It represents a major change to the US tax system, holding high significance particularly to multinational companies and the US economy as a whole.
In the long term, the reform is predicted to raise the US GDP and wages, assuming that the tax cuts will provide increased stimulus for investment and activities, thereby increasing labor demand. These new incentives and deterrents have consequences on the foreign investments of US companies, including in the GCC region.
The US Tax Cuts and Jobs Act entered into force on 1 January 2018 is meant to significantly positively impact businesses.
Through this reform, along with an important reduction of the corporate income tax rate, another major change in the US taxation system appeared: the worldwide US taxation system has been switched to one that is very close in nature to a territorial system. This shift is accompanied by a “transition tax” and implies that corporations doing business abroad will no longer be taxed by the US on the profits they generate overseas.
While the reform brings restrictions on interest and loss deductions, related party payments and movements of intangible property (IP), it also introduces favorable dividend exemptions, capital investmentand exportincentives. This will ideally provide the necessary push to repatriate reserves of cash held overseas.
The reform also introduces new anti-avoidance and incentive tax measures, namely the Base Erosion and Anti-Abuse Tax (BEAT), the Global Intangible Low Taxed Income (GILTI) and the Foreign Direct Intangible Income (FDII).
IMPACT ON US BUSINESSES
1. Corporate Income Tax Rate Reduction
The main feature of the US tax reform is definitely the reduction of the Federal Corporate Income Tax (CIT) from 35% to 21%, starting from tax years beginning after 1 January 2018, with an average drop from 39% to 26%, including state income taxes.
This 26% CIT rate will be in line with the average among Organization for Economic Co-operation and Development (OECD) member nations.
2. Interest Expense Deduction Limitation
This new provision provides for a limitation of the interest deduction for all business interest expenses paid by the taxpayer, namely interest paid or accrued on debt which can be traced back to a trade or business.
This new restriction applies to all businesses, regardless of entity type, at the legal entity level. This includes “C corporations” which are taxed separately from their owners and subject to corporate income taxation, and “S corporations” which' shareholders are directly subject to tax on their pro-rata shares of income based on their shareholdings (e.g. sole proprietorship).
However, this restriction does not affect small businesses since it applies only if the taxpayer’s average annual gross receipts for the three tax year period ending with the prior tax period do not exceed $25 million. Certain regulated public utilities, real estate and farming businesses that use the alternative (generally straight line) depreciation system for particular properties are allowed to elect for an exemption of this limitation.
This new measure, subject to some exceptions, limits the deductibility of interest to 30% of the “adjusted taxable income”. This “adjusted taxable income” can be largely compared to earnings before interest, depreciation, depletion, interest income, interest expense and amortization (EBITDA) for the first four years till 2022. From 2022 onwards, the limitation will be applied on an amount closer to the EBIT of the company. Any disallowed business interest deduction can be carried forward indefinitely.
This restriction on interest expense deduction was designed to deter companies from shifting debt financing to foreign subsidiaries, thereby discouraging cross company loans and borrowing for tax avoidance.
3. Loss restriction
The treatment of the Net Operating Losses (NOLs), the carry back and carry forward provisions were notably modified by the reform. The NOLs deduction is now limited to 80% of the taxable income of the year.
Previously, the NOLs offset was not limited and could be carried forward up to 20 years and carried back up to two years for corporate income tax purposes. With the reform, the carry back is eliminated while the carry forward is allowed indefinitely.
The reform only applies to NOLs generated in taxable years ending after 31 December 2017. Subject to limitations, NOLs generated earlier will be subject to the former rules. Therefore, taxpayers have to track NOLs depending on the year of their generation.
This reform aims at dissuading companies from bringing losses to the US to artificially reduce their profit and shift costs including interest to foreign affiliates to make better use of loss deductions.
4. Foreign Participation Exemption:
US parent companies who own at least 10% of a foreign group or affiliates are exempt from tax on dividends received from these companies. The ownership criterion can alternatively be the number of voting shares or their value.
The objective is to encourage US multinationals to shift their foreign profits onshore, since they can now bring cash back without heavy tax liabilities.
This exemption will not apply to any “hybrid dividend”, defined as any dividend for which the foreign affiliate received a deduction for local income tax purposes. This might notably happen when the capital provided to the foreign affiliate is deemed as a loan and grants the right to interest deduction to the foreign company, while the return on the same capital would classify as dividends in the US and be exempt. This would result in a double tax deduction on these amounts.
5. Transition Tax:
The inclusion of a transition tax is a strong signal that the US tax reform will confer many benefits from the territorial tax system but comes with compensation.
Current overseas untaxed earnings still accumulated and held abroad since 1986 will be subject to a one-time transitional tax payable over 8 years. This applies to controlled foreign corporations (CFC) or any other foreign companies with a 10% US corporate shareholder. The law refers to them as “Specified Foreign Corporations” (SFC).
The untaxed earnings would be charged at a lower rate of 15.5% for earnings held in cash or specified asset. Such items include:
- net accounts receivable,
- actively traded personal property, and
- obligations with a term of less than a year.
Any remainder will be taxable at 8%.
US shareholders are allowed to opt to pay the transition tax over eight years:
- 8% each year during the first five years,
- 15% the 6th year,
- 20% the 7th year,
- 25% the 8th year.
In case the US corporation does not pay this tax within 10 years of the Act’s enactment, a safety net ensures that the full amount of untaxed earnings is subject to the transitional tax to a 35% tax rate.
This is directed at increasing the amount of corporate cash available for M&A transactions and overall increasing the liquidity levels in the US.
This computation may present extreme complexity as there is a need to determine post-1986 earning pools and historic tax payments to substantiate any foreign tax credit attributable to post-1986 earnings. This would potentially require companies to arrange significant cashflow needed to pay tax.
6. Capital investment:
The previous bonus depreciation percentage which qualified property could benefit from has been increased, following the reform, from 50% to 100%, from September 2017 up to the end of 2022.
Accordingly, a company that acquires assets may be able to immediately deduct a significant portion of the purchase price as compared to the acquisition of the equity interests.
Beginning 2023, this bonus depreciation will be phased-out till 2026 (i.e. 80% for qualified property placed in service before 1 January 2024, 60% before 1 January 2025; 40% before 1 January 2026; and 20% before 1 January 2027).
The bonus depreciation is also applicable to non-original first use property as long as it is the tax payer’s first use.
This provision encourages structuring investments in new ways to take advantage of the deductions in the US along with the reduced effective tax rate as compared to other regions like Europe, Asia and Latin America.
7. Base erosion and anti-avoidance tax (BEAT):
The BEAT is introduced amid a global crackdown against companies which have used the world’s tax regimes and deprived governments of a large chunk of corporate revenue, estimated at USD 100-240 billion.
According to the BEAT, if a large multinational, operating in the US makes related-party payments that are potentially part of aggressive profit shifting, they will be subject to a new minimum tax.
BEAT only applies to companies:
- with average annual gross receipts of at least $500 million for the most-recent three year period, and
- with related-party deductible payments of 3% (2% for banks) or more of their total deductions for the year (the “base erosion percentage”).
These related party disallowed payments include royalties, interest, rent, high-margin service payments to a foreign related party for the purposes of avoiding tax but exclude most cost of goods sold, payment for services at cost and certain qualified derivative payments.
Computation is done by using a minimum rate of tax a company should be paying on income without disallowed payments (Modified Taxable income or MTI), comparing this to the regular tax liability of the taxpayer arising at the federal corporate tax rate. If the regular tax liability is lower than the minimum computation, the excess is the BEAT amount to be paid as an additional tax.
The minimum rate of tax to be used for this calculation is 5% of the MTI for year one, 10% thereafter and increasing to 12.5% from 2025 (additional 1% for banks and broker-dealers).
The BEAT is of major concern to foreign subsidiaries and could lead to a significant increase in US tax liability. Companies may find it beneficial to establish contracts in such manner that cost-sharing contracts between parents and subsidiaries are used instead of transactional payments in order to avoid the profit shifting arrangement.
8. Global intangible low tax income (GILTI):
This regime taxes the intangible low taxed income received from CFCs in the hands of the US shareholders.
This tax is charged on an accrual system where the US parent includes in their income the GILTI value to be fully taxed regardless of whether it is remitted back to the US or not. This decreases the benefit for US companies to shift their IP in foreign low tax jurisdictions.
The GILTI amount is calculated on a net deemed tangible return based on the CFC’s tangible assets, which equal 10% of the shareholder’s aggregate pro rata share of the CFC’s qualified business asset investment (QBAI). The QBAI can be defined as the CFC’s quarterly average tax basis in depreciable tangible property used in the CFC’s trade or business to produce tested income or loss.
The GILTI requires also to determine the US shareholder’s aggregate pro rata shares of its CFCs’ “net tested income”, which corresponds to the difference between the “tested income” (Gross income of a CFC excluding several listed incomes) and the specific “tested losses”.
The portion of the CFC’s net tested income that exceeds the deemed tangible return on tangible assets is then included in the U.S. shareholder’s GILTI amount.
For C corporations only, a deemed deduction of 50% will be applied to the GILTI amount but subject to a taxable income limitation. 80% of certain foreign income taxes paid by the CFCs will be deductible from the GILTI tax amount.
If the foreign effective tax rate on GILTI is at least 13.125% the US residual tax on the GILTI can be eliminated. If no foreign tax applies on the GILTI, US will tax this amount at a default rate of 10.5%.
9. Deduction for foreign derived intangible income (FDII):
While the tax reform uses GILTI to penalize taxpayers that have migrated IP offshore, it simultaneously incentives companies that leave their valuable IP in the U.S. using the FDII.
This provision grants a preferential effective tax rate of 13.125% to eligible income of C companies. This is relevant to US headquartered companies and non-US companies doing business in the US.
FDII can be defined as the net domestic income earned thanks to operations in the US but only related to export (sales, services, lease…).
Similarly to GILTI, the FDII is the part of the income of the US company that exceeds the deemed tangible return amount calculated with reference to the QBAI.
IMPACT ON BUSINESSES IN THE GCC
In the aftermath of the US reform, companies around the world will look to alter their policies to maintain their corporate revenue and tax advantages.
Some GCC countries have almost no corporate tax (i.e. UAE, Bahrain) and are, similar to other jurisdictions, being affected by the aforementioned measures. It would prove beneficial for US subsidiaries in the GCC to assess the extent to which costs have been shifted to them from the US. It is also expected that lower budgets will now be allocated to these subsidiaries, to hold cash within the US, impacting the available cash in the GCC.
Adversely, GCC headquarters with US affiliates will be impacted by the BEAT, as a transfer pricing inter-company loan component. Any major cash remittances back to the GCC parent will be under scrutiny for anti-tax avoidance purposes.
Offshore companies in the Jebel Ali Free Zone Authority (JAFZA) are a special breed in the UAE. An offshore company incorporated under the recently amended 2018 JAFZA Offshore Companies Regulations (“Regulations”) is not subject to the federal commercial laws in the UAE and is not able to conduct any commercial business activities in the country. They are considered as non-resident for commercial purposes but are in fact treated as resident for VAT purposes.
The benefit of incorporating a JAFZA offshore company, amongst others, is to allow foreign investors to hold shares in other companies within the UAE as well as to own property in freehold areas in Dubai.
Assessing the VAT Impact
Like many other companies in the UAE, JAFZA offshores have been impacted by the introduction of VAT on 1 January 2018. Although for all intents and purposes JAFZA considers such companies as “offshore”, for VAT purposes they are not.
JAFZA offshore companies still need to determine whether they need to register for VAT with the UAE's Federal Tax Authority (FTA). Any business making taxable supplies with a total value exceeding the mandatory threshold of AED 375,000 (+/- USD 100,000) must get registered. Whether or not the JAFZA offshore companies need to get registered will depend on their activity. Although they are not allowed to conduct business in the UAE as per the Regulations, from a VAT perspective they may still receive a business income.
JAFZA Offshore and Rental Income through Property Ownership
In accordance with the Regulations, JAFZA offshore companies are allowed to own property in Dubai, and therefore many offshore companies choose to exercise this right. The purpose of such property ownership would most likely be to obtain some form of rental income.
Any rental income obtained from a residential property is exempt from VAT (in most cases) and does not trigger an obligation to register for VAT.
The situation differs however for offshore companies leasing commercial units and obtaining their rental income as such, since the leasing of commercial properties is considered a taxable supply for VAT purposes, and is subsequently subject to 5% VAT. When the value of such supplies exceeds the VAT mandatory threshold, VAT registration is required. Therefore, any JAFZA offshore company which owns property in Dubai needs to carefully assess the criteria they fall under in order to determine their VAT liability.
Receiving Dividends and Selling of Shares
Since such JAFZA offshore companies act as holding companies, they will often be receiving dividends or income from selling participations.
The receiving of dividends from UAE companies and the sale of shares to UAE companies are transactions which are VAT exempt. They impact negatively the right to recover input VAT of the holding company.
The fact that the receiving of dividends is exempt in the UAE is unusual from a VAT perspective. Generally, the payment of dividends is out of scope of VAT, like for example in the Kingdom of Saudi Arabia or like in all EU countries.
As such, if the JAFZA offshore company only receives dividends from UAE companies or only sells shares to UAE companies, it will not have to get registered for VAT purposes.
However, when these same transactions are done with non-resident recipients, they are no longer VAT exempt, but they are zero rated. Accordingly, dividends paid to a JAFZA offshore company by a foreign company and shares sold to foreign investors are, for VAT purposes, treated as taxable supplies. Therefore, if the total amount of these transactions exceeds AED 375,000, the JAFZA offshore company needs to register for VAT. Since one of the purposes of setting up a JAFZA offshore company is holding participations, this will often occur.
The rationale behind this rule copied from the EU is not to disadvantage the financial sector when it has to compete with businesses in countries which do not have VAT. However, the unusual position taken by the UAE on dividends has the strange consequence that these JAFZA offshore companies may be required to register for VAT purposes.
Due to the nature of its revenue, more often than not, a JAFZA offshore company will indeed have to register for VAT.
The FTA does provide certain exceptions from registration in the event a taxable person’s supplies are exclusively zero rated. Therefore, if the offshore company solely exports financial services - by virtue of receiving dividends from participations abroad or selling shares to non-residents - an alternative is to apply for this exception from registration for VAT with the FTA, in order to mitigate the impact of the offshore company’s VAT obligations.
The exception from registration cannot be granted when the offshore company is leasing commercial property and it cannot be granted retroactively.
Penalties and Consequences
All JAFZA offshore companies need to assess whether they need to register for VAT with the FTA. In practice, most JAFZA offshore companies have been under the impression that they do not need to register.
The FTA imposes very strict fines for companies which have not yet registered for VAT. The penalty for late registration is AED 20,000. In addition, a penalty of up to AED 2,000 per return will apply for not filing the VAT return.
Furthermore, in case VAT is due (e.g. leasing of commercial property) and is not paid to the FTA, a daily penalty of 1% may be charged on any amount that is still unpaid one calendar month following the deadline for payment (with a maximum of 300%). In addition to that, a penalty of 50% on the amount unpaid to the FTA will be imposed as well.
On 10 October 2018, Bahrain published its VAT Decree law (No. 48) in its Official Gazette. The Bahraini VAT law was written mainly by the Ministry of Finance and borrows largely from the GCC VAT Framework and the KSA VAT legislation. In addition to the VAT Decree law, Decree No. 47 approves the GCC VAT Treaty and Decree No. 45 establishes the Bahraini Tax Authorities. As a next step, Executive Regulations will be adopted in Bahrain to provide further detail on all provisions.
As is expected the VAT rate is 5% and businesses making taxable supplies in excess of BD 37,500 are required to register for VAT purposes. Bahrain has adopted a similar stance to financial services as the UAE and KSA. With respect to Real Estate, Education, Health Care and Local transport it has borrowed more from the UAE. Contrary to both the UAE and KSA, it has zero rated a number of foodstuffs. Regretfully it has taken over the too strict conditions to apply the zero rate on "exports of services" (in fact services' which place of supply takes place abroad) like the UAE and KSA have. These conditions are not in line with modern international EU VAT practice or the guidelines of the OECD in this matter.
Unfortunately it has also implemented the obligation to appoint a fiscal representative in some cases, whereas experience has taught that in KSA this structure is practically difficult to implement and leads to less compliance. No automatic reverse charge on imports of goods has been foreseen, contrary to the UAE. Remarkably, the sale of pearls in Bahrain has been zero rated, relatively similar to the wholesale of diamonds in the UAE where a reverse charge applied.
In line with KSA and UAE, steep penalties have been adopted to deter any non-compliance. A specific prison sentence has been determined as well for tax evasion. Extremely long transitional provisions have been foreseen for supplies to governments.
Businesses in Bahrain have to prepare for the introduction of VAT now and UAE and KSA businesses with subsidiaries in Bahrain have to compare their current implementation with the Bahraini framework. In addition, businesses in the other GCC States will have to analyse the impact of the implementation on their dealings with Bahrain, such as the exchange of VAT numbers but also the different Customs framework which will apply.
The United Arab Emirates’ (“UAE”) Federal Tax Authority (“FTA”) has published a new Value Added Tax (“VAT”) public clarification on tax invoice requirements. The new public clarification is relevant to all businesses making taxable supplies and provides further clarity on the issuance of tax invoices.
VAT Public Clarification VATP006 addresses the application of article 59 of Cabinet Decision No. (52) of 2017 on the Executive Regulations of the Federal Decree Law No. (8) of 2017 on Value Added Tax, which sets out the requirements for when a tax invoice must be issued and the particulars that must be included.
A tax invoice can be defined as a written or electronic document in which the occurrence of a taxable supply is recorded with details pertaining to it and is generally issued by the supplier of goods or services.
The tax invoice plays a crucial role for the supplier as it may dictate the date if supply, thereby determining the tax period in which the output VAT is to be paid. On the other hand, a recipient will need the VAT invoice for the recoverability of the input VAT.
The Federal Tax Authority (FTA) prescribe certain criteria for who is obligated to issue a tax invoice.
- VAT registered person making a taxable supply (excluding zero rated supply)
- VAT registered person making a deemed supply
The FTA requires suppliers to issue the tax invoice within 14 calendar days of the date of supply, providing flexibility to compound multiple monthly transactions for the same customer under a single invoice.
As per the FTA guidelines, there exist certain situations when the obligation of producing the tax invoice is shifted from the supplier. It may be the responsibility of the recipient to issue a “Buyer-created tax invoice”. In cases of consignment of goods to an agent, the agent may issue a tax invoice in relation to that supply with the particulars of the agent as if that agent had made the supply of goods or services itself with a reference to the principal supplier (e.g including the supplier’s name and tax registration number “TRN”).
Where the recipient is not registered for VAT, or where the recipient is registered for VAT and the consideration for the supply is under AED 10,000, optionally a simplified tax invoice can be prepared with requirements as follows:
- the words “Tax Invoice” clearly displayed on the invoice;
- the name, address, and TRN of the registered supplier;
- the date of issuing the tax invoice;
- a description of the goods or services supplied; and
- the total consideration and the VAT amount charged.
In addition to the above, supplies over AED 10,000 necessitate additional requirements for a full tax invoice as follows:
- where the customer is registered for VAT, the name, address, and TRN of the customer;
- a sequential tax invoice number or a unique invoice number;
- the date of supply (where different from date of issue of the tax invoice);
- for each good or service, the unit price, the quantity or volume supplied,
- the rate of VAT and the amount payable expressed in AED;
- the amount of any discount offered;
- the gross amount payable expressed in AED;
- the tax amount payable expressed in AED together with the applied exchange rate;
- where an invoice relates to a supply under which the recipient is required to account for VAT, a statement that the recipient is required to account for VAT, and a reference to the relevant provision of the Law.
The public clarification clarifies that there is no requirement for line items to be shown on the simplified tax invoice at a net value. This means that the total gross amount and the VAT amount should be stated in separate lines at the bottom of the simplified tax invoice.
However, for full tax invoices, the line items must show the tax value and net value, but there is no need to present the gross amounts for each line item as this is reflected in the total gross amount payable.
Whenever a taxable supply is made, a tax invoice must be issued and delivered to the recipient. If the conditions for a simplified tax invoice are met, then a simplified tax invoice can be issued and delivered instead. It is not acceptable to offer only an option of providing an invoice upon request and thus not provide one if the customer does not request one. A tax invoice must be provided in all circumstances where a taxable supply is made.
However, the Cabinet Decision No. (3) of 2018 on Tax Invoices provides issuers of tax invoices the flexibility of using the mailing address of the recipient as an alternative to their physical address.
Furthermore, the clarification requires that all tax invoices must have the tax amount converted and stated in UAE Dirham even if the transaction is made in some other currency. The invoice may still contain information regarding prices in the original currency. The exchange rate used must be a rate determined by the UAE Central Bank.
Another important thing to note for a tax invoice is the rounding of amounts to the nearest Fils (that is up to two decimal places) where the invoice amount is a fraction of a Fils (1 Dirham = 100 Fils). The clarification guide instructs to follow the mathematical principles for rounding off. The general rules for rounding off are as following,
- If the number you are rounding is followed by 5, 6, 7, 8, or 9, round the number up.
Example: 4.5387 rounded upto 2 decimals as 4.54
- If the number you are rounding is followed by 0, 1, 2, 3, or 4, round the number down.
Example: 6.7234 rounded to 6.72
This publication is important as the tax invoice process is relevant to all businesses making taxable supplies, and tax invoices received must be compliant with the UAE’s VAT legislation to enable input tax recovery on the VAT return. In this regard, it is important to note that these requirements are mandatory rather than optional.
Failure to comply with the stated requirements can have a number of implications for the business, ranging from commercial (such as the customers may not be entitled to a Tax Credit for VAT incurred), to the imposition of penalties for the failure to issue and deliver compliant tax invoices. The FTA has prescribed a penalty of AED 5,000 for each tax invoice in case of failure by the taxable person to issue a tax invoice when making any supply.