Over supply of oil and under demand due the current economic crisis caused by COVID-19 has led to WTI prices for oil fall below zero as at 21 April 2020. Storage capacity is near full and therefore expensive. In the present situation, sellers are paying buyers to take oil off of their hands.
The situation is complicated for the oil sector and adds another “unprecedented” badge to the state in which the world currently finds itself in dominated by a health and economic crisis. Like oil companies, tax authorities now also face the task of having to consider how their legal frameworks apply to negative oil prices. We analyse those issues below.
Buyers are doing sellers a service for VAT purposes
At first sight Value Added Tax rules are made for transactions happening with a positive value. They calculate VAT on the price agreed with the customer. Whether the VAT laws implicitly assume that the transactions are always at a positive value is probably debatable, but certainly not unreasonable.
The tax authorities are expecting VAT revenue on the sales, not having to refund VAT to the sellers. Although the VAT law allows you to sell at a loss, to make no sales but have the intention of selling and still recover input VAT, hand out goods for free (taxed as deemed supplies), it does not foresee the situation of negative values charged when a good is sold.
The current situation is very similar to a furniture store charging a pick up fee for picking up your old furniture. The furniture store receives the ownership of the old furniture for free and charge a service fee for the pick-up. It then goes on to perhaps on-sell the old furniture, up-cycle it or use it for its own purposes.
Irrespective of the technical debate, tax authorities will be lukewarm to the idea to allow sellers to issue invoices with negative values. This would effectively mean that for each sale made, the tax authority would have to refund VAT to the seller. The only negative values allowed to be mentioned by sellers are usually reserved for credit notes. It therefore stands to be reasonably expected that tax authorities will take the view that buyers are rendering a service to the sellers. Therefore the buyers will need to issue an invoice to the sellers.
Depending on the applicable place of supply rules, that service will then effectively be subject to VAT, or not. Given that most of the sellers and buyers will be businesses with full input VAT recovery, that should not constitute an issue.
With the place of supply rules in the individual GCC countries, which deviate from the GCC VAT Framework, and their mix up with the zero rating rules (oddly imported from New Zealand), this may trigger some additional concerns for foreign sellers, which may be charged with 5% GCC VAT when the service relates to a good in the GCC. Even though a business refund is foreseen, it is only currently effectively available in the UAE, and only on condition of reciprocity.
In the UAE, VAT registered buyers of crude or refined oil are expected to apply the reverse charge mechanism on the domestic purchase of these goods. Instead of reverse charging on purchases for negative amounts, they will now likely need to apply VAT on a service. In a domestic context, this means an additional 5% VAT added for the seller, which, recoverable as it may be, will lead to added pre-financing for the seller. In KSA, local traders were already used to applying 5% VAT to each other. In Bahrain, a zero rate applies for oil and oil derivates.
It is safe to say that this is uncharted territory and that diverging opinions on the topic may emerge.
Non deductible expenses and additional withholding taxes
The situation from a corporate tax point of view seems, again prima facie, slightly more straightforward. The corporate tax is generally calculated on the basis of the books of account of the seller. From a financial point of view, and from a conceptual point of view, those books could record negative revenue (Note: the author of this article is not an accounting expert).
Negative revenue goes untaxed, because the business is not making positive sales. However, does the negative revenue constitute a deductible expense which reduces your corporate tax liability? This issue will surely be hotly debated with the tax authorities in the GCC which will be required to take a stance.
Additionally, in countries with broad withholding tax provisions on services, like KSA, there may be an additional element of surprise. The main concern with the fact that buyers may now be providing services to the sellers, is that when such a service takes place in an international context, the Saudi payer may need to apply a withholding tax (subject to relief in double tax treaties).
What are offset programs
Offsets are types of arrangements in which the governments procuring from overseas may oblige the suppliers to reinvest some proportion of the contract in their country. This allows the governments of the purchasing country to regain some of the economic benefits that it may be losing as a result of substantial public sector expenditures on foreign products, services and technology.
The offset programmes also stimulate multinational corporations to seek business opportunities with the local private sectors in a number of fields.
There are direct and indirect offset agreements. Direct offset agreements are related to the good or service imported, and could require co-production or subcontracting. Indirect agreements may involve purchases of goods or services unrelated to the main contract.
Offset programmes in the GCC
The GCC-countries typically import defense equipment and ancillary services from abroad. In order to compensate trade imbalances and within the context of overall economic strategy, offset programmes in the GCC typically require the defence contractors to make investments in the importing country.
In the GCC, the Kingdom of Saudi Arabia (“KSA”), United Arab Emirates (“UAE”), Kuwait, and Oman have implemented offset programs. Qatar and Bahrain have not officially announced any programme and may conclude contracts on a case to case basis.
With regard to taxation in the GCC, there are some GCC wide taxation rules relating to VAT and Customs and some country specific tax rules.
Currently, VAT has been introduced in only three GCC States, the UAE, Bahrain, and the KSA in a fairly similar manner, whereas corporate income tax is implemented in four GCC (States, Kuwait, Qatar, Oman and the KSA).
We cover the tax aspects of defence offset programs in the GCC in more detail below.
The main supply contract normally involves the export of goods to the GCC territory by a foreign business. To determine the VAT implications from the seller’s perspective, it is important to analyse the contractual obligations between the seller and the customer.
Generally, the obligation of the seller is limited to the export as the buyer imports the goods into the GCC and pays the import VAT (if any). The seller will not have any VAT obligations in the importing country. In case the supplier is required to import into the GCC, import VAT will be due. The subsequent supply to the buyer then becomes a domestic supply.
The common VAT rate across the GCC is 5%. However, generally, the goods are imported into the GCC by or on behalf of armed forces or internal security forces and they qualify for a VAT exemption.
The offsets, on the other hand, can be provided in multiple forms such as training, technology transfer, investments, maintenance of vehicles etc. Therefore, the VAT implications may vary depending on the type of services which are being offered as part of the offset contract.
Generally, for the services supplied by a foreign seller who does not have a Fixed Establishment (“FE”) in the GCC, the customer has to account for VAT, provided the customer is registered for VAT in the respective GCC Member State.
However, these contracts are mainly entered into by the government entities which may not be registered for VAT in the GCC. This would entail that the seller will have to get registered for VAT purposes in the GCC and to charge GCC VAT.
It also very common that the sellers have human and technical resources in a fixed location to render or receive services in the country where it has offset obligations. This would mean that the foreign seller effectively has a FE and an obligation for VAT registration.
All of the GCC Member States apply custom duties upon the entry of goods into the their respective country. The importer of record is responsible for the payment of custom duties at the point of entry.
In general, a 5% custom duty applies in the GCC. However, an exemption from custom duties is available for imports of military goods by or on behalf of all sectors of the military forces and internal security forces.
An import permit along with a letter from the armed forces or the internal security forces may be required confirming the ownership of the goods if someone else is importing on their behalf.
Corporate Income Tax
Kuwait, Qatar, Oman and KSA apply corporate income tax on the adjusted net profits derived from income in the respective Member State at the rate of 15%, 10%, 15%, and 20% respectively (often with exemptions for GCC held companies).
Companies carrying out business in these States, either by setting up a local entity or by virtue of having a Permanent Establishment (“PE”), are subject to corporate income tax.
A PE by definition is as a fixed place of business through which the business of a taxpayer is wholly or partly carried on. This may include, for example, a branch, office, factory, workshop, a building site, or an assembly project (a “fixed PE”). A PE also includes activities carried out by the taxpayer through a person acting on behalf of the taxpayer or in the taxpayer’s interest, other than an agent of an independent status (the so-called “agency PE”). Some GCC Member States have a wide interpretation of the concept of PE in order to tax all income sourced from the States, such as a “services PE”.
The export under the supply contract, would arguably not have its source in the GCC and the export of goods, standalone, would not trigger the qualification as a PE in the tax jurisdiction where the goods are shipped to.
The offset arrangements potentially increase the risk of having a PE. Services offered as offsets, if performed for a prolonged period of time along with the deployment of employees, can give rise to a service PE for the foreign businesses.
Withholding taxes or retention
The GCC States which implement corporate income taxation, generally, also apply domestic withholding taxes on the payments made from the State to a business outside the State.
Qatar applies a withholding tax of 5%, Oman applies 10% (with some recent exceptions), and the KSA applies between 5%-20%. The income tax law in Kuwait does not impose any withholding tax and rather applies a retention tax of 5% on each payment made to any suppliers until it is confirmed that the respective supplier has settled all of its tax liabilities in Kuwait. Qatar also has a local retention.
The withholding taxes are applicable only on the gross income generated from a source located in the respective State, such as royalties, dividends, interest, consideration for research and development, management fees etc. However, this mostly excludes the payments made for the purchase of goods from a foreign seller. Therefore, no withholding taxes would apply to the export.
Any double tax treaties signed by the concerned GCC Member States may provide a relief for the withholding taxes.
The withholding taxes may not apply, if a company has a PE in the concerned Member States, and payments are attributed to the PE.
For supply contracts, where GCC governments import goods supplied by foreign suppliers into the GCC, no direct taxes apply on the imports into the GCC and the taxation issues mainly relate to indirect taxes, such as VAT and customs duties.
The tax regime applicable to offsets is more complicated than the tax regime applicable to the supply contract. Offsets can create a PE for corporate tax and a FE for VAT. This means that the foreign seller will have to get registered for VAT and also for direct tax purposes and attribute profits to the PE.
Managing the supply chain well can avoid any additional VAT or customs duty costs. Other unavoidable taxes should be taken into account by sellers when finalizing contracts with GCC governments.