Egypt slowly adopting tax changes on base erosion and profit shifting

By Sherif Sabakhawy, Managing Partner for consultation and Tax Planning, TAXONOMY, Cairo

Egypt is making slow-moving but accurate steps towards the complete framework of international tax norms outlined in the OECD’s base erosion and profit shifting (BEPS) project. However, the current application of introduced actions in place is still immature and requires more integration and development. Nonetheless, while the roadmap is quite young, its implementation is promising for both multinationals and the tax administration.

Tax system progress in Egypt

Before the issuance of the corporate income tax measures to cope with the massive and rapid transformation toward international trade, Egypt was suffering from a disproportionate amount of base erosion and profit shifting. Egyptian tax laws and regulations (both corporate tax and value-added tax) had been almost designed for a purely local environment, with minimal to zero practice for the application of international trade.

Egypt implemented its first action plan moving into the global environment by introducing transfer pricing rules in law no. 91 of 2005 and in its executive regulation. For both multinational corporations and tax authorities, the tax clauses were unfamiliar and difficult to apply. The tax guidelines of transfer pricing have been retained for a long period with no real interaction with cross-border transactional flows.

In 2010, Egypt issued its first transfer pricing guidelines. In 2018, updated guidelines were published to reflect the OECD’s base erosion and profit shifting (BEPS) recommendations, transfer pricing guidelines, and model tax convention 2017 updates.

As a consequence of such slow interaction, taxpayers were for years reluctant to submit the transfer pricing local file since there were no fines or penalties for late submission or non-submission. While value-added tax or general sales tax have long been in existence across African jurisdictions, Egypt moved toward a full value-added tax concept only five years ago. The reverse charge mechanism was not known at all levels for multinationals and local authorities prior to such launch.

Recently Egypt issued the Unified Tax Law, which introduced a transfer pricing threshold, penalties, and sanctions, in addition to the requested package of documentation.

Egypt roadmap toward BEPS

Base erosion and profit shifting is a significant problem for developing countries, including Egypt, due to the heavy reliance on corporate income tax. The engagement of developing countries in the international tax roadmap is very important to ensure that they receive support to address their specific needs and can effectively participate in the process of standard-setting in international tax.

Although the BEPS project provides 15 actions to provide local authorities and governmental bodies with both domestic and international instruments to manage tax avoidance, Egypt is still in the early steps of adopting the full framework.

Its progress has started with a focus on specific actions related to the transfer pricing guidelines — Actions 8, 9, and 10 – and it still does not have 100%-accurate measurable tools to ensure that profits are taxed where economic activities generating the profits are performed. Such tools can also give businesses greater certainty by reducing disputes over the application of international tax rules and standardizing compliance requirements.

On the roadmap toward country-by-country reporting under Action 13, big multinational enterprises are required to prepare such a report with aggregate data on the global allocation of income, profit, taxes paid, and economic activity among the tax jurisdictions in which it operates. The first country-by-country official reporting requirement in Egypt was implemented for fiscal year 2020 with severe and very aggressive penalties for multinationals who fail to submit the report by the end of the year. The fines vary from 1% up to 3% of the total value of the intra-group transactions as stated in the financials.

Such aggressive fines for the failure to file the country-by-country report at year-end represents a pain point for both multinationals and tax administrations. On the ground there is no actual procedure for the tax audit of transfer pricing in place from local governmental bodies, therefore taxpayers have no clear roadmap as of now to run an internal risk assessment for the topic.

On the digital economy roadmap, Egypt started launching an e-invoicing system to implement a fully automated platform by 2022. The campaign has been introduced in stages. The first phase started in November of last year and covered 134 companies. In February of this year, an additional 347 businesses joined the system. From July 2021, all large Egyptian taxpayers will need to start using e-invoicing. By 2022, electronic invoicing will become mandatory for all taxpayers operating in Egypt.

It is also worth underlining that any businesses working with the government (B2G model) will need to start using e-invoicing as of July 2021 at the latest, regardless of their size. Otherwise, they will no longer be allowed to trade with public bodies. The model of  Egyptian e-invoicing is mainly focusing on an online real-time transactions model known as the clearance model. This means that each invoice must be validated and approved by the tax authorities before it is sent to the customer.

Some slight actions have been implemented for the purpose of interest deductions, and the main concept is the eligibility for deduction after offsetting any tax-exempt interest income. There are some restrictions for the deduction where the interest rate does not exceed twice the discount rate as determined by the Central Bank of Egypt at the beginning of the calendar year in which the tax year ends. Another restriction regarding interest expense is that the return on loans should comply with the local thin capitalization rule, i.e., a 4:1 debt-to-equity ratio.

In the case of a tax audit, if the interest rate is not proven to be at arm’s length, the tax authority has the right to adjust the price to arrive at the “arm’s-length price” and re-calculate the taxes due accordingly. Yet the journey is somehow quite long to be in line with the global transformation for interest deductions, and some extra alignment has to be considered regarding conditional interest deductions on retained earning as per the newly introduced business taxation in the European Commission. This will encourage companies to finance their investments through equity contributions rather than relying on debt financing.

The introduction of BEPS Actions 2, 3, and 5 – on hybrids, controlled foreign company rules, and harmful tax practices – will require more paved roads for a correct tax application in the medium- and long term.

—Sherif Sabakhawy is Managing Partner for consultation and Tax Planning at TAXONOMY in Cairo, Egypt.