- Introduction to Tax Litigation in KSA
In recent years, the Kingdom of Saudi Arabia (KSA) has gone through tremendous reforms, and tax and the Customs authorities were part of this. Going from Department of Zakat and Income Tax (DZIT) to the General Authority of Zakat and Tax (GAZT) to the Zakat, Tax and Customs Authority (ZATCA). The tax administration went from a Department to an Authority (important semantic difference), and merged with the Customs authority.
A host of tax reforms were pushed through, with the introduction of Excise Tax and VAT, the introduction of extensive Transfer Pricing rules and compliance requirements, to an increase in the VAT rate, the introduction of a Real Estate Transfer Tax and the introduction of mandatory E-invoicing.
We are even leaving out smaller reforms here, such as the increase of the Zakat rate for financial institutions, and the implementation of a look through principle for Saudi businesses to determine whether they are subject to Zakat or Corporate Income Tax.
In the years to come, we still expect a reform of the Zakat system in favor of a generalized broad-based Corporate Income Tax system, a decrease in the standard VAT rate, an upskilling of the authority to catch fraudsters more effectively, and very likely, the implementation of Pillar I and II in KSA.
The reforms and the importance tax has taken in the Kingdom, has lead to boardroom unrest. This is perfectly illustrated by the publicised tax assessments of Careem and Fetchr. The assessments are seen as at odds with the favourable business climate Saudi wishes to create. Fetchr is likely to be liquidated, and Careem is facing a tax bill exceeding $100 Million.
KSA is an interesting country for Foreign Direct Investment, but the authority may run the risk of being perceived as lacking in providing the legal certainty which taxpayers yearn for. Taxpayers sometimes remind the authority that tax does not drive the business. Business drives the business. This has led to an exponential increase in litigation with the authority. With the merging of the authorities, we expect Customs litigation to be following the same pattern going forward, similar to litigation on VAT, Corporate Income Tax and Zakat.
In this article, we have a closer look at these disputes.
- Parties and departments involved
In Saudi Arabia, the players involved in the disputes process are the taxpayers, the Authority (ZATCA) and what are effectively the specialized tax courts. These were previously managed under the General Secretariat of Tax Committees (GSTC), which now is called the General Secretariat of Zakat, Tax and Customs Committees (GSZTCC), after the merger of the Tax and Zakat committees with the Customs committees. For each type of tax, the GSZTCC has a specialized committee comprised of 3 members and a chairman. There is one of each specialized committee in Jeddah, Riyadh and Damam. Each specialized committee is further comprised of 2 levels, the preliminary level and the appellant level.
Within ZATCA, there are 3 separate departments that are potentially involved with any tax dispute.
- The Assessments and Examinations department: branch of ZATCA which initially issues the assessment or penalty and undertakes the audit.
- The Review and Objections Department: Considered the first stage of the tax dispute journey, where the taxpayer submits an objection/review request against the assessment issued by the authority.
- Internal Dispute Settlement Committee (“IDSC”): Committee responsible for dispute resolution between the Authority and the Taxable Person. Typically, but not necessarily, this department will rule on the relevant dispute following the objection department’s decision.
- Matters of dispute
Any matters concerning disputes between taxpayers and the Authority can be litigated with ZATCA, and can be ultimately ruled over by the GSZTCC. In other words, the disputes can concern VAT, RETT, Excise Tax, Zakat, Corporate Income tax, Withholding Tax, and penalties imposed by the ZATCA.
When looking at the statistics, as of September 2021, the grand majority of the cases brought before the committees concerned Zakat and VAT. Together, they make up approximately 87% of all cases.
In decreasing order of importance, the disputes brought before the GSZTCC concern Zakat, VAT, Mixed taxpayers, CIT, WHT, Excise Tax and the Real Estate Transfer Tax.
Typically, under all stages of the litigation, the plaintiff (taxpayer) will assert that ZATCA’s assessment, penalty or rejection of the objection is unwarranted.. In all stages, the burden of proof lies on the taxpayer in his capacity as the plaintiff/appellant. A different scenario occurs when ZATCA successfully appeals the decision of the preliminary committee as the GSZTCC, where it assumes the burden in proving that the first instance committee members inadequately applied the law.
- Taxpayer Rights and general principles
A taxpayer always has the right to dispute a matter upon disagreement with ZATCA. There is no set of legally defined generally applicable principles for the taxpayer and the tax authority in the Saudi legal framework.
Therefore, the general principles would apply, such a nemo censetur legem, no taxation without representation, in dubio contra fiscum …
The process is somewhat shaped by Sharia law principles which would require justice and fair treatment for all. Other Sharia principles refer to applicably of punitive actions in absence of fault and the extent of taxpayers’ obligations in contrast with the possibility to effectuate such obligations.
In practice, the tax authority adopts an assertive approach, issuing assessments sometimes contrary to its own legislation and guidance, and suggests a taxpayer follows his course with the designated litigation procedure.
There is no official procedure for settlements with ZATCA. There is the Internal Disputes Settlement Committee, which has no apparent independence from the tax authority, and may therefore not necessarily adopt an objective view despite its presumed individuality from the assessment and objection teams. A significant compromise by the taxpayer is also expected to be presented to the IDSC to accept the settlement request and proceed with negotiations.
- Statute of Limitations
Different limitations apply for the assessment of taxes to be statute barred. The general principle in KSA is 5 years, but this can be extended to 10 years. For VAT purposes, the same statute of limitations applies, but the audit period can be extended up to 20 years.
The extensions generally apply when a taxpayer does not submit a return, or submits an incomplete return with the intention to evade taxes. Tax evasion in this context is often interpreted broadly by ZATCA.
- Stages of Tax Litigation
ZATCA will usually issue a preliminary assessment, leaving some room for discussions with the taxpayer, before it issues a final assessment. Some informal communications via email will take place, where the Authority will often collect numerous documents. As granted by the law, the Authority retains the power to demand any documents it deemes necessary. Some in-person meetings may also be held with larger taxpayers prior to finalizing the assessment.
After the issuance of the final assessment, the taxpayer has 60 days to object against the assessment. ZATCA has recently also started to exercise its discretionary power granted by the law which allows it to mandate the payment in full of the disputed tax and penalties, or the provision of a bank guarantee, before the taxpayer can proceed.
Alternatively, if the taxpayer is unsuccessful in his objection, he has the option to request for a settlement or submit his case to the GSZTCC. He needs to do both within 30 days of the issuance of the decision by the Objections department. However, both avenues cannot be perused simultaneously and hence, while the settlement is running with the Internal Settlement Dispute Committee, the case with the GSTZCC is put on hold.
While resorting to the IDSC is theoretically a good approach, given that the settlement is ruled over and presided by ZATCA, the chances that the taxpayer will have a favorable outcome are on average limited. The GSTZCC case becomes active again, after the ISDC rules on the case, and the taxpayer is unhappy with the results.
The GSTZCC is really the first instance of an independent review of the case, by expert judges. Often an expert is additionally appointed in the proceedings to deliver a report. Several exchanges of memorandum are made until the committee is satisfied with the amount of information and can rule on the case. Subsequently, hearings are conducted virtually or in person. Finally, a decision is made which can be appealed against by any party within 30 days. The decision of the appellant committee is construed to be final and non-contestable by any other judicial authority.
At the primary level of the GSTZCC, only 11% of taxpayer grievances are accepted. In two thirds of the cases, the grievance of the taxpayer is refused on procedural or substantive grounds. When the case goes to the appellate level, in 50% of the cases, the appeal is not granted on substantive grounds. These statistics, coupled with the associated financial costs and time expenditure, shape a taxpayer’s options and therefore his strategy.
Contrary to the other GCC States, where the publication of case law is spotty, the GSTZCC publishes some of the cases on a relatively regular basis. Compared to the UAE, where the TDRC cases are not published, this is a stark difference.
While they do not have precedent value, it is interesting to examine a number of these, and interestingly enough, they do side with the taxpayer on a number of occasions, underscoring their independence. The ratios of these cases can however be persuasive for subsequent litigants as the authority themselves sometime refer to previous GSTZCC principles in the pleadings.
Considering the recent growth in the volume of ZATCA’s audits, the number of disputes is bound to increase substantially. This heavily neglected aspect is now on the verge of being one of the most vital areas of the Saudi Tax and Legal framework.
There are ways to avoid conflict, such as the use of advanced tax rulings, which is unfortunately not used sufficiently. Informal agreements with ZATCA have unfortunately also not resisted the test of time.
The taxpayer can seek consolation in the fact that the GSTZCC is relatively independent, and therefore, unfortunately after spending an vast amount of resources, may actually prevail. However, as numbers show, in practice, the tax authority still wins more often.
Thomas Vanhee, Mohamed AlAradi
This is a write up in respect of an event held by Aurifer and its partners earlier this year. We polled 25 tax directions in regards to the tax function in the GCC, its current status and perceptions.
Ever since being part of the team that prepared the introduction of VAT in KSA in 2017, participating in the drafting process, I have been amazed at how things have developed since then. Before 2017, the Gulf Cooperation Council States barely had tax practitioners, when compared with mature jurisdictions.
While matters have changed much, the GCC has not evolved yet into a mature tax market. This shows for example, in my view, in the disparity in salaries offered, in how there is no relation between the size and complexity of the business, and the number of tax people employed by the business.
A fragmented market
Upon the introduction of VAT, the large demand drew many interested people. Many firms started dedicating themselves to VAT. There were the usual suspects, i.e. the big4 companies. There were a few law firms which dipped their toes in the water, a few challengers and a whole range of businesses trying to cater the market, usually small .
Conspicuously, there are massive differences in the market, from a big4 partner charging USD 1,000 an hour to price challengers trying to access the biggest names in the market for hourly partner rates as low as USD 150. One can attribute that to immaturity in the market, but I expect this to continue, as there is a regional cost sensitivity, and the offer from the subcontinent to take on outsourced services is ever present.
This fragmentation shows in the hiring market as well. There are extreme differences in what is offered to tax people. According to Indeed, the average base salary for a tax director is AED approximately AED 31,000 (https://www.salaryexpert.com/salary/job/tax-director/united-arab-emirates/dubai). According to Payscale, for the same position, the average yearly salary is AED 590,000 (approx. AED 49,166 per month).
At the lower levels, we see the same disparity. One ad offers AED 6,000-8,000 per month for a “VAT auditor” with at least one year of experience. The same outfit offers AED 3,500 for an “Excise Tax Auditor”. Another one is for an “Accounts Executive” and offers AED 2,400-2,800 per month, and asks that the applicant is “updated with FTA rules and regulations”.
At present though, a sufficient level of maturity does not seem to have reached. Important GCC businesses where one would expect multiple people in the tax department sometimes have no tax department. Smaller tax departments are sometimes found in mid size companies. From discussing with these businesses, the fact that there is no tax department in some of the big companies is not explained by the fact that the function is outsourced, as the work is done by accountants in the Finance department.
The tax function
Businesses have struggled identifying the right place for the tax function, the right role and responsibilities, and also the right remuneration.
One of the questions is for example whether the tax function should sit with the Finance Department, or with the Legal Department. The tax function is naturally at the intersection of a number of functions, as it needs to deal as well with the Logistics department and IT.
How much Legal work does the tax function do?
The Tax function should engage with the legal department on what positions to take in key contracts. It should engage with the CFO to understand tax provisions taken. It should discuss with the tax authorities key positions taken, or strategise these positions to understand and assess the risks.
How much Accounting work does the tax function do?
The Tax function should guide the internal accountants in respect of the preparation and filing of tax filings, whether it is VAT returns, Economic Substance Returns, Corporate Income Tax returns, Country by Country reports, etc.
In many organizations, even if there is a Head of Tax, the returns are still filed by the Finance Department. The Head of Tax is probably happy not to bear the responsibility but is it not giving away too much responsibility? It begs the question of centralized compliance versus decentralized compliance.
Organising the tax function
What do you need to start the tax function? Do you require an expert in CIT, VAT, or Transfer Pricing? Do you need an all around person? Do yo need an accountant, a lawyer or otherwise? Accountants can’t read and lawyers can’t count, right? The balance is sometimes delicate, but getting it right means getting your tax function right, which is important.
Results of our survey with in house tax directors
Who better to ask these questions, than the tax directors themselves? We asked 11 polling questions to 25 in house tax persons. Some of the results, may surprise you, others may not.
Question 1 The importance of the Tax Function in the GCC is underestimated
All attendees agreed and one had no opinion. Perhaps this shows a certain level of immaturity in the market, or just basic human need for recognition.
Question 2 The Tax Function in the GCC is undervalued in terms of its remuneration.
88% agreed with this statement. Surprisingly enough, one person disagreed. How much of this is attributable to a wish to make more, versus the undervaluation inside a company of the function, is hard to say.
Question 3 The Tax Function should be handled by who?
60% of respondents indicated that the Tax Function should be handled by a combination of Accountants, Lawyers and Economists. 32% said the Tax Function should be handled by an accountant. When the EU VAT system gained in considerable complexity in 1993, a similar way of thinking was present in the minds of companies. Tax was an accounting matter. With time, the tax departments started to develop independently.
Question 4 The tax function should report to who?
88% stated the tax function should report to the CFO. 8% said to the CEO and 4% to the Chief Legal Officer. This seems to be aligned to the current structures in many companies.
Question 5 The bigger the company, the more people the tax team should have
60% said they agreed. 28% disagreed.
Question 6 The key driver of a Tax Function should be
88% responded the driver is to support the business in the most efficient way. 12% answered it was to minimize disputes. No respondent answered that it was to maximize tax savings. That is perhaps indicative of a low amount of tax planning being conducted.
Question 7 Filing VAT returns should be handled by
16% answered they should be handled by the Finance department, while 84% replied they should be handled by the Tax Department. The respondents were therefore considerably in favor of centralized compliance.
Question 8 Why do I outsource work ?
The grand majority (72%) replied they wanted a second pair of eyes. 20% said they lacked the internal resources. 4% said they lacked the technology.
Question 9 Consultants are worth their money
60% agreed here, while 20% disagreed, and the rest had no opinion. The question obviously does not allow for great subtlety or explanation, but it is nonetheless interesting to note the outcome.
Question 10 When I select a consultant, my criterion is
32% answered previous experience, the same amount replied trust, and 28% replied that the main criterion is value for money.
Question 11 The differences in salaries and structures of tax departments are due to the immaturity in the market
88% of respondents expects the differences to level out in the long run. 12% expects that the GCC will always remain a jurisdiction of stark differences.
What did we get out of the poll?
Consultants are worth their money and are selected on previous experience, trust or value for money. Consultants are mostly appointed to have a second pair of eyes. The respondents mostly expect salary differences to level out in the long run. They like to handle VAT filing in the tax department, and consider that the role of that tax department is to support the business in the most efficient way. The bigger the company, the more tax people, and they want to be accountable mainly to the CFO. Tax directors feel undervalued in terms of their remuneration and underestimated.
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.