposed Law explicitly states that expenses related to Real Estate Transactions Tax (“RETT”) and non-deductible VAT paid by the taxpayer will be deductible, provided these expenses are for the purpose of generating taxable income.

In this regard, it also states that any payments to a Related Person that is not at arm’s length will exclude the excess payment from being permitted as a deduction for the purpose of the proposed Law.

The statute of limitation for audits and refunds would further become five years instead of the currently applicable three years. Exit taxes apply for removing assets from KSA.

 

Pillar Two and entry into force

Currently, there are no Pillar 2 rules on the Global Minimum Tax detailed in the Draft ITL, even though many large GCC-held businesses may have an ETR below 15%, considering the application of Zakat. When they have constituent entities in other jurisdictions that implement Pillar 2, these businesses may be impacted as of 1 January 2024.

The Entry into force is foreseen for 90 days after publication in the Official Gazette. The Regulations are aimed to be issued by the ZATCA Board 180 days after issuance of the Law and would immediately enter into force after publication. Given the timelines on the public consultation, this means that the Law will likely not enter into force and be applicable before Q2 2024.

Categories
Int'l Tax & Transfer Pricing Tax Updates

Aligning Thin Capitalization Rules under Income Tax Law with OECD/G20 BEPS Action 4

Aligning Thin Capitalization Rules under Income Tax Law with OECD/G20 BEPS Action 4

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Aurifer is a boutique tax law firm with offices in Dubai (UAE), Riyadh (KSA), and Brussels (Belgium), advising governments, companies, and other stakeholders on tax policy matters all across the Gulf Cooperation Council (“GCC”) countries. We also participate in public consultations launched by international organizations such as the Organisation for Economic Cooperation and Development (“OECD”).

Aurifer is pleased to provide its comments in response to the Sultanate of Oman Tax Authority’s proposal of replacing or adding to the current thin capitalization rules applied on companies according to the Income Tax Law with recommendations stated in the OECD/G20 Base Erosion and Profit Shifting Action 4 Final Report issued on 5 October 2015 (“BEPS Action 4 Final Report”) and following implementation.

We commend Oman for its continuing efforts to align domestic tax rules and procedures with best practices developed by international organizations such as the OECD. We particularly appreciate Oman’s ongoing commitment to identify and close the gaps in the existing international tax rules and counter tax treaty abuse as part of its duties as a signatory of the Multilateral Convention to Implement Tax Treaty Related Measure to Prevent Base Erosion and Profit Shifting (“Multilateral Convention” or “MLI”). This progress has also been acknowledged by Oman’s removal from the EU list of non-cooperative jurisdictions for tax purposes on 6 October 2020.

The sections below set out specific comments in relation to the policy recommendations outlined in the BEPS Action 4 Final Report, taking into account the specificities and dynamics of Oman’s economy. We hope our comments may be useful in redrafting or updating the current thin capitalization rules under Oman’s Income Tax Law and express our endorsement of any initiative that seeks to improve legal certainty for taxpayers and tax authorities alike. We are happy to discuss the contents of this letter at your convenience.

1. Background

The Sultanate of Oman has developed various initiatives to attract investment from abroad and to stimulate multiple economic sectors. According to the latest data released by the National Centre for Statistics and Information (NCSI), Foreign Direct Investment (FDI) in Oman reached a staggering OMR 19.620 billion during the last quarter of 2022. Increasing amounts of FDI highlight the growing interest of international investors in Oman’s economy, particularly in the oil, gas, and real estate sectors.

When investing in Oman, Multinational Enterprises (MNEs) may finance investments via equity or debt financing. Although economically equivalent, the decision to pursue equity or debt financing is not neutral from a tax standpoint. This is because interest on debt constitutes a deductible expense for the payer and taxable income for the payee. On the contrary, dividends or similar equity returns are generally not deductible for the payer and simultaneously the payee may benefit from participation exemption on dividends.

In the case of intra-group arrangements, these differences in treatment may create a tax-induced bias towards debt financing, particularly if the parent company is able to claim relief, in the residence country, for interest expenses towards subsidiaries in other jurisdictions. In the case of hybrid instruments, what constitutes interest in Oman, may not necessarily constitute taxable income in the country of residence.

In a cross-border context, such as in the case of FDI in Oman, debt financing may lead to BEPS practices in the form of international debt-shifting. For instance, MNEs and other foreign companies may decide to invest in Oman through heavily debt-financed entities, sheltering local profits from Oman’s Income Tax and affecting the integrity of the country’s income tax system.

Aligning with many other countries’ experiences, Oman has already introduced various provisions in its income tax legislation to counter BEPS practices involving excessive debt financing (Chapter 9 of the Executive Regulation of the Income Tax Law). Notably, interest deduction on the loans taken from related parties is limited to twice (2:1) of the debt-to-equity ratio (Articles 41 and 42 of the Executive Regulation of the Income Tax Law). The interest deduction is further restricted if the interest rates on foreign debt are not comparable to the third-party rates or terms (Article 43 of the Executive Regulation of the Income Tax Law).

The provisions currently in place under Oman’s income tax legislation are an important first step to limiting the possibility for domestic and foreign investors to resort to debt financing too heavily.

However, the current rules fail to consider the varying levels of debt that may be needed depending on the economic sector in which the financed entity operates. They also create administrative burdens on both tax authorities and the taxpayers. Moreover, the current provisions are not sufficiently robust in tackling complex structural arrangements where the actual debt raised by the financed entity is disguised.

Overall, the existing rules do not appear sufficiently elaborated to tackle all the BEPS risks relating to the exploitation of excessive debt financing. In the following sections, we discuss possible measures to improve the alignment of the current thin capitalization rules under Oman’s Income Tax to the recommendations outlined in the BEPS Action 4 Final Report.

2. General Interest Deduction Limitation Rule

A first measure to better align the existing thin capitalization rules under Oman’s Income Tax to the recommendations outlined in the BEPS Action 4 Final Report would be implementing a General Interest Deduction Limitation Rule, calculated based on a predetermined benchmark fixed ratio. The introduction of this measure is the main recommendation outlined in the BEPS Action 4 Final Report.

Under this rule, an entity’s net deductions for interest (and payments economically equivalent to interest) are capped to a percentage (i.e., a fixed ratio) of its earnings before interest, taxes, depreciation, and amortization (“EBITDA”). In this regard, the BEPS Action 4 Final Report recommends a range of 10 – 30% of the EBITDA that should be allowed as a deductible tax expenditure. Compared with a gross interest rule, a net interest rule would reduce the risk of double taxation, as an entity’s interest income would be set against its interest expense before the interest limitation is applied. Factors such as carry-forward of disallowed interest expenditure, interest rates in the country, whether the fixed ratio rule is applied in isolation or in conjunction with other regulations, etc., play an important role in determining the level of benchmark required to be fixed.

Although relatively straightforward to apply and administer, the fixed ratio rule outlined above is a blunt tool that does not consider the varying levels of debt that entities operating in different sectors may raise. This issue can be resolved by applying the fixed ratio rule in combination with a so-called “group ratio rule”, which considers the level of debt financing within a group of companies. Setting a ratio at the group level allows a group’s entity to deduct net interest expenditure up to its group’s net third-party interest to EBITDA ratio.

We submit that introducing the fixed ratio rule, combined with a group ratio rule, is crucial to ensure that an entity’s net interest deductions are directly linked to the taxable income generated by its economic activities. From a comparative perspective in GCC countries, we note that a general interest deduction limitation rule (capped at 30% of the financed entity’s EBITDA for the relevant tax period), applicable to standalone as well as group entities, has been introduced under the UAE Corporate Tax (Article 30 of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses). Qatar instead applies an interest limitation rule similar to the current one in force in Oman, whereby interest paid to related parties on the share of debts exceeding a 3:1 ratio of the company’s equity as per the accounts is not deductible (Article 10 of Executive Regulations to Law No. 24 of 2018). No thin capitalization rules currently exist in the corporate tax legislation of Saudi Arabia and Kuwait, although both do have limitations in place for interest deductibility.

Even though a general interest deduction limitation rule, in accordance with BEPS Action 4 Final Report, may be relatively straightforward to implement, the definition of the actual meaning of the terms “Interest” and” EBITDA” requires further deliberation. The next section elaborates on the factors that may be considered while defining these terms.

3. Definition of the Terms “Interest” and “EBITDA”

The BEPS Action 4 Final Report considers the risk that standalone or group entities may easily circumvent the thin capitalization rules by disguising debt arrangements, especially if involving related entities. To this end, the BEPS Action 4 Final Report highlights the need to adopt an approach focusing on a payment’s economic substance rather than its legal form.

Based on this substance-over-form approach, the BEPS Action 4 Final Report stipulates that interest on all forms of payments that are linked to the financing of an entity, determined by applying a fixed or variable percentage to an actual or notional principal over time, must be taken into account for the purposes of the thin capitalization rules. The same considerations apply to other expenses incurred in connection with raising finance, such as arrangement and guarantee fees.

From a comparative perspective in GCC countries, we note that the UAE has followed the BEPS

Action 4 Final Report’s recommended approach in this regard. Notably, under UAE Corporate Tax (Ministerial Decision No. 126 of 2023), it is stipulated that amounts incurred in connection with raising finance shall be considered interest for the purposes of the General Interest Deduction Limitation Rule. Moreover, the concept of “interest” under UAE Corporate Tax includes other types of payments such as guarantee, arrangement, and commitment fees. It is also important to note that UAE Corporate Tax provisions ensure that interest-equivalent component on Islamic Financial Instruments are treated as interest for the purposes of the General Interest Deduction Limitation Rule. Finally, specific rules are set for capitalized interest, foreign exchange movements, and finance and non-finance leases.

In addition to the definition of “interest”, guidance would also be required to understand how EBITDA needs to be calculated, i.e., based on earnings in financial statements or the determination prescribed for income tax purposes. We believe the net interest deduction limitation computation should be based on earnings in the financial statements since the group ratio rule can only be applied based on the group’s consolidated financial statements. At the same time, however, it is appropriate that accounting EBITDA is adjusted for any tax-exempt income (e.g., dividends).

From a comparative perspective in GCC countries, we note that certain types of interest expenditure are included or excluded from the EBITDA calculation for the purposes of the General Interest Deduction Limitation Rule under UAE Corporate Tax. Among the included expenses are depreciation, amortization, and capitalized interest expenditures. On the other hand, interest expenditures relating to “Qualifying Infrastructure Projects” are excluded for EBITDA calculation purposes. Such an exclusion aligns with BEPS Action 4 Final Report’s recommendations, which provide carve-outs for interest paid on loans used to fund public-benefit projects, where the BEPS risk is reduced given the strong connection with the relevant country.

4. Carried Forward of Disallowed Interest Expenditure

The current thin capitalization rules under Oman’s Income Tax do not allow carry-forward or carry-back of disallowed interest. A permanent disallowance of net interest expense is considered economically inappropriate as it does not consider earnings volatility and possible mismatches in the timing of interest expense and EBITDA, nor major capital expenses for projects spanning multiple years which do not immediately generate revenues. The lack of carry-forward of disallowed interest under thin capitalization rules may also lead to double taxation to the extent that interest income is taxed in the hands of the payee.

To address these issues, we consider it appropriate to set up provisions under Oman’s Income tax allowing the carry-forward of disallowed interest expenditure to future years. The BEPS Action 4 Final Report advises countries to set up carry-forward mechanisms of disallowed interest expenses to reduce the impact of earnings volatility on the ability of an entity to deduct interest expense. The BEPS Action 4 Final Report also adds that this measure can help entities that incur interest expenses on long-term investments expected to generate taxable income only in later years. It also allows entities with losses to claim interest deductions when they return to profit. To reduce possible BEPS risks, strict requirements in terms of time and/or value of interest to be carried forward can be imposed.

From a comparative perspective in GCC countries, we note that the carrying-forward of disallowed interest expenses is permitted under UAE Corporate Tax for a period of 10 years (Article 30 of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses). To reduce BEPS risks, limitations exist for exploiting and carrying forward disallowed or unutilized interest expenses by standalone entities before or after joining a tax group (Ministerial Decision No. 126 of 2023). What the exact duration should be for the carry forward of losses, depends on policy preferences in the country.

5. De Minimis Rule

Unquestionably, introducing a General Interest Deduction Limitation under Oman’s Income Tax would be a major step in tackling BEPS risks involving excessive debt financing. At the same time, however, it is important to exclude from the scope of the application of this rule situations that do not pose significant BEPS risks. In this regard, the BEPS Action 4 Final Report suggests setting a de minimis threshold based on the monetary value of net interest expense. Entities or groups falling below this threshold may deduct interest expense without restrictions. Where a rule is applied at the level of an individual entity, anti-fragmentation rules might eventually be introduced to avoid abuse of the de minimis rule by a business setting up multiple entities.

Introducing a de minimis threshold to apply the fixed and group ratio rules would enable Oman to focus on entities that pose material BEPS risks relating to excessive debt financing. Being based on a monetary value, a de minimis threshold would be relatively easy to implement, while avoiding major administrative costs for taxpayers and tax authorities alike. It may also be a measure favourable to SMEs. The setting of the monetary threshold should reflect several factors, including the local economic and interest rate environment, as well as relevant tax or legal considerations.

This threshold may be reviewed and updated periodically to reflect changes in these factors.

From a comparative perspective in GCC countries, we note that the General Interest Deduction Limitation Rule under UAE Corporate Tax provides for a de minimis threshold, which applies

where the net Interest expenditure for the relevant tax period does not exceed AED 12 million (Ministerial Decision No. 126 of 2023).

6. Conclusions

We believe that the introduction of a General Interest Limitation Rule, incorporating a fixed ratio rule and group ratio rule, under Oman’s Income Tax would provide an effective framework to tackle most BEPS risks involving excessive debt financing. These rules should be accompanied by a series of other measures, notably defining the concepts of “interest” and “EBITDA”, allowing the carry-forward of disallowed interest expenditure, and setting a de minimis threshold and carve-outs for specific economic sectors. Eventually, besides a General Interest Limitation Rule, Oman might consider implementing targeted anti-avoidance rules that disallow interest expense on specific transactions showing particular BEPS risks.

Categories
Int'l Tax & Transfer Pricing

Outcome statement from the OECD’s Inclusive Framework on BEPS

Outcome statement from the OECD’s Inclusive Framework on BEPS

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An update was published by the OECD on 12 July 2023 in relation to the status of the BEPS 2.0 project following the conclusion of the 15th meeting of the OECD/G20 Inclusive Framework. With so much of the focus seemingly on Pillar Two over the last number of months, the Outcome Statement provides some important, albeit brief, updates in relation to Pillar One as well as the Subject to Tax Rule (STTR) from Pillar Two. We have summarized these below for reference: 

Pillar One – Amount A  

Text has been developed for the multilateral convention (“MLC”) on Pillar One’s Amount A. The objective of the MLC is to allow jurisdictions to exercise a domestic taxing right on a portion of residual profit of in scope MNE’s which have a defined nexus in the respective market jurisdictions, subject to the specified revenue and profitability thresholds. The MLC shall be accompanied by an Explanatory Statement setting out the common understanding and will include key features necessary for it to be prepared for signature including but not limited to:

  • Scope and operation of taxing right, 
  • Mechanism for relief of double taxation, 
  • Process for ensuring tax certainty, 
  • Conditions for the removal of existing DSTs. 

The Outcome Statement outlined that some jurisdictions have raised concerns about specific items in the MLC and efforts are underway to resolve these issues. According to the Outcome Statement, the MLC will be opened for signature in the second half of 2023 and a signing ceremony will be arranged by year-end. The objective is for the MLC to enter into force in 2025.

Additionally, the Outcome Statement announced that IF members have agreed to refrain from introducing new DSTs or similar measures during the period between 1 January 2024 and 31 December 2024. This agreement is subject to the condition that at least 30 jurisdictions accounting for at least 60% of the Ultimate Parent Entities of in-scope MNEs, sign the MLC before the end of 2023. IF members have agreed to extend this pause on DSTs to 31 December 2025 provided “sufficient” progress has been made. Sufficient has not been defined. 

Pillar One – Amount B

Amount B provides a framework for the simplified and streamlined application of the arm’s length principle to in-country baseline marketing and distribution activities. Consensus has been reached on many aspects of Amount B. However, further work will be undertaken on the following aspects: 

  • Ensuring an appropriate balance between a quantitative and qualitative approach in identifying baseline distribution activities; 
  • The appropriateness of: 
    • the pricing framework, including in light of the final agreement on scope, 
    • the application of the framework to the wholesale distribution of digital goods, 
    • country uplifts within geographic markets, and 
    • the criteria to apply Amount B utilising a local database in certain jurisdictions. 

A public consultation will be launched next week (17 July 2023) on these topics, with comments due to be submitted by 01 September 2023. Following this, a final report on Amount B will be published which will then be incorporated in the OECD TP Guidelines by January 2024. The report shall include critical items such as consideration for low-capacity jurisdictions as well as timelines for transitioning to Amount B for all jurisdictions.

Pillar Two – STTR

The OECD have completed work on both an STTR model provision and commentary as well as an MLI and Explanatory Statement to facilitate implementation. These documents will be released next week (17 July 2023) and the MLI will be open for signature from 02 October 2023. 

The STTR shall apply to certain intra-group payments (including interest and royalties) between jurisdictions where the recipient’s jurisdiction of residence imposes tax on such income at a nominal rate of below nine percent and the treaty limits the rate at which the source jurisdiction can tax such income. Subject to satisfying other conditions the STTR allows the source jurisdiction to tax the income at a rate up to the difference between nine percent and the rate imposed at the resident jurisdiction. The STTR is subject to certain exclusions, a materiality threshold, and a mark-up threshold, and is administered through an ex-post annualised charge. 

There should be a G20 meeting next week discussing the same topics, and providing further endorsement of the work so far. The Inclusive Framework meanwhile notes that over 50 jurisdictions have already taken steps towards the implementation of Pillar Two. 

Read our previous analysis on the impact of Pillar Two on the GCC here: https://aurifer.tax/pillar-two-and-the-gcc-important-consequences-for-tax-havens-and-exemptions-for-nationals/

Categories
Int'l Tax & Transfer Pricing

2022 – Inflation and the Impact of Transfer Pricing for your Business

2022 – Inflation and the Impact of Transfer Pricing for your Business

Introduction

In addition to the festivities so often associated with this time of year, December is also a time to reflect on the preceding 12 months and consider what the New Year may bring.

When we reflect on 2022, one of the defining features has been the marked increase in inflation across the globe. We have seen inflation impact all major economies in 2022, with key markets such as Europe, the United Kingdom and the United States recording their highest inflation rates in decades. Some of the key drivers have been the disruption in global supply chains of both food and energy due to the ongoing conflict in Europe, as well as the over stimulation of developed economies as a result of quantitative easing and other stimulus measures employed by governments to counteract the impact of the pandemic on global markets.

Due in part to the Gulf Cooperation Council’s (GCC) status as one of the world’s primary energy exporters, the impact of inflation has been relatively less severe than in other parts of the world. However, the GCC nations have not been immune to the rise in inflation. As of October 2022, the International Monetary Fund (IMF) reported the United Arab Emirates’ (UAE) average Consumer Price Inflation (CPI) rate was 5.2%, up from 0.2% in 2021. Similarly, Qatar’s CPI rate has increased considerably from 2.3% to 4.5% in the same timeframe.

Impact of Inflation

In a business context, the impact of inflation has been significant for both Small and Medium Enterprises (SME) and multinationals globally. Increased supply chain costs have put negative pressure on business margins and the rise in interest rates, employed as an effort to curb inflation, have impacted companies’ ability to obtain debt financing and subsequently affected cash flow and liquidity. 

Transfer pricing is predicated on the Arm’s Length Principle (ALP), which states that the commercial and financial arrangements between related parties are conducted in a manner that is consistent with arrangements between independent enterprises. In this regard, the abovementioned economic circumstances have had a profound affect on pricing arrangements between independent enterprises globally.

As such, it is important for multinationals to consider the impact of inflation on their existing transfer pricing arrangements and operating model, to determine whether an adjustment is required on a go-forward basis. For businesses operating in the UAE, where the introduction of formal transfer pricing rules is imminent, it will also be important to appropriately factor these changes in economic circumstances into any prospective transfer pricing policy/operating model.  

Given the pervasive impact transfer pricing can have on a multinational’s tax arrangements (taxable profit, Value Added Tax (VAT), customs duties etc.), it is important to be proactive in addressing these considerations for your business and appropriately factoring it into the 2023 planning cycle.  

Mechanical Impact

As outlined above, inflation can have a significant financial impact on businesses. The relative impact of inflation on the mechanical operation of a group’s transfer pricing policy is dependent on the nature of the intercompany arrangements, as well as the transfer pricing methodology applied. 

For example, a Limited Risk Distribution (LRD) entity that is remunerated with a fixed operating margin (operating profit/revenue) may require a manual transfer pricing adjustment at year-end to account for inflation, to ensure that the LRD’s margin remains aligned with the transfer pricing policy.

In contrast, where an entity performs contract manufacturing and is remunerated with a mark-up on its cost, any increase in the underlying cost base as a result of inflation should automatically be reflected in the contract manufacturer’s return, as the basis of remuneration (i.e., cost) correlates with the impact of inflation.

However, although a cost-plus return may not be disrupted from the perspective of the contract manufacturer, the higher cost base will impact the profit margin of the counterparty compared to forecasts. Below, we discuss the impact of inflation on the group and how to effectively manage these negative impacts.

Allocation of Risk, Reward and Downside Impact

Under the arm’s length principle, the attribution of business profit amongst group entities should be aligned with each entity’s relative contribution to the functions, assets, and risks of the business.

In this regard, group entities that perform high-value functions and/or assume, control, and have the financial capacity to bear the key market and other operational risks are rewarded with an entrepreneurial return. An entrepreneurial return is typically the residual system profit after rewarding related parties that perform routine activities with a fixed return (“routine returns”).

Under both examples discussed above, we considered how transfer pricing policies adapt to the impact of inflation from the perspective of maintaining the remuneration profile of the routine return entities. However, where the system profit is substantially reduced as a result of inflation or wider economic downturn, the question arises whether the existing remuneration policy remains fit for purpose and appropriately rewards each entity for its relative contribution to the group’s activities.

Under first principles, an entrepreneurial entity that retains any upside on the residual system profit should equally bear the downside risk associated with inflation/economic downturn on group profit. However, as often is the case in transfer pricing, nothing is ever so black and white.

For example, there may be commercial, regulatory, or capital requirements that could impact the entrepreneur (and the business as a whole) which would necessitate an adjustment to the group’s pricing policies to reflect market conditions. In these circumstances, an independent enterprise acting at arm’s length would be expected to re-negotiate existing arrangements to protect themselves from such consequences.

In this regard, there are a number of methods that could be employed to effectively spread downside risk amongst related parties while maintaining the arm’s length principle:

  • Selection of a lower point in the arm’s length range. The selection of a point within the interquartile range may be appropriate. An adjustment should be applied in accordance with the terms of the intercompany agreement and supported by robust documentation outlining the rationale for the adjustment, as it is likely to be challenged from the local tax authority of the routine entity.
  • Defer payments until a recovery in economic circumstances. This situation may be more relevant for royalty license arrangements. Rather than a complete forgiveness of a royalty payment, a licensor may allow licensees to defer payment until such time as the economic circumstances have improved. Again, consideration to the terms of the existing intercompany agreement and appropriate support documentation is required. It may be appropriate for the licensor to apply a small portion of interest, as the characterization of the arrangement may take the form of a loan or working capital balance.
  • New transfer pricing policy/benchmarking. Performance of an updated benchmarking or implementation of a new operating model may result in a more equitable distribution of profits/losses between group entities.

The appropriateness of the above options will depend on each business’s specific facts and circumstances, the risks for which each entity is responsible, the impact of inflation on system profit etc. We would advise that these points are considered and addressed pro-actively, as retrospective adjustments may be more likely to be challenged by tax authorities.

Finance Arrangements

As indicated above, one of the key measures adopted by central banks to counteract inflation has been to increase interest rates. These measures have had a seismic effect on capital markets and the liquidity of multinationals and SMEs. 

From a transfer pricing perspective, where the group’s external borrowing costs have increased significantly as a result of these measures, this should be appropriately reflected in prospective intercompany loans. It may be possible to reflect this change in economic circumstances through application of an increased rate of interest or the introduction of additional loan fees and charges (e.g., commitment fees, annual fees etc.) to ensure the lender is appropriately rewarded. In this regard, multinationals should ensure that their interest rate benchmarking analyses are up to date such that the group’s financing arrangements are reflective of the financial markets at the time a loan is entered into.

Inflation and higher interest rates may also affect a borrower’s key financial metrics. In the context of debt financing, this could impact the borrower’s credit rating and/or ability to demonstrate that the quantum of intercompany debt it has on its balance sheet is not excessive relative to ordinary market behavior. This in turn may impact the group’s ability to claim interest deductions on its existing or prospective debt. An assessment of these metrics is an important step to consider when determining the debt/equity mix for companies in 2023.

Separate to intercompany financing, rising interest rates may also affect the valuation of intellectual property and other assets when priced using an income-based approach. The underlying premise of this approach is that the value of an asset can be measured by the net present value of the economic benefit to be received over the life of the asset. The steps followed in applying this approach include estimating the expected cash flows attributable to an asset over its life and converting these cash flows to a net present value using an appropriate discount rate.

In principle, an increase in the cost of debt would lead to an overall increase in the discount rate applied. Ultimately, a higher discount rate would reduce the net present value (i.e., price) of the asset.

Documentation

Finally, multinationals should be considerate of the impact of inflation and other economic shocks from a documentation and benchmarking perspective.

For example, many jurisdictions allow companies to maintain a TNMM benchmarking for up to three years (with an annual financial refresh), before a full re-performance is required. This is based on the recommendation in the OECD Guidelines on the frequency of documentation updates. However, the key caveat for this allowance is that there is no change to the operating conditions, including economic circumstances, to the controlled transaction. Any of the abovementioned factors discussed may trigger the requirement to re-perform an existing benchmarking analysis.

Additionally, we note that many jurisdictions in the GCC have a strong preference for the use of local comparables (e.g., Saudi Arabia). However, in practice it is common for a benchmarking analysis to incorporate comparables from other jurisdictions, including Africa and Eastern Europe, in an arm’s length range.

The OECD Guidelines indicate that arm’s length prices may vary across different markets even for transactions involving the same property or services. As such, in order to achieve comparability, the markets in which the independent and associated enterprises operate should not have differences that have a material effect on price. In this regard, given the relative impact of inflation and other economic and political circumstances in places such as Eastern Europe compared to the GCC, these practices may no longer be appropriate over the short-term.

However, the OECD Guidelines suggest that it may still be appropriate to rely on such comparables where appropriate adjustments can be made. Where it is not possible to completely eliminate these jurisdictions from a comparable set, appropriate adjustments to reflect the difference in inflation or other economic differences should be reflected in the transfer pricing documentation.

With the forthcoming introduction of transfer pricing in the UAE, transfer pricing continues to gain momentum in the GCC. As such, multinationals should be pro-active in determining an appropriate operating model and transfer pricing policy for the region. As part of this, companies need to make sure they consider the wider global economic circumstances in addition to their specific business strategies and plan accordingly.

Categories
Int'l Tax & Transfer Pricing

ATAD – another substance tale for the GCC

ATAD – another substance tale for the GCC

’t is the season, but not the jolly one. In many European countries it is filing season. A new kid on the block causes additional headaches for European businesses, the Anti Tax Avoidance Directive, or “ATAD”.

One of the provisions of this Directive, which was implemented with effect from 2019 and therefore impacts for the first time tax reporting in 2020 covers a now relatively familiar topic in some GCC countries: substance.

Businesses in scope of the Economic Substance Regulations (“ESR”) implemented in the UAE in 2019 were recently very occupied with their ESR notifications, and potentially filings. In Bahrain the filing of the ESR report was 30 June. The ATAD is another substance tale, but with far more direct consequences.

Why ATAD?

The ATAD protects the corporate tax base in the countries of the European Union (“EU”). There are currently 27 Member States of the European Union. The UK recently left the EU.

In the ongoing focus in the EU on fighting tax avoidance, the European Commission proposed a number of anti tax avoidance measures to the Member States to protect the corporate tax base.

One of the measures is one often referred to as “CFC-rules”, or Controlled Foreign Corporation rules. Other measures included provisions to avoid hybrid mismatches, an exit tax for assets moved out of the EU, interest limitations and a General Anti Abuse Rule (“GAAR”).

The ATAD directive had to be implemented in the Member States and have effect from 1 January 2019. This year is therefore the first filing seasons where its effects are reflected in corporate tax filings.

EU CFC rules explained

CFC have the effect of re-attributing the income of a low-taxed controlled subsidiary to its parent company. The parent company adds the revenue of its subsidiary to its own taxable income.

The EU CFC rules are now harmonized between the Member States. However, even prior to the entry into force of the ATAD directive, many Member States had comparable legislation, even going back 40 years (e.g. Germany implemented them in 1972). With the EU CFC rules though, there is now a level playing field.

Subsidiaries in which a parent has a 50% interest (50% of the capital or voting rights, directly or indirectly, or the right to receive 50% of the profits), and which are only subject to low taxation, are considered CFCs.

Low taxation is defined as the actual corporate tax paid by the entity or permanent establishment and is lower than the corporate tax it would have paid had it been established in the Member State of the parent. Member States have some freedom with this provision, e.g. France says it considers a country has low taxation if its CIT rate is lower than 50% of its own rate.

The same principles apply for head offices and branches.

When a business has a CFC, the Member State can either choose to automatically integrate certain types of income (e.g. royalties, dividends, …), or only integrate non distributed income arising from non-genuine arrangements put in place for the essential purpose of obtaining a tax advantage, unless … there is substance (a “substantive economic activity”). 

What is the relation with Economic Substance Requirements?

There is no direct relation with the ESR as they were recently introduced in the UAE and Bahrain for which there are notifications to be made and reports to be filed.

However, with the CFC rules ATAD focuses amongst others on the same matter, i.e. substance. Where the ESR requires some compliance and administrative work, the ATAD has a direct tax consequence.

In terms of not meeting the substance though, the consequences under the ESR are lighter. Businesses can incur a penalty. Worst case scenario, their license can be revoked. Worse actually is the notification to the tax authority of the parent, that there is no substance. When they handle Intellectual Property, there may be an automatic notification of the tax authority of the parent jurisdiction.

Insofar as the Regulatory Authorities in the UAE and Bahrain will enforce compliance with the ESR, and they will verify substance with their licensees, there may be some of these inconvenient notifications.

Notifications may trigger tax audits in the country of the parent, and may lead the tax authority to compare the input with the corporate income tax (CIT) return filed. If that Member State has implemented the CFC rules with the substance carve out, and the CIT return does not include the income of the entity, but the notification flagged it as having insufficient substance, there may be an important issue.

The current situation was reminiscent of the introduction of VAT on 1 January 2018. Everyone is an adviser, and there’s a lack of expertise. Likely around 350,000 businesses had to ask themselves the question whether they are in scope of the ESR and whether they need to file. It was a massive exercise, similar to the scale at which the Federal Tax Authority administered the registration for VAT purposes in 2017.

The ESR notification is simple, and therefore some providers offer it cheaply. However, without a proper assessment which thinks about the long term, its consequences can be grave. 

Out of complacency adopting a too broad interpretation of the Relevant Activities means that when the Licensee files a notification declaring he is in scope of the ESR in the UAE, he needs to file an ESR report by the end of 2020, related to 2019. 

Even though the ESR report may also not turn out to be very extensive in terms of the information to be filled out, it will be much more extensive than the notification. And even though there are penalties foreseen for not filling out the notification correctly, and for not meeting the substance requirements, this is not what businesses should worry about. It is rather the direct tax consequences in the jurisdiction of the parent.

Substance compared between CFC rules and ESR

Same cookie, different flavour. The preamble to the ATAD directive mentions a “substantive economic activity”. Member States can choose not to apply the substance rule for non EU countries and use their own rules.

The criterion is not defined in detail, but neither is it in the ESR applicable in Bahrain and the UAE. In those last two jurisdictions, when a business conducts a relevant activity, they are in scope and they need to meet a substance test. In order to pass the test, you must generally show that:

  • core income generating activities are conducted
  • The activities are directed and managed in the country
  • There is an adequate level of FTE’s, Opex and physical assets

The entities regulating the ESR are in Bahrain and the UAE though, whereas for CFC purposes, the conversation is to be had with the tax jurisdiction of the parent.

Substance is not over 

The ESR Filing is done, remains the report. It does not stop there though. The tax policy changes signal an increased attention for substance. The sometimes complicated legal framework in the GCC may therefore also have to evolve. The increased attention in the EU for low tax jurisdictions means that this filing season, the CIT return in the EU has again become a bit more complicated.

Categories
Int'l Tax & Transfer Pricing

Negative oil prices trigger tax conundra

Negative oil prices trigger tax conundra

Over supply of oil and under demand due the current economic crisis caused by COVID-19 has led to WTI prices for oil fall below zero as at 21 April 2020. Storage capacity is near full and therefore expensive. In the present situation, sellers are paying buyers to take oil off of their hands.

The situation is complicated for the oil sector and adds another “unprecedented” badge to the state in which the world currently finds itself in dominated by a health and economic crisis. Like oil companies, tax authorities now also face the task of having to consider how their legal frameworks apply to negative oil prices. We analyse those issues below.

Buyers are doing sellers a service for VAT purposes

At first sight Value Added Tax rules are made for transactions happening with a positive value. They calculate VAT on the price agreed with the customer. Whether the VAT laws implicitly assume that the transactions are always at a positive value is probably debatable, but certainly not unreasonable. 

The tax authorities are expecting VAT revenue on the sales, not having to refund VAT to the sellers. Although the VAT law allows you to sell at a loss, to make no sales but have the intention of selling and still recover input VAT, hand out goods for free (taxed as deemed supplies), it does not foresee the situation of negative values charged when a good is sold.

The current situation is very similar to a furniture store charging a pick up fee for picking up your old furniture. The furniture store receives the ownership of the old furniture for free and charge a service fee for the pick-up. It then goes on to perhaps on-sell the old furniture, up-cycle it or use it for its own purposes.

Irrespective of the technical debate, tax authorities will be lukewarm to the idea to allow sellers to issue invoices with negative values. This would effectively mean that for each sale made, the tax authority would have to refund VAT to the seller. The only negative values allowed to be mentioned by sellers are usually reserved for credit notes. It therefore stands to be reasonably expected that tax authorities will take the view that buyers are rendering a service to the sellers. Therefore the buyers will need to issue an invoice to the sellers. 

Depending on the applicable place of supply rules, that service will then effectively be subject to VAT, or not. Given that most of the sellers and buyers will be businesses with full input VAT recovery, that should not constitute an issue. 

With the place of supply rules in the individual GCC countries, which deviate from the GCC VAT Framework, and their mix up with the zero rating rules (oddly imported from New Zealand), this may trigger some additional concerns for foreign sellers, which may be charged with 5% GCC VAT when the service relates to a good in the GCC. Even though a business refund is foreseen, it is only currently effectively available in the UAE, and only on condition of reciprocity.

In the UAE, VAT registered buyers of crude or refined oil are expected to apply the reverse charge mechanism on the domestic purchase of these goods. Instead of reverse charging on purchases for negative amounts, they will now likely need to apply VAT on a service. In a domestic context, this means an additional 5% VAT added for the seller, which, recoverable as it may be, will lead to added pre-financing for the seller. In KSA, local traders were already used to applying 5% VAT to each other. In Bahrain, a zero rate applies for oil and oil derivates.

It is safe to say that this is uncharted territory and that diverging opinions on the topic may emerge.

Non deductible expenses and additional withholding taxes

The situation from a corporate tax point of view seems, again prima facie, slightly more straightforward. The corporate tax is generally calculated on the basis of the books of account of the seller. From a financial point of view, and from a conceptual point of view, those books could record negative revenue (Note: the author of this article is not an accounting expert). 

Negative revenue goes untaxed, because the business is not making positive sales. However, does the negative revenue constitute a deductible expense which reduces your corporate tax liability? This issue will surely be hotly debated with the tax authorities in the GCC which will be required to take a stance.

Additionally, in countries with broad withholding tax provisions on services, like KSA, there may be an additional element of surprise. The main concern with the fact that buyers may now be providing services to the sellers, is that when such a service takes place in an international context, the Saudi payer may need to apply a withholding tax (subject to relief in double tax treaties).

Categories
Int'l Tax & Transfer Pricing UAE Tax

UAE introduces Country by Country reporting

UAE introduces Country by Country reporting

By way of a Cabinet Resolution, the UAE has introduced Country by Country reporting (“CbC reporting”). Almost simultaneously with the introduction of economic substance regulations, the UAE further implements international tax standards and joins around 80 other countries which have implemented the CbC reporting. The impact of this reporting on international corporations in the UAE cannot be understated.

Background

In the Framework of the Base Erosion and Profit Shifting (“BEPS”) project of the OECD and the G20, countries agreed, amongst others, to implement BEPS action 13 in order to tackle the shortcomings of the international tax system. 

This action prescribes that countries implement legislation requiring multinational enterprises (MNEs) to report annually and for each tax jurisdiction in which they do business certain relevant tax related information and exchange this information with other countries.

UAE implementation

The UAE’s legislation very much mirrors the standards imposed by the OECD which have been adopted in countries which have already implemented CbC reporting. It is applicable to groups which have subsidiaries in at least two tax jurisdictions. The threshold for the consolidated revenues is AED 3.15 billion.

Ultimate Parent Entities in the UAE will therefore have the obligation to file a CbC report to the Ministry of Finance (“MoF”). Certain entities in the UAE may become Surrogate Parent Entities as a result of the legislation.

The Federal Tax Authority is not involved in the process, even though according to its Establishment Law it is also competent.

There is currently no requirement to prepare master files and local files. There is additionally no requirement to file a Controlled Transactions Disclosure Form or similar, which KSA has implemented.

Information to be shared by 31 December 2019

The CbC report needs to include the amount of revenues, profits (losses) before income tax, income tax paid, income tax payable, declared capital, accrued profits, number of employees, and non-cash or cash-equivalent assets for each country. In absence of any UAE Generally Accepted Accounting Principles, it will be interesting to see what accounting methods will be used to share the information.

In addition to the above information, the tax residency of the subsidiaries needs to be disclosed, the nature of its activity or main business activities.

The notification needs to be done by the end of this year and the CbC report by the end of 2020 for companies with a financial year matching Gregorian calendar years. The portal can be found here: https://www.mof.gov.ae/en/StrategicPartnerships/Pages/Country-by-Country-Reporting.aspx

In KSA, the CbCR notification is made along with the corporate income tax or zakat declaration (within 120 days following the financial year end). In case of the CbCR filing, similar principles apply where the report must be submitted within 12 months following the end of the reporting year of the MNE group. Recently, the General Authority of Zakat and Tax of KSA has made the portal available to submit such reports: https://gazt.gov.sa/en/eServices/Pages/eServices_082.aspx.

In Qatar however, since the CbCR portal is not in place yet, only Qatari resident Ultimate Parent Entities of the MNE Group who fall within the scope of the CbCR regulations are required to submit a notification for the financial year started 1 January 2018 and also another notification with respect to financial year starting on 1 January 2019 maximum by 31 December 2019. 

The notification for two consecutive years will have to be done manually in paper form, until the online platform is set up. The notification has to be submitted to the Department of Tax Treaties and International Cooperation of the General Tax Authority of Qatar or the tax department of the Qatar Financial Center, whichever is applicable. 

Sharing of the information

The collected information will be shared by the UAE Ministry of Finance with other countries with which it has information sharing agreements. These could be bilateral treaties or the Convention on Mutual Assistance in Tax Matters. The bilateral treaties concluded by the UAE generally include a provision allowing the exchange of information.

Internationally the intention is to move towards an automatic exchange of the CbC reports. The first automatic exchanges have taken place in June 2018.

Penalties for non compliance

If businesses fail to file to comply with their obligations under the CbC reporting, they run a penalty exposure of up to AED 2,250,000.

Conclusion

The UAE is the third GCC country to implement CbCr reporting after Qatar and KSA had done so previously. The context of the UAE is slightly different, given the current absence of Federal Corporate Income Tax. Both Qatar and KSA have a form of corporate income tax.

How useful the CbC reporting is for MoF currently in absence of any Federal Corporate Tax remains to be seen. However, the introduction of the reporting will allow the UAE to be removed from domestic, European and other blacklists.

The Federal Tax Authority may be interested in the file for VAT purposes and ask tax payers to reconcile the amounts in the CbC report, as it can do today already with audited financial statements.

The importance of the introduction of CbC reporting cannot be understated. The UAE’s important neighbour, Saudi Arabia, will be very keen to examine the information in the CbC reports filed by UAE companies to verify whether it is receiving the right end of the tax portion.

Categories
Customs & Trade Int'l Tax & Transfer Pricing

10 things to know about the UAE’s Country by Country Reporting

10 things to know about the UAE’s Country by Country Reporting

The UAE is a popular destination for foreign entities to set up their businesses in the Middle East region, amongst others because there is no corporate income tax on the federal level. 

In line with international developments around tax transparency, the UAE decided to align its legislative framework with international tax practices by adopting Country by Country Reporting (“CbCR”). The adoption of BEPS Action 13 (introduction of CbCR legislation) is a strong recommendation from the OECD and is part of the wider OECD BEPS action plan and the Inclusive Framework.

Below we list the top 10 things to know for UAE businesses in relation to the new CbCR.

     1. What is a Country by Country Report?
The CbCR is a high level report through which multinational groups report relevant financial and tax information, for each tax jurisdiction in which they do business.

      2. Who does it apply to?
The reporting is compulsory for multinational groups which are present in at least two tax jurisdictions and which meet the consolidated revenue threshold of AED 3.15 billion (approx. USD 878 million) in one financial year. The subsidiaries of the group need to be linked through common ownership or control.

     3. Which entity files the CbCR?
Multinational groups have to establish which entity must submit this report, the i.e. the ultimate parent entity (“UPE”) or a surrogate parent entity (“SPE”). If the tax jurisdiction of the UPE does not have CbCR legislation or does not (automatically) exchange the reports, the tax jurisdiction of the SPE needs to file the CbCR.

The jurisdiction where the CbCR is filed will automatically exchange the information shared in the CbCR with the other tax jurisdictions in which the group is active.

    4. If the UAE entity does not file the CbCR, does it have any other obligation?
If the UAE entity is part of a multinational group, it needs to notify the UAE Ministry of Finance of the name of the entity submitting the CbCR and the tax residence of this entity before the last day of the financial reporting year (31 December 2019 for the first year). There is no formal process in place yet for notifying MoF of this.

    5. When do we submit the CbCR?
The CbCR regulations came into effect as of 1 January 2019, this means that for the financial year ending 31 December 2019, the CbCR must be submitted at the latest by 31 December 2020, and annually thereafter.

    6. What information should we provide?
The CbCR needs to include the amount of revenues, profits (losses) before income tax, income tax paid, income tax payable, declared capital, accrued profits, number of employees, and non-cash or cash-equivalent assets for each country. 

     7. What will the CbCR be used for?
The CbCR allows tax authorities around the world to automatically exchange information on taxable profits in different tax jurisdictions. The information allows the tax authorities to make a first assessment before highlighting risk jurisdictions in which too little tax is being paid.

Given the current absence of Federal Corporate Income Tax, the UAE authorities will not have a particular interest in the CbCR. Other States however will be interested in what the UAE subsidiary of the international group is reporting.

     8. How long do we keep the information?
The relevant records need to be maintained until 5 years after submitting the CbCR. The records can be kept electronically and in English.

     9. Is there a format for submitting the CbCR?
The report should be in the same format as per the OECD guidelines. Click here for Appendix C of OECD’s guide for reference.

    10. Are there any penalties for non-compliance?
(See above table)
Except for the additional daily penalty, the total fines imposed may not exceed AED 1,000,000 in one financial year.

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