By Raman Ohri, Head of Direct Taxation, Keypoint, Bahrain
The July 1 inclusive framework agreement on a global minimum tax created a dilemma for zero or weak corporate tax regimes, such as the six countries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – which make up the Cooperation Council for the Arab States of the Gulf (previously called the Gulf Cooperation Council or GCC).
The GCC tax authorities must decide whether to impose or increase the corporate income tax rate or introduce an âincome inclusion ruleâ. If no action is taken, profits generated within the GCC could be taxed outside the region. Would the tax authorities be prepared to lose this tax revenue?
Changing the international tax system
Historically, tax laws were designed for businesses with a physical presence. Due to globalization and digitization, companies can now sell goods or provide services without having a physical presence. In response, a joint initiative by the OECD and the G20 group of countries aims to tackle profit attribution issues and tax the digital economy. Known as the Base Erosion and Profit Shifting (BEPS) project, signed by 139 countries, the framework sets out 15 actions to tackle tax evasion, create a cohesive international tax system and encourage tax transparency.
The OECD published on July 1 a master plan to meet the fiscal challenges of the digital economy – BEPS Action 1 – divided into âpillar 1â and âpillar twoâ. As of August 13, 133 countries (Kuwait is the only exception of the GCC) had signed the declaration. A detailed implementation plan is expected by October, with targeted implementation in 2023.
The first pillar reforms deviate significantly from standard tax rules which rely heavily on physical presence. Updated rules for profit attribution and taxable presence are expected to see multinational entities with gross sales exceeding 20 billion euros (approximately 23.6 billion USD) and profits (before tax) above 10% taxed more equitably, as tax rights are agreed between jurisdictions.
20-30% of the residual profits of a multinational enterprise (profits greater than 10%) (amount A) will be reallocated to the jurisdictions in which it operates. A multilateral instrument to implement Amount A is expected to be signed in 2022, and Amount A is expected to apply from 2023.
An arm’s length charge (amount B) will also be calculated for marketing and distribution activities. The calculation process is ongoing and is expected to be completed in 2022.
The second pillar is based on two rules: the comprehensive anti-erosion tax base rule and the taxable rule
Under the global anti-base erosion rule, an income inclusion rule imposes additional tax on the parent company when a controlled foreign entity is in a low-tax jurisdiction (less than 15%) . A secondary mechanism, known as the under-taxed payment rule, applies a fee – or denies a deduction for payments to the parent – when the additional taxes have not been recovered from the parent.
The tax liability rule allows jurisdictions to impose a withholding tax (such as withholding tax) on related party payments such as royalties or interest that are subject to tax below the rate. minimum tax (7.5% to 9%). The tax liability rule applies regardless of the rules for including income or under-taxed payments and is considered a covered tax when determining the effective tax rate of a multinational enterprise.
The Pillar Two reforms require multinational companies with annual global turnover exceeding 750 million euros (approximately US $ 885 million) to pay an aggregate minimum tax of 15% on profits. An additional tax will be imposed on multinational companies when a group entity has paid an effective tax rate of less than 15%. For example, if the effective tax rate of a multinational enterprise in a jurisdiction is 5%, an additional tax of 10% will be charged. The effective tax rates will be calculated by jurisdiction in proportion to the taxes covered, with financial income being calculated according to the global anti-base erosion rule.
Implications for CCG companies
The current corporate tax rates for multinational entities doing business in the GCC are:
Saudi Arabia – 20%
UAE – no corporation tax
Qatar – 10%
Bahrain – no corporate tax
Oman – 15%
Saudi Arabia, Qatar and Oman impose a higher corporate tax rate for companies related to hydrocarbons. The United Arab Emirates imposes a corporate tax only on hydrocarbon-related companies and branches of foreign banks. Bahrain only imposes corporate tax on companies related to hydrocarbons. Kuwait has not currently adhered to the Comprehensive Minimum Tax Framework. In addition, some of these countries also levy a lower tax rate from their nationals in the form of zakat.
Reforms in pillars 1 and 2, including a global minimum tax, are expected to be implemented by 2023. While it may still seem a long way off, time is increasingly precious for multinational companies operating in the GCC. A more harmonious and interconnected international tax system could force multinational companies to rethink their business models and supply chains while carefully examining the way they do business globally.
GCC tax authorities that introduce or update their corporate tax laws will need to determine the accuracy of the bases on which tax is paid and assess whether related party transactions comply with the arm’s length principle. Therefore, a strong transfer pricing policy should help multinational companies optimize tax supply chains while justifying fees charged on transactions between parties related to local tax authorities.
Key decision-makers in all GCC companies should urgently analyze the potential impacts of these tax reforms.
âRaman Ohri is Head of Direct Taxation at Keypoint, Bahrain