What companies and Governments can do to make tax less taxing in the Middle East
In the late summer of 2015 we asked Tax and Finance leaders at some of the largest companies operating in the Middle East about the tax and business challenges they face, the way their tax functions are organised, and the impact of international and domestic tax reforms.
Many consider the Middle East to be a low tax, or even a ‘no tax’ area, but as our survey shows, the taxation regimes in the region can be complex and challenging to manage, and their implementation can give rise to uncertainty and confusion, which in turn creates risk. As a result, companies need to manage their Middle Eastern tax affairs with the same care and attention to detail that applies everywhere else in the world. This will be even more important with the expected introduction of Value Added Tax (VAT) across many countries in the region, and the reforms that are likely to be made in response to the OECD’s recommendations on Base Erosion and Profit Shifting (BEPS).
The results of the survey support the observation that there is considerable scope for the region’s authorities to reform, modernise and streamline their tax regimes, which would make their markets more attractive to foreign investors.
Both authorities and businesses could increase efficiency and speed up their processes, by employing more digital technology, and need to look at the skills they require, now, and as tax regimes evolve. Many businesses in the region have little or no dedicated in-house tax resource, despite the significant challenges in areas like compliance, and the need to integrate tax planning more closely into business decision-making.
It is an interesting time to be talking about tax in the Middle East.
After decades of being perceived by some as a ‘low tax’ environment, tax is back on the agenda for many of the region’s governments, even within the Gulf Co-operation Council (GCC). With the oil price at historical low, some countries are facing for the first time budget deficits, and others selling assets to fund their expenditure.
Countries across the Middle East want to have sustainable revenue streams to fund their long-term policy objectives, away from hydrocarbon revenues, and hence they are exploring how to broaden the tax base and collect money more efficiently. GCC Countries – are looking at introducing sales taxes like VAT; others are considering raising or establishing corporate taxes. Elsewhere in the region, the tax environment is more like that of other developing nations – corporate tax is a primary source of government revenue (unlike in the GCC), and there are personal income taxes as well as sales taxes or VAT.
3% of respondents said they considered there was a high level of certainty in relation to the tax legislation in the region
In 2005, the Egyptian authorities introduced comprehensive tax reforms. The aim was to streamline the system and align it with international good practice, while increasing the tax take and reducing evasion. Personal and corporate taxes were aligned at 20%, and the fines for evasion were significantly increased. OECD definitions of concepts like transfer pricing were also adopted. It was a successful move, and went a long way to create a more stable tax system and build trust and confidence with international investors. But with the 2011 revolution, all that changed.
Since then, the political situation has been very unpredictable: with no parliament in place, laws have been made by presidential decree, and as government revenues from the Suez Canal have fallen, tax has had to bridge the gap; existing taxes have been changed or raised, and new ones have been introduced; Corporate tax was increased to 30%, which meant an effective rate of 37% for foreign-owned firms, after adjusting for withholding tax; and a new Capital Gains Tax was announced, then frozen, and then re-introduced later with different rules. All in all, the picture was confused and unpredictable, with little clarity on the scope and implementation of all the new taxes, and very high penalties for non-compliance.
Companies could neither clarify what they owed, nor plan for the future, and foreign investors like Private Equity houses had reduced confidence in their ability to realise any potential investments. In the last couple of years, the government has been trying to stabilise the system and rebuild trust. Corporate tax has recently been reduced to 22.5%, and new mechanisms have been introduced to protect the rights of payers, but it’s too early to evaluate the impact these measures, which are still subject to ratification by the new parliament, as and when it’s elected.
It’s possible that Egypt will also introduce VAT to replace the current sales tax with potential increase in tax rate from 10% to 12%, and higher taxes for alcohol, cigarettes and cars. Fears about VAT's inflationary impact have delayed the implementation so far, but this, in turn, is increasing uncertainty for the business community, many of whom lack the reporting systems or resources to deal with VAT.
“Tax regimes in the region can be complex and challenging to manage and their implementation can give rise to uncertainty and confusion, which in turn creates risk. As a result companies need to manage their tax affairs with the same care and attention to detail that applies everywhere else in the world.”
Before 2004, there was no formal tax framework in Saudi Arabia, but this has become more systematised in the last decade, and more in line with international norms. A significant number of double taxation treaties have been introduced (for example, with India, the UK, China, and Russia, but not, thus far, with the US or Germany). New transfer pricing regulations have also been drafted, but not yet issued, and there has been discussion of a new land tax, to encourage landowners to use the land they acquire, rather than just stockpile it.
Uncertainty can arise, for example, from the rules governing tax residency, which can be interpreted differently by different tax authorities within the Kingdom. The same lack of clarity applies to some social security taxes, and the tax consequences of listing on the Saudi Stock Exchange, which has recently been opened up to foreign companies.
Corporate tax is another area where more clarity would help create a more stable taxation regime. Unlike Bahrain and the UAE, the KSA has corporate taxes, but there are different rules for foreign and domestic businesses: overseas-owned firms pay 20%, while local companies pay a 2.5% ‘Zakat’ derived from Islamic law, which is charged on their net worth. But because Zakat is governed by decree and not by law, its precise interpretation is left to individual officials, which can create uncertainty about current and likely future liabilities.
Looking ahead, there’s the possibility that KSA could introduce VAT in the next few years, not least because of the pressure to raise more government revenue. To do this effectively, the Kingdom will probably require more skilled staff and more comprehensive systems, and this may delay the process. However, as a member of the G20, Saudi Arabia may be one of the first to adopt the reforms recommended by the OECD project on Base Erosion and Profit Shifting (BEPS).
“You need to pay as much attention to your tax affairs in the Middle East as you do everywhere else in the world – in fact, probably more.”
The BEPS project is the OECD’s response to harmful tax competition by countries, aggressive tax planning by multinationals, and the lack of transparency which can impede tax authorities from making fair assessments of what companies owe. ‘Base erosion’ refers to the failure to pay tax in countries where companies are making profits, and ‘profit shifting’; to the artificial movement of these profits to lower-tax regimes. The BEPS project is backed by the G20 and many governments will revise their tax laws and policies based on the recommendations issued by the OECD.
The OECD’s Action Plan, which was drafted with the active participation of its member states, contains 15 separate action points, and has now been endorsed by the G20 and OECD countries. The implementation phase is likely to include changes to the international taxation system, changes to domestic laws, double taxation treaties, and the development of a multilateral instrument to ensure a swift application of these changes.
Companies need to urgently consider how the BEPS recommendations will impact them, and put in place the policies and systems to comply with the increased reporting requirements. For example, the Action Plan covers issues such as transfer pricing, and how governments define whether a company is ‘resident’ for tax purposes – in a digital age, firms can make profits in a jurisdiction without needing any physical presence in that market.
Overall, the OECD plan is designed to help tax authorities ask the right questions to businesses, and they in turn will be required to provide an unprecedented level of disclosure, from how they are structured, to where exactly they are making their money on a country-by-country basis.
For governments looking to increase their revenue stream, VAT has many advantages: it is an efficient tax is levied on consumption at all stages of the supply chain, which makes it a substantial source of revenue for Governments. It is also neutral for businesses who are tax collectors and do not bear the burden of VAT, as cumulative taxation is avoided through the right to deduct/refund input VAT. The GCC States are in the course of agreeing a common framework for VAT and implementation at national level could happen in the coming two to three years. It will be important to ensure that the system adopted is business-friendly and easy to administer: the governments in the region are well aware that the easier it is to comply, the higher the revenue stream will be. There will also be localised issues to resolve notably in terms of evaluating other forms of existing local consumption taxes/fees that would apply in addition to the VAT.
60% of our survey respondents believe it is likely or very likely that the GCC will start to introduce VAT by the end of 2017, with 36% seeing this as unlikely. On balance, therefore, most seem to think this will happen.
Turning to corporate tax, 60% of our survey respondents believe that it is likely or very likely that Bahrain and the UAE will implement a corporate tax regime by the end of 2017. 64% say this will have some negative impact on the two countries’ attractiveness to investors, with 30% believing the effect would be more severe.
“The Paying Taxes 2016 Report prepared by PwC and The World Bank Group indicates that stable tax systems and strong tax administration are important for businesses, helping them to operate in an environment where the tax treatment of transactions is predictable and where governments operate transparently. In addition, the way in which the tax system collects and administers its taxes has an impact on businesses in terms of the time required and the costs associated with that time.”
Given the ‘low tax/no tax’ image of the Middle East, it’s not surprising to find that even very large businesses often have very small tax functions: 27% of our survey respondents have no dedicated resource at all, and another 43% have only one or two people. Without knowing the seniority of these people, it’s hard to say if companies in the region have the skills and resources they need to manage an increasingly complex area. There is also the wider question of the ‘right’ size for a tax function, which can only be determined on a case-by-case basis. The size of the company is certainly a relevant factor, but not necessarily the most important one. A mature, stable business will need less resource than a fast-growing company, especially one which is actively acquiring assets, or moving into new territories. A more mature business may also have developed useful tax know-how within its business units.
Taking all these factors into account, it may not necessarily be the case that the best way forward is to build large in-house tax functions for Middle East groups, but rather look to optimise the use of systems, finance and other terms and specialist external advisers where required. However, some firms may need more staff, or more senior staff, to ensure their tax affairs are being given the priority and oversight they require. In either case, it will be vital to ensure clear accountability and efficient communications between everyone making tax decisions, both internal and external. A responsibility assignment matrix can be a good way to work through the issues and priorities, to determine where there are gaps, and where the accountabilities should sit.
“The key is to develop an effective controls framework, so you know what's being filed and paid, and where.”
Tax and Legal Services Leader, PwC Middle East
Tel: +971 (0)4 304 3100