By Raman Ohri, Head of Direct Tax, Keypoint, Bahrain
The 1 July inclusive framework agreement on a global minimum tax has created a dilemma for no or low corporate tax regimes, such as the six countries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates – that make up the Cooperation Council for the Arab States of the Gulf (previously known as the Gulf Cooperation Council or GCC).
Tax authorities across the GCC need to decide if they are going to impose or increase the rate of corporate income tax or introduce an “income inclusion rule.” If no action is taken, profits generated within the GCC could be taxed outside the region. Would tax authorities be willing to lose out on that tax revenue?
Changing international tax system
Historically, tax laws were designed for businesses with a physical presence. As a consequence of globalisation and digitisation, businesses 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 nations sets out to address profit attribution issues and tax the digital economy. Known as the base erosion and profit shifting (BEPS) project, signed up to by 139 countries, the framework sets out 15 actions to help tackle tax avoidance, create a coherent international tax system and encourage tax transparency.
The OECD on 1 July released a blueprint to address the tax challenges of the digital economy – BEPS Action 1 – divided into “Pillar One” and “Pillar Two.” As of 13 August, 133 countries (Kuwait is the only GCC exception) had signed the statement. A detailed implementation plan is expected by October, with implementation targeted in 2023.
Pillar One
The Pillar One reforms depart significantly from standard tax rules that rely heavily on physical presence. Updated profit attribution and taxable presence rules should see multinational entities with gross revenue over EUR 20 billion (approximately USD 23.6 billion) and profits (before tax) over 10% taxed more equitably as tax rights are agreed across jurisdictions.
20%–30% of a multinational enterprise’s residual (profits over 10%) profit (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 should apply from 2023.
An arm’s length fee (Amount B) will also be calculated for marketing and distribution activities. The calculation process is ongoing and should be completed in 2022.
Pillar Two
Pillar Two is based on two rules: the global anti-base erosion rule and the subject to tax rule.
Under the global anti-base erosion rule, an income inclusion rule imposes a top-up tax on the parent where a controlled foreign entity is in a low tax (less than 15%) jurisdiction. A secondary mechanism, known as the undertaxed payment rule, applies a charge – or denies a deduction for payments to the parent – when top-up taxes have not been recovered from the parent.
The subject to tax rule allows jurisdictions to impose a source-based tax (such as a withholding tax) on related-party payments such as royalties or interest which are subject to tax below the minimum tax rate (7.5%–9%). The subject to tax rule applies irrespective of the income inclusion or undertaxed payments rules and is considered a covered tax when determining a multinational enterprise’s effective tax rate.
The Pillar Two reforms require multinational enterprises with annual global turnovers exceeding EUR 750 million (approximately USD 885 million) to pay a global minimum tax of 15% on profits. A top-up tax will be imposed on multinational enterprises where 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%, a top-up tax of 10% will be charged. Effective tax rates will be calculated by jurisdiction as a proportion of covered taxes, with financial income calculated under the global anti-base erosion rule.
Implications for GCC businesses
Current corporate income tax rates for multinational entities doing business in the GCC are:
Saudi Arabia – 20%
UAE – no corporate tax
Qatar – 10%
Bahrain – no corporate tax
Oman – 15%
Saudi Arabia, Qatar and Oman impose a higher rate of corporate income tax for hydrocarbon-related businesses. UAE imposes corporate income tax only for hydrocarbon-related businesses and branches of foreign banks. Bahrain imposes corporate income tax only for hydrocarbon-related businesses. Kuwait has currently not signed up to the global minimum tax framework. In addition, some of these countries also collect a lower rate of tax from their nationals in the form of zakat.
The Pillar One and Pillar Two reforms, including a global minimum tax, are planned to be implemented by 2023. While this may seem some time away, time is increasingly precious for multinational enterprises operating across the GCC. A more harmonious, interconnected international tax system may force multinational enterprises to review business models and supply chains while carefully looking at how they do business globally.
GCC tax authorities that introduce or update their corporate income tax laws will need to determine the accuracy of the bases on which tax is paid and assess whether related-party transactions are aligned with the arm’s length principle. Consequently, a robust transfer pricing policy should help multinational enterprises optimise tax supply chains while justifying fees charged on related-party transactions to local tax authorities.
Key decision-makers at all GCC businesses should urgently analyse the potential impacts of these tax reforms.
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