The four GCC countries which have introduced VAT so far, UAE, KSA and Bahrain, have based themselves on the GCC VAT Treaty to draft their laws.
There is a special group of VAT payers, which have a special capacity as stakeholders in the VAT system. They sit on the fringes of the VAT system, not being a full on taxable person, and neither simply a payer, like private persons would be.
In the EU, this special group is sometimes called the “group of four”, or the “persons benefiting from an exception regime”. Together with the capital assets scheme, it is one of the more technical matters in VAT, and its status under GCC VAT is at a minimum lacking in clarification.
In a previous article, we explored the status of the non taxable legal persons (https://www.aurifer.tax/news/non-taxable-legal-persons-in-the-gcc-may-need-to-register/?lid=482). In this article, we cover the exempt table persons. In the upcoming articles, we will be covering also the other special categories of taxable persons. Going forward we will refer to them as “special tax payers”.
GCC VAT and its origins
While not stated, the origin of the GCC VAT Framework (or “Common VAT Agreement of the States of the Gulf Cooperation Council” in full) lies in the EU VAT directive 2006/112/EC. More specifically it corresponds to the version applicable after 2011 and before 2013. The reasons for drawing inspiration from the EU VAT directive are obvious. The GCC had ambitions to copy the EU model.
For example, the Economic Agreements between the GCC States of 1981 and 2001 read like the Treaty of Rome, which established the European Union.
The GCC had ambitions to form a similar trade bloc like the EU. While it indeed negotiates free trade agreements together, internally it works in a different way. It tried to establish a currency union as well, but was unsuccessful, although given that the countries have pegged their currency (relatively closely to) the US dollar, in practice they may have implemented certain elements of the monetary union. One of the more eye catching provisions of the Economic Agreements is that GCC citizens are allowed free circulation within the GCC. Such free circulation is again exactly the same principle which applies to EU citizens.
In addition to wanting to follow in the footsteps of the EU politically, there is another good reason to incorporate EU VAT provisions. The EU has the oldest VAT systems, and has the oldest VAT systems integrated in a customs union (see https://aurifer.tax/news/the-challenges-of-drafting-tax-legislation-and-implementing-a-vat-in-the-gcc/?lid=482&p=15 for a discussion on the genesis of the laws).
The copy is never better than the original
Like VHS tapes, the copy is never better than the original. This holds even more true when the copy is made from an old original. The GCC VAT Treaty does not incorporate the important changes to the EU VAT directive entered into force in 2013, 2015 and now in 2021.
At the same time, that does not necessarily need to mean that adverse consequences are triggered for the GCC States. The UAE has for example integrated the 2015 changes in its guidance and de facto applies them (https://www.aurifer.tax/news/e-commerce-vat-rules-in-the-gcc-a-missed-opportunity-at-perfect-harmonization-with-the-eu/?lid=482). Bahrain has done the same in its guidance for the place of supply rules applicable to telecoms services.
A special group of tax payers
Like EU VAT, GCC VAT has two important main groups of stakeholders. They are the taxable persons on the hand and the private individuals on the other. The taxable persons are the businesses complying with VAT. That means they charge it, collect it and pay it to the tax authority. The private individuals are the consumers who carry the economic burden of the VAT and pay it to the businesses. They are the ones hit with the rise in cost.
Let’s say that the taxable persons are “all in” and the private individuals “all out”. The private individuals have no obligation whatsoever. Although it may surprise, they have no legal obligations, except for their contractual obligations towards their contracting parties (and for imports made by private individuals).
There’s another special group though. They often go by a special name even. In France for example they call them the persons benefiting from an exceptional regime (“personnes beneficiant d’un regime derogatoire”). Elsewhere they may call them the “group of four”. In this article, we refer to them as the “special tax payers”.
Contrary to the taxable persons and the private individuals, the special tax payers are neither all in, nor all out. Whether they have VAT obligations or not, depends on their activity.
The special tax payers in the EU are:
- Exempt tax payers
- Non taxable legal persons
- Small businesses
Out of these four categories, the first three do not have any VAT obligations. The farmers are subject to special rules, but can generally opt out and follow the general rules.
An important feature of this group is that when it receives a service from abroad, it is obliged to apply the reverse charge mechanism. Indeed, for VAT purposes, it is considered as a taxable person. Equally so, when it receives goods from inside the EU, and the value exceeds a certain limit, they are liable for VAT on the intra-community acquisition (the EU internal equivalent of the import). Below, and in our next articles, we will analyze who the special tax payers are in GCC VAT. First however, we need to revisit the concept of taxable person.
The taxable person concept in the GCC
The concept of taxable person in the GCC is where the GCC deviates from more mature VAT systems. In the EU, a taxable person is “any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity.” (article 9, 1 EU VAT directive 2006/112/EC). Economic activity is then “Any activity of producers, traders or persons supplying services, including mining and agricultural activities and activities of the professions…”.(ibidem).
Although at first sight only subtly different, a taxable person in the GCC is “A Person conducting an Economic Activity independently for the purpose of generating income, who is registered or obligated to registered”. The last bit of the phrase is crucial.
In the EU, the registration is a consequence of the fact that an economic activity is conducted, it is not a defining element of it. Note also that it is a global concept in the EU, i.e. anyone in the world can be a taxable person. This last element is in stark contrast with KSA, which, strangely enough, does not acknowledge the fact that a foreign company could be a taxable person (but does require non residents in certain cases to register).
As a comparison, the GCC inspired itself on the UK definition of a taxable person, which is “A person is a taxable person for the purposes of this Act while he is, or is required to be, registered under this Act.”
Does the detail matter? In the majority of the cases it does not, but as we will demonstrate in the next section, it does sometimes. First however, we need to remind ourselves of when a business is required to register for VAT purposes.
VAT registration requirements
A Person is required to register for VAT purposes when resident in a Member State and making annual supplies in that State above the Mandatory registration threshold of SAR 375,000 (USD 100,000 or its equivalent in local currency). Non resident businesses making taxable supplies in a Member State need to be registered as from the first cents made.
A person can voluntarily register when resident in a Member State and making annual supplies in that State above the Voluntary registration threshold of SAR 187,500 (USD 50,000 or its equivalent in local currency).
The GCC Member States have not deviated from this principle yet, although the UAE has set the forward looking threshold for the next 30 days instead of the next year (mimicking the UK).
Calculating the thresholds
According to the GCC VAT Treaty, in order to calculate the threshold, the following elements need to be included:
- The value of taxable supplies, except for capital assets
- Value of goods and services supplied to the Taxable Person who is obliged to pay Tax
- The value of intra-GCC supplies which have a place of supply in another State but would have been taxable had they taken place in the State of residence
The third element is not applicable right now, as none of the GCC Member States recognize each other as Implementing States.
The first element is straightforward, the second is much less so. The second one suggests that imported goods and services received from abroad need to be counted towards the registration threshold. It mentions a Taxable Person. It may be Circular, since a business may not be a Taxable Person, but as a result of purchasing from abroad may become a Taxable Person and therefore may be required to register.
The Second group of Special Tax Payers - The Exempt tax payers
In our previous article, we discussed the non taxable legal persons. In this article, we will discuss the exempt tax payers. All GCC countries so far have established a number of supplies which are exempt.
As a legislator, one exempts supplies, not tax payers. Tax payers become exempt though because they make exempt supplies. That is why we do not have exempt sectors, only exempt supplies.
From a tax policy point of view, when applying an exemption, you remove VAT from the supplies made, however you increase the costs for businesses making exempt supplies. Those businesses cannot recover input VAT. Until recently, the GCC countries which have implemented VAT have been very conservative in applying exemptions (see https://www.aurifer.tax/news/uae-publishes-its-vat-law/?lid=482&p=16,. Oman seems to be gearing much more towards a European model, applying wide exemptions for education and healthcare (https://www.aurifer.tax/news/oman-publishes-vat-law/ ).
Below we are listing the applicable exemptions (excluding the import exemptions) in the GCC countries so far.
UAE Residential rent; Bare land; Margin based financial services; Local passenger transport
Bahrain Residential rent; Sale or lease of Bare land and buildings; Margin based financial services
KSA Residential rent; Sale building; Margin based financial services
Oman Residential rent; Sale bare land and resale residential property; Financial services; Local passenger transport; Health care; Education
The descriptions in the above table are limited, and they are much more complex in practice, especially when it comes to applying the VAT exemption for financial services. This holds even more true when it comes to the application of VAT on Shariah compliant financial products.
Due to the fact that Oman has more exemptions, the status of the exempt businesses will become more important.
In the EU we refer to them as “exempt taxable persons”, suggesting that they are taxable persons, because they conduct an economic activity, but they are part of the VAT system.
In the GCC, a business making exclusively exempt supplies is not required to register for VAT purposes, and therefore it is not a taxable person. As shown above, the exempt supplies also do not count towards the VAT registration threshold.
What is its status then? Is it similar to the EU in the sense that it may have certain obligations? When examining their status, they in principle have no registration obligation, no obligation to charge VAT on their supplies, no bookkeeping or record keeping obligations, but also importantly, no right to recover input VAT.
However, similar to the non taxable legal persons, when the exempt tax payers start “importing” services or goods, and the exceed the registration threshold, they are required to register for VAT purposes.
Application of the exemptions
As stated above, the descriptions in the above table are limited, and they are much more complex in practice, especially when it comes to applying the VAT exemption for financial services.
In the EU, exemptions need to be interpreted in a strict way, as an exception to the broad base of VAT needs to be interpreted in a limited way (cf. EU case law citation).
In the GCC, we do not have such an established principle. The FTA has stated though that it considers that the VAT legislation in the UAE prescribes a “narrow approach to the VAT exemption”.
Complex mixed status for exempt and taxable tax payers
For many exempt tax payers, the complexities arise when these tax payers are also making taxable supplies, i.e. supplies subject to 5% (15% in KSA) or 0% VAT in the GCC. This triggers a mixed situation, where they are partly entitled to input VAT recovery and partly not.
Organising that input VAT recovery for what is referred to in the EU as “mixed taxable persons”, or in the UK as a tax payer subject to the “partial exemption method” is where complexities arise.
The default method in the EU is the application of the so-called “pro rata” on the basis of the turnover. The second most prescribed method is the “direct allocation”. There are a number of other methods possible as well (e.g. floorspace, transaction count, …).
When comparing the methods in the GCC States so far, different methods have been proposed. Especially the UAE stands out with its default direct attribution method followed by a very specific type of method, an input tax based apportionment method for residual tax. For residual tax, alternative methods can be used as well, but these do not replace the initial direct attribution method, unfortunately.
KSA prescribes a direct attribution method, followed by an apportionment method based on turnover. Although Bahrain initially seemed to have followed the EU in prescribing a default turnover method leading to the calculation of a pro rata in its VAT Law (article 45), in its Executive Regulations (article 59), it reverts back to the KSA approach: a direct attribution method, followed by an apportionment method based on turnover. The same goes for Oman (article 58 of its Executive Regulations).
The available alternative methods are:
- For UAE: turnover, floorspace, transaction count, sectoral
- For KSA: input tax based apportionment, floorspace, transaction count, sectoral, number of employees
- For Bahrain: turnover, headcount, number of transactions
- For Oman: none - it is left up to the tax payer to determine an acceptable apportionment based on actual use of the goods and services and which includes an annual adjustment.
Compliance obligations and conclusion
Barring the situation where an exempt tax payer makes imports, it does not have to be registered for VAT purposes. Where the tax payer is mixed, because he makes taxable supplies, he obviously needs to register for VAT purposes when meeting the registration threshold, or can choose to do so when meeting the voluntary registration threshold. Upon registration, periodic VAT returns need to be filed, and VAT invoices issued for taxable supplies. Obviously the associated record keeping obligations need to be met as well.
The main challenge with these types of tax payers is with the calculation of their input VAT deduction, less with the registration. The applicable regime is different in the different GCC States, with especially the UAE imposing quite extensive administrative obligations.
The same thing is happening with Pillar One and Pillar Two as with BEPS. Initially, it seemed to be a topic for insiders, tax administration officials and a handful of academics, but eventually it became a topic for everyone.
Discussions around Pillar One and Pillar Two have picked up very considerable speed since the endorsement by the G7 on 5 June 2021, and the endorsement by most of the Inclusive Framework members on 1 July 2021.
With laws being drawn up in 2022, and an implementation in 2023, Pillar Two is right around the corner. In this article we analyse Pillar Two. We will leave an analysis of Pillar One for next month’s article.
What is Pillar Two?
Simply said, Pillar Two establishes a Minimum Global Tax of 15% for businesses operating in multiple jurisdictions. Those businesses need to have a consolidated turnover in excess of 750M EUR though in order to be caught be the Global anti-Base Erosion Rules (GloBE).
The minimum tax is achieved through the inclusion on the parent level of untaxed income of the subsidiary (the Income Inclusion Rule), or, as a backstop, via a rejection of the deduction of undertaxed payments (the Undertaxed Payment Rule).
In addition, a subject to tax rule applies, allowing source jurisdictions to impose a limited source taxation on certain related party payments, which will be taxed below the 15% minimum rate.
The rules are designed to create a level playing field, canceling out income declared and taxed below the minimum rate of 15%, or not at all, by having to “top up” the tax. This is done a jurisdiction basis (no consolidation between jurisdictions).
There’s an additional so-called “substance carve-out” for businesses, in jurisdictions where staff and tangible assets are used.
There are limited exemptions to be foreseen, which will be reserved for Government entities, international organisations, non-profit organisations, pension funds or investment funds that are Ultimate Parent Entities (UPE) of an MNE Group or any holding vehicles used by such entities, organisations or funds.
Do all countries have to apply it?
Technically no, but let’s call it fiscal peer pressure. Most of the Inclusive Framework members have endorsed the principles of Pillar Two. Amongst those are all GCC Member States, except Kuwait. The overwhelming majority of the important economies stand behind it, which means that the rest of the world is bound to follow.
What choices do countries have in terms of the implementation?
Countries with a corporate tax system leading to an effective taxation in excess of 15% may simply implement Pillar Two in their domestic tax legislation, with the abovementioned principles to be adopted. This means they will mainly target jurisdictions with a lower Corporate Income Tax rate, and include the top up tax in the most simple cases.
If a country however has a Corporate Income Tax below 15%, if may consider the following reforms:
- Adopt a higher rate compliant with Pillar 2 provisions. It will therefore collect more revenue.
- Adopt a higher rate compliant with Pillar 2 provisions, on a limited scale, i.e. only for businesses with a consolidated turnover in excess of 750 M EUR.
- Do nothing – this will entail that other countries will tax the revenue of the source jurisdiction.
A country with no corporate income tax, may consider implementing corporate income tax, on a limited scale, or full scale.
What will the GCC countries do?
While arguably the UAE and Bahrain face the most important choices, with a potential (limited) implementation of corporate income tax on a national level on the cards, Saudi Arabia, Qatar and Kuwait will also need to reform their laws. Potentially, Oman will not need to amend its legislation.
On an international level, if UAE and Bahrain start taxing income recorded in those jurisdictions at 15%, as long as the corporate income tax rate in the parent jurisdiction is higher, the ETR may overall be equal or lower, than in the case where the parent includes the income of the UAE/Bahraini subsidiary and taxes the income at the CIT rate of the parent, under the current circumstances. The UAE faces a double conundrum as well, in regards to the free zones and its federal structure.
Was doing nothing an option?
While the UAE and Bahrain are often heralded because of the absence of the application of corporate income tax, and their large double tax treaty network, because they were often considered a tax haven, they were subject to measures taken by other countries, therefore reducing their attractivity.
The measures taken by other jurisdictions could be:
- Monitoring payments with tax havens
- Denying participation exemption for dividends received from tax havens
- Controlled Foreign Corporations rules which include revenue recorded in tax havens in the country of the parent
- Rejection payments as deductible expenses in jurisdiction of the parent
- Imposing substance requirements on tax havens (such as those imposed under the Economic Substance Regulations)
This means that in effect today already transactions with tax havens are being targeted by other jurisdictions.
While Oman has been labeled a tax haven in the past for insufficiently exchanging information, and Saudi Arabia at some point as well for solely taxing non GCC shareholders, they undergo much less the same types of measures.
The OECD and the IF Members will further develop a more granular set of rules for Pillar Two. In the meantime, governments will start exploring policy options, and implement them over the course of 2022 and 2023.
The OECD will likely develop a new multilateral treaty to implement Pillar Two. There’s bound to be some transitional rules as well.
The adoption of Pillar One, not discussed here, and Pillar Two, are undoubtedly going to have a profound impact on the international tax landscape. Simultaneously, it will put a number of governments as well before some policy choices, which will have an important impact on a domestic level.
Businesses can already analysis what the impact will be, at a high level, or on a more detailed level, by following the detailed guidelines given by the OECD in regards to the implementation. If prior implementation of transfer pricing or substance rules provides any lessons, it is that jurisdictions often implement them wholesale in their domestic jurisdictions. Businesses can therefore anticipate now already what the impact will be. The overall design is not expected to be changed much, and therefore analysis and planning can already be conducted now.
What concrete steps could be taken are:
- Mapping the jurisdictions and the ETR under the Country by Country report which is already required to be filed by the same businesses.
- Analyse what potential policy choices the jurisdictions with a nil to low ETR may take.
- Analyse what measures are currently taken by other jurisdictions in respect of tax havens, and what impact Pillar Two might have on these transactions (i.e. identify “high risk jurisdictions”).
- Calculate the financial impact of the imposition of the Global Minimum Tax on profits in terms of the net profit after tax.
In May 2020, the KSA announced an increase in the standard VAT rate from 5% to 15% effective from 1 July 2020. Transitional rules for supplies spanning the date of the VAT rate change (1 July 2020) were introduced. In brief, these transitional rules state that if you entered into a contract prior to 11 May 2020 for supplies to be made after 1 July 2020, the 5% rate would still apply until the end of the contract, the contract renewal date or 30 June 2021 (whichever occurs first), if the customer is entitled to recover the VAT charged by the supplier in full, or if the customer was a government entity.
These transitional rules were optional, and even if the conditions were met, you could choose to apply VAT at 15% from 1 July 2020. B2C supplies were simply immediately subject to 15% VAT, as were imports of goods.
Meanwhile, the other GCC countries which implemented VAT, i.e. the UAE, Bahrain and Oman continue to apply 5% and have no plans currently to increase the VAT rate. The average VAT rate applied in the EU is approximately 21%. KSA therefore still has a relatively reasonable rate.
End of transitional period
Businesses currently applying the transitional regime, will no longer be able to avail it, and need to be mindful to apply 15% VAT for supplies rendered as from 1 July 2021.
You may still be making supplies under a contract entered into prior to 11 May 2020, where this contract has continued and was not subject to renewal, i.e. there was no cessation or renewal of the contract to trigger the end of the application of the 5% rate. In this case, where you are still charging VAT at 5%, this must end on 30 June 2021. For goods or services supplied before 30 June 2021 the 5% rate can still apply, however for all supplies made from 1 July 2021 the VAT rate of 15% must apply.
Action to be taken
Where business are currently still applying 5%, this will need to be increased as of 1 July 2021. The boxes in the VAT return where 5% output or input needs to be reported, may remain for some time. Tax payers may need to issue credit notes for initial supplies subject to 5%, and the recovery of input VAT can be done during a period of 5 years.
For businesses that had been availing the transitional regime, the cash flow impact will be significant. Caution needs to be taken as well as to expense invoices, as invoices with the wrong VAT rate will not be claimable.
Where do we go next
The Crown Prince of KSA, H.E. Mohammed Bin Salman (“MBS”), announced recently that the 15% VAT rate is a temporary measure that may last only for the coming 5 years. Increasing the VAT rate was necessary to help the ambitious government toward realizing its KSA 2030 vision.
MBS stated that the rate will reduce to a rate of 10% or even 5%. Undoubtedly, there will be new transitional provisions then.
Do not miss our webinar covering the first two quarters of 2021 from a GCC tax perspective.
Attend our webinar on 24 May and make sure you are up to date with every single tax development in the GCC.
Are you afraid you missed KSA's First Free Zone? Not sure what to do with round 2 of ESR? That you missed the Clarifications in the UAE? Did you miss the Qatari TP updates?
We will cover all important 2021 updates across the GCC and across all taxes.
The webinar is a must attend for any in-house tax person.
Registration via the following link: https://us02web.zoom.us/webinar/register/WN_kcOGTdr0Sb-vLRxNKqhjSA
Seats are limited!