Category: Int’l Tax & Transfer Pricing

Outcome statement from the OECD’s Inclusive Framework on BEPS

Post author By Liam Purcell
Post date July 14, 2023

Outcome statement from the OECD’s Inclusive Framework on BEPS

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 15^th 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/

Int'l Tax & Transfer Pricing

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

Post author By Liam Purcell
Post date January 3, 2023
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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.

Int'l Tax & Transfer Pricing

ATAD – another substance tale for the GCC

Post author By Thomas Vanhee
Post date July 1, 2020
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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.

Int'l Tax & Transfer Pricing

Negative oil prices trigger tax conundra

Post author By Thomas Vanhee
Post date April 21, 2020
No Comments on 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).

Int'l Tax & Transfer Pricing UAE Tax

UAE introduces Country by Country reporting

Post author By Thomas Vanhee
Post date December 6, 2019
No Comments on 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.

Customs & Trade Int'l Tax & Transfer Pricing

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

Post author By Thomas Vanhee
Post date August 31, 2019
No Comments on 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.

Customs & Trade Int'l Tax & Transfer Pricing

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

Post author By Thomas Vanhee
Post date July 1, 2019
No Comments on Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

At a glance

On 30 April 2019, the United Arab Emirates (“UAE”) issued Cabinet Decision No. 31 concerning economic substance requirements (“Economic Substance Regulations”). UAE onshore and free zone entities that carry on specific activities mentioned in the regulations will need to examine whether they meet the economic substance requirements. Failing to meet those will trigger penalties. But why is this at first glance inane looking piece of legislation so important for the UAE?

Background

The introduction of a legal framework regulating the economic substance criterion in the UAE is a direct consequence of the Organisation for Economic Co-operation and Development’s (“OECD”) ongoing efforts to combat harmful tax practices under Action 5 of the Base Erosion and Profit Shifting (“BEPS”) project.

It also follows the increased focus by the European Union (EU) Code of Conduct Group (“COCG”) on companies established in jurisdictions with a low or no income tax regime, resulting in the publication of the first EU list of non-cooperative jurisdictions, which currently includes the UAE (“EU Blacklist”). In response to the EU COCG initiatives, the governments of the Bahamas, Bermuda, British Virgin Islands (BVI), Cayman Islands, Guernsey, Isle of Man, Jersey, Mauritius and Seychelles introduced economic substance rules with effect from 1 January 2019.

There has also been growing interest and scrutiny from the public opinion as to whether entities established in such jurisdictions should be required to have sufficient economic substance before being able to benefit from beneficial tax regimes.

The purpose of the Economic Substance Regulations is to curb international tax planning of certain business activities, which are typically characterised by the fact that they do not require extensive fixed infrastructure in terms of human and technical capital, in a way which allows profits to be shifted to no or nominal tax jurisdictions, as opposed to taxing profits where the company has actually created economic value.

One of the reasons why the UAE has attracted so many businesses is because there is currently no income tax regime at a federal level. The economic substance legislation is specifically targeted at businesses that do not have genuine commercial operations and management in the UAE.

The main reason why the UAE has decided to introduce economic substance legislation lies in the country’s aim to further align its legislative framework with international tax practice and the standards set out in the OECD BEPS action plan.

What is economic substance?

Economic substance is a concept introduced to ensure that companies operating in a low or no corporate tax jurisdiction have a substantial purpose other than tax reduction and have an economic outcome that is aligned with value creation. In other words, economic substance requirements are used to analyze whether a company’s presence has a purpose besides the mere reduction of a tax liability.

Which entities are in scope?

The Economic Substance Regulations apply to UAE onshore and free zone entities that carry out one or more of the following activities:

Banking
Insurance
Fund management
Lease-finance
Headquarters
Shipping
Holding company
Intellectual property (IP)
Distribution and service centre

Entities that are directly or indirectly owned by the UAE government fall outside the scope of the Economic Substance Regulations.

Economic Substance Test

Entities are required to meet the Economic Substance Test when they conduct any of the above activities.

For each Activity, the regulations have defined the so-called Core Income Generating Activities (“CIGA”). This is a list of activities that must be conducted in order to meet the Economic Substance Test. For example, for intellectual property the CIGA would consist of research and development.

In general, the Economic Substance requirements will be met:

If CIGA are conducted in the UAE;
If the activities are directed and managed in the UAE;
If there is an adequate level of qualified full-time employees in the UAE,
If there is an adequate amount of operating expenditure in the UAE,
If there are adequate physical assets in the UAE.

In case the CIGA are carried out by another entity, these need to be controlled and monitored.

In accordance with EU recommendations, the regulations provide for less stringent requirements for Holding Company Businesses (“Holding Companies”).

Outsourcing

The CIGA may be outsourced, if there is adequate supervision and the outsourced activity is conducted in the UAE. Economic substance requirements will not be met if multiple Licensees outsource the same activity to the same service provider. There is no possibility for double counting the same service provider.

Reporting and compliance

Licensees will need to prepare and submit an annual report to their Regulatory Authority (Free Zone Authority or DED), within a period of twelve months after the end of each financial year. The Regulatory Authority will then submit the report to the Ministry of Finance (“Competent Authority”).

Since the Economic Substance Regulations came into effect per 30 April 2019, for existing entities, the first report will have to be submitted in 2020.

Administrative penalties and sanctions

– Failure to meet the economic substance test

AED 10,000 to AED 50,000 (First Financial Period)

AED 50,000 to AED 300,000 (Consecutive Financial Periods)

– Failure to provide information

AED 10,000 to AED 50,000

In case of continuous non-compliance, Regulatory Authorities may suspend, revoke or deny renewal of an entity’s license.

Exchange of information

If a Licensee fails to meet the Economic Substance Test for a financial year, the Regulatory Authority will inform the Minister of Finance for the financial year in question.

The Minister of Finance will then inform the foreign competent authority where the parent company, ultimate parent company or ultimate beneficial owner is established of the non compliance. This may lead in these countries to denying treaty benefits. This requires that the UAE has entered into a Treaty or similar arrangement with that country.

Takeaway – much ado about?

UAE entities involved in banking, insurance, fund management, investment holding, financing and leasing, distribution and service center, headquarter companies and intellectual property (IP) activities should asses whether their current presence and activity level meets the newly introduced Economic Substance requirements.

Where required, they make the necessary adjustments to ensure that their business is compliant with the UAE regulations which entered into force on 30 April 2019, in order to avoid administrative penalties, and potentially deregistration.

Moving away from the dusty provisions of the law, what consequences does the Economic Substance law now really trigger?

Operational companies should be little worried. They will not be impacted. The very small companies should be slightly worried. The businesses that were attracted by 50 year tax holidays and other promises and failed to develop any substantial activity in the UAE should be more worried.

How much the UAE will be effectively policing this legislation remains to be seen. Merely taking the example of Switzerland, that country had signed up to multiple exchange of information obligations but dragged its feet for the longest time.

For now though, the UAE has an argument towards the EU and, more importantly, individual countries, to get the UAE off their blacklists. This is important, since some UAE headquarters are currently being denied double tax treaty benefits in a number of countries, because of its failure to comply with international norms.

The legislation may potentially become obsolete though, if the UAE introduces Corporate Income Tax at a rate considered high enough to no longer be considered as a low tax jurisdiction.

Read our previous article on the introduction of Economic Substance Requirements in the UAE here.

Customs & Trade Int'l Tax & Transfer Pricing

UAE economic substance requirements to be implemented

Post author By Thomas Vanhee
Post date May 8, 2019
No Comments on UAE economic substance requirements to be implemented

UAE economic substance requirements to be implemented

With the impending publication of the drafting of an economic substance law in the UAE, it is important to anticipate the consequences of the introduction of such a law on the UAE and offshore structures in the UAE. The UAE currently has no such substance requirements but has been strongly encouraged by the European Union to implement them. The impact on offshore structures will be substantial.

Current lack of substance requirements

The UAE is a federation of seven emirates. There is currently no direct tax legislation on a federal level in the UAE. However, some Emirates (e.g. Abu Dhabi, Dubai, Sharjah,…) have introduced income tax regimes for oil and gas companies and foreign banks. These decrees only apply to companies which are established in one of the aforementioned Emirates. The Income Tax Decrees do not contain any substance criteria.

Partly as a result of the current lack of substance requirements in the UAE, it has become increasingly important for international companies established or operating in the UAE to prove that the entity or structure has not been set up solely for tax purposes.

Tax residency certificate

Corporations established in the UAE can apply for a ‘tax residency certificate’ (‘TRC’) with the Ministry of Finance of the UAE. A tax residence certificate (‘TRC’) is a certificate issued by the UAE government to eligible government entities, companies and individuals to benefit from Double Tax Treaties signed by the UAE.

The following documents are generally required in order to apply for the tax residency certificate:

Valid Trade License.
Certified Articles or Memorandum of association.
Copy of identity card for the Company Owners or partners or directors.
Copy of passport for the Company Owners or partners or directors.
Copy of Residence Visa for the Company Owners, partners or directors.
Certified Audited Report.
Certified Bank Statement for at least 6 months during the required year.
Certified Tenancy Contract or Title Deed.

Please note that although the requirements do not expressly mention that the certificate can only be granted to local companies, the Ministry of Finance does not issue tax residence certificates to offshore companies (not to be confused with free zone companies).

Although the TRC may be helpful to obtain benefits under double tax treaties, in itself it cannot be considered as proof of economic substance in the UAE.

Developments on substance requirements in the UAE

Background

On 1 December 1997, the EU adopted a resolution on a code of conduct for business taxation with the objective to curb harmful tax competition. Shortly thereafter, the Code of Conduct Group on Business Taxation (COCG) was set up to assess tax measures and regimes that may fall within the scope of the code of conduct for business taxation.

On 5 December 2017, the COCG published the (first) EU list of non-cooperative jurisdictions for tax purposes, in cooperation with the Economic and Financial Affairs Council (ECOFIN).

The EU applies three listing criteria, which are aligned with international standards and reflect the good governance standards that Member States comply with themselves:

Transparency: Jurisdictions should comply with the international standards on exchange of information, automatic (1.1) and on request (1.2). In addition, jurisdictions should sign the OECD’s multilateral convention or signed bilateral agreements with all EU Member States to facilitate such exchange (1.3).
Fair Tax Competition: Jurisdictions should not have harmful tax regimes (2.1) nor facilitate offshore structures which attract profits without real economic activity (2.2).
BEPS Implementation: Jurisdictions should commit to implement the OECD’s Base Erosion and Profit Shifting (BEPS) minimum standards, starting with Country-by-Country Reporting.

The UAE was initially placed on the EU Black list. However, following commitments to take appropriate measures against the above criteria, the EU transferred the UAE to the EU Grey list.

However, due to non-compliance with criterion 2.2, the UAE was subsequently put back on the Black list at the start of this year. Criterion 2.2 requires that a jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction.

Therefore, in order to fulfill its commitments to the EU, it is reasonable to expect that the substance requirements are likely to be introduced in the UAE in the foreseeable future.

In accordance with the scoping paper on criterion 2.2 published by the COCG on 22 June 2018 and the associated work of the OECD’s Forum on Harmful Tax Practices (FHTP), the below describes how businesses may be impacted and what substance requirements could potentially be introduced in the UAE in the future.

Expected substance Law requirements

The scoping paper suggest to implement the substantial activities requirement in three key steps:

(1) identify the relevant activities in their jurisdiction;

(2) impose substance requirements;

(3) ensure there are enforcement provisions in place.

According to the Scoping Paper, the economic substance test would be met if:

a) Taking into account the features of each specific industry or sector, the concerned jurisdiction introduces requirements concerning an adequate level of (qualified) employees, adequate level of annual expenditure to be incurred, physical offices and premises, investments or relevant types of activities to be undertaken.

b) The concerned jurisdiction ensures that the activities are actually directed and managed in the jurisdiction. Any UAE substance requirements are likely to further specify when this condition would be met e.g., depending on frequency of board of director meetings, directors physically present, minutes recording strategic decisions and the knowledge and expertise of the directors.

c) The core income generating activities are performed in the jurisdiction. These substance requirements should mirror the requirements used in the FHTP in the context of specified preferential regimes. As per the scoping paper, the core income generating activities for banking could be: raising funds; managing risk including credit, currency and interest risk; taking hedging positions; providing loans, credit or other financial services to customers; managing regulatory capital; and preparing regulatory reports and returns.

Comparison with the other low tax jurisdictions which introduced the substance requirements

Following the EU blacklist of non-cooperative jurisdictions, many other low and nil tax jurisdictions have introduced economic substance requirements. Jurisdictions where substance compliance is required from 2019 include Bermuda, the British Virgin Islands (BVI), the Cayman Islands, Guernsey, and Jersey.

The Economic substance Law of BVI and Cayman Island are inspired by the core requirements in the scoping paper of the COCG and the FHTP requirements. The UAE is expected to follow the same path.

Conclusion

Currently, there are no substance requirements in the UAE. Corporations established in the UAE may apply for a ‘tax residency certificate’ with the Ministry of Finance of the UAE, when they qualify. Obtaining such a ‘TRC’ does not necessarily entail that a company has economic substance in the UAE.

Considering the efforts made by the UAE with respect to compliance with the fair tax competition criteria of EU, we anticipate that the UAE will issue economic substance requirements in the very foreseeable future, similar to the ones published recently by other low tax jurisdictions.

The specific substance requirements in the UAE will likely depend on the type of activities conducted by the relevant business (e.g., banking, shipping and headquarter services would each require different substance requirements).

Businesses in the UAE should already assess their operations against the substance requirements in the light of the COCG and FHTP guidelines.

GCC Tax Int'l Tax & Transfer Pricing

KSA Transfer Pricing obligations

Post author By Thomas Vanhee
Post date March 31, 2019
No Comments on KSA Transfer Pricing obligations

KSA Transfer Pricing obligations

Early 2010’s, following the financial crisis and multiple tax scandals, such as the Panama papers and LuxLeaks, the BEPS initiative was launched by the OECD and the G20. The BEPS initiative is a set of international recommendations meant to prevent Base Erosion and Profit Shifting (international tax avoidance).

As part of the BEPS initiative, Transfer Pricing (TP) rules were put on the agenda worldwide as a means to avoid tax evasion. The first detailed and comprehensive TP rules were designed in the 1990’s. The US published regulations in 1994 and the OECD published guidelines in 1995.

Saudi Arabia is member of the G20 and was expected to adopt a comprehensive set of rules to tackle tax avoidance through transfer pricing rules. Recently, it published these By-Laws on Transfer Pricing (GAZT Board Resolution No. [6-1-19] 25/5/1440H (31/12/2018 G).

KSA’s Income Tax Law had already implemented general anti-TP avoidance measures and approved the arm’s length principle, similar to other GCC Member States. However, these new By-Laws are going a lot further in terms of defining the applicable transfer pricing principles and documentary requirements. The new obligations trigger important compliance obligations and require extensive preparation.

What is a transfer price?

A transfer price is the price agreed between entities of a same group for their internal transactions (‘controlled transactions’). Transfer pricing legislation targets the relocation of profit within the Group: one entity located in a tax haven invoices its supplies (services or goods) at an artificially high price to another entity located in a high tax jurisdiction, successfully decreasing its taxable base.

In order to avoid this artificial profit shifting, the transfer price is required to comply with the arm’s length principle. This principle requests that the controlled transaction price is determined as if the transactions were made between unrelated parties.

Who needs to comply?

All taxable persons under the KSA Income Tax Law including mixed ownership entities subject to both Income tax and Zakat must comply with these By-Laws.

Exclusive Zakat payers are not subject to TP bylaws, but must comply with CbCR requirements if they meet the threshold.

What’s new?

The By-Laws determine the applicable methods and documentation inspired directly by the OECD guidelines and BEPS reports.

KSA has approved the 5 OECD transfer pricing methods:

Comparable Uncontrolled Price Method
Resale Price Method
Cost Plus Method
Transactional Net Margin Method
Transactional Profit Split Method

A transfer pricing method other than the ones above can be adopted, provided the taxable person can prove that none of those methods provides a reliable measure of an at arm’s-length result.

Documentation

In line with the OECD recommendations, KSA requires:

A Master File and Local File to detail the Group and entities’ transfer pricing policy (notably an explanation of the applied transfer pricing method) to be prepared on an annual basis at the time of the income tax declaration (only for MNE Group with an aggregate arm’s length value of controlled transactions exceeding SAR 6,000,000 during any 12 month period);
The Country by Country Report (CbCR) to be submitted no later than 12 months after the end of the concerned reporting year for MNE groups with a consolidated turnover of more than SAR 3.2 billion.

In addition, it requires a ‘Controlled Transaction Disclosure Form’ to be submitted on an annual basis along with the income tax declaration (no threshold applies).

The By-Laws do not mention the language in which the documentation is to be maintained and filed. However, the FAQs mention that GAZT encourages to maintain and submit documentation in the official language.

It is important to note that these obligations are already applicable to fiscal years ending on 31 December 2018. This implies that the concerned companies must start preparing the required documentation. The latter must be ready within 120 days following the end of the fiscal year, i.e. by the end of April 2019 for the first concerned MNEs. However, a 60 day extension has been provided for the purposes of maintaining the Local File and Master File.

Exceptions

The draft contains certain exceptions for maintaining the Local file and the Master file. Are exempt from these obligations:

Natural persons;
Small Size Enterprises;
Legal persons who do not enter into Controlled Transactions, or who are a party to Controlled Transactions where the aggregate arm’s-length value does not exceed SAR 6,000,000 during any 12 month period.

Adjustments

Where the price is not at arm’s length, GAZT can adjust the tax base accordingly. This can result in a higher tax liability if part of a tax deduction is rejected or if it considered that the KSA entity should have charged a higher price to its foreign affiliate.

GAZT can also be informed of any TP adjustments made in another country, on a controlled transaction made with a KSA resident, if a treaty is in place with this country. GAZT can ensure the changes by the foreign authority are in line with the arm’s length principle. GAZT can subsequently make the appropriate adjustment to take into account the increase in the taxable base by the foreign tax authority.

In case GAZT disagrees with the adjustment, it can communicate and discuss with the respective foreign authority. An existing mutual agreement procedure (‘MAP’) with the foreign authority will be necessary.

Advance Pricing Agreements

An APA can safeguard companies against tax reassessments, as it provides for an agreed transfer price by the Tax Authority regarding specific transactions.

The By-Laws do not currently provide for an Advance Pricing Agreements (APA) procedure.

Tax Audit and penalties

GAZT has been working on TP for many years and is well prepared to enforce the new TP requirements. A specific tax unit, with experienced auditors, has been created to guarantee the correct implementation of these laws.

The By-Laws do not foresee penalties in case of non-compliance. However, the common penalties relating to corporate income tax apply.

Impact on the GCC

Any GCC company performing controlled transactions with a KSA company will have to comply with the KSA TP rules. The valuation of its intra-group sales must comply with the valuation methods recommended by the KSA TP rules.

In addition, GCC affiliates with a KSA headquarter will have to prepare a local file describing their own transfer pricing policy for the transactions with their KSA related parties. Important accounting information will also have to be gathered and transmitted to the KSA headquarter to be compiled in the CbCR.

Concerned entities must start to plan immediately. Practically this does not only encompass preparing the documentation. Companies must also keep evidence of the invoiced work, especially when intangible (e.g. management fees might be requested to be evidenced by proof of rendered services: announcements of internal seminars, memoranda, presentations, emails…). This implies to retain all data regarding intra-group transactions and to draft and maintain the required documentation or information and keep it up to date.

Finally, these new KSA By-Laws open the door to the implementation of TP rules in the other GCC countries, and notably in the UAE. The UAE committed to introducing a CbCR by joining the BEPS Inclusive Framework earlier in 2018.

Customs & Trade Int'l Tax & Transfer Pricing

KSA publishes long awaited DTT with UAE

Post author By Thomas Vanhee
Post date March 5, 2019
No Comments on KSA publishes long awaited DTT with UAE

KSA publishes long awaited DTT with UAE

The Double Tax Treaty (“DTT”) between the UAE and the KSA provides a significant tax incentive for businesses operating in the two contracting states. A positive impact on investment and trade between the two contracting States is expected in the aftermath of its entry into force.

This is the first DTT signed between two GCC countries. KSA is a member of the G20 and a key player in the GCC economy and on the global oil markets. It is keen to reinforce its promising investment environment. On the UAE side, the signing of this DTT reinforces its status as a regional hub for foreign investments and shows its commitment to its continued attractiveness and excellence.

Both contracting countries are members of the BEPS inclusive framework and signed the Multilateral Instrument (“MLI”). Signing such a bilateral DTT is a new step towards compliance with BEPS minimum standards – notably regarding transparency and tax avoidance. It goes hand in hand with the extensive TP legislation recently published in KSA.

This article highlights the key features of the DTT and analyses its tax implications for businesses operating in the two contracting states.

1. About the Treaty

Due to lengthy negotiations, the treaty is based on the 2014 OECD Model Tax Convention, even though the model was updated in 2017.

However, the KSA has already included this DTT in the list of its Covered Tax Agreements (“CTA”) in the MLI. It is yet to be included by the UAE, since the UAE signed the MLI shortly after the treaty.

The treaty will enter into force on the second month of the official notification between the two contracting countries. It is expected that the treaty will apply as of 1 January 2020.

2. Key Features

Persons covered

Only the “residents” of the contracting states shall benefit from this treaty.

This residence principle is generally adopted by the KSA in most of its recent treaties, contrary to the UAE which has recently opted for a citizenship criterion, such as for its recent DTT with Brazil.

Residence

As a primary definition for “resident”, the treaty uses the standard language of the OECD Model Tax Convention.

An additional interesting provision is that the DTT expressly qualifies as resident, any legal person established, existing and operating in accordance with the legislations of the contracting states and generally exempt from tax:

• if this exemption is for religious, educational, charity, scientific or any other similar reason; or

• if this person aims at securing pensions or similar benefits for employees.

Although the treaty does not specify whether the residence concept is applicable to businesses established in the Free Zones (UAE) or the Special Economic Zones (KSA), the competent tax authorities are required to coordinate to determine the requirements and conditions to be satisfied to be entitled to any tax benefit granted by this treaty.

Permanent Establishment “PE” Clause

The PE clause is largely based on the OECD Model Tax Convention, but features two elements inspired by the UN Model. It notably qualifies:

• As a PE: a building site, construction or installation project after 6 months (12 in the OECD Model)

• As a service PE: providing services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose if their presence lasts for a period or periods aggregating more than 183 days in any 12-month period

Taxes covered, rates and double taxation elimination

The DTT covers income tax and Zakat in the KSA and income tax in the UAE, inspite of the absence of a federal income tax law in the UAE.

No withholding tax regime applies in the UAE. The table added to this article shows the impact on the withholding tax rates in the KSA and the consequences of the treaty.

The DTT will not apply for royalty payments in case the beneficiary has a PE in the source country (exceptions apply). Similarly, excessive interest payments made between related parties shall not benefit from the DTT exemption.

The treaty provides for source country taxation only on income from natural resources exploration and development. The elimination of double taxation is performed through the tax credit method.

Zakat and the Treaty

Zakat is covered by the treaty (for the KSA). An interesting provision, introduced in several DTTs concluded by Saudi Arabia (e.g. Georgia, Mexico and Kazakhstan), states that “In the case of the KSA, […] the methods for elimination of double taxation will not prejudice the provisions of the Zakat collection regime.”

This provision may have an impact on Zakat for UAE businesses, considering the recent update of the Zakat implementing regulations. This notably impacts PE headquarters that might be subject to Zakat in the KSA, if specific criteria are met.

3. MAP and other provisions

The treaty provides for a Mutual Agreement Procedure (“MAP”) which can be requested to the competent authority in any of the contracting states within 3 years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention.

Investments owned by Governments (e.g. investments of Central Banks, financial authorities and governmental bodies) shall be exempt from taxes in the other contracting state. The income from such investments (including the alienation of the investment) is also exempt. The exemption does not include immovable properties or income derived from such properties.

There is no provision in the treaty for non-discrimination, assistance in the collection of taxes or territorial extension.

The entitlement to the benefits of the treaty will not be granted in case the main purpose of the transactions or the arrangements at stake is proved to be the enjoyment of such a benefit.

4. Conclusion

Even though this DTT between the KSA and the UAE is largely based on the OECD model 2014, the PE definitions it provides adopted from the UN model, broadens the scope of the activities taxable in the source countries, and will require specific attention.

The relief of withholding tax on royalties and interests, along with the MAP will reinforce the business relationships between these two countries. It is regretful that there is not a clear framework for Free Zone or Special Zone companies.

Finally, it is to be expected that the treaty will soon be notified by the UAE as a CTA under the MLI. In such case, businesses willing to benefit from this DTT will have to satisfy the Principal Purpose Test for the concerned transactions or other investment arrangements.

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Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

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KSA publishes long awaited DTT with UAE

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