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BACKGROUND

The Transfer Pricing landscape in the Middle East region has been continuously evolving in the last couple of years largely as a consequence of developments arising out of the OECD’s Base Erosion and Profit Shifting (‘BEPS’) project. Several countries in the ME have committed to implement minimum tax standards under the BEPS Implementation Framework (‘IF’), one of which includes Action 13 – TP documentation and Country by Country Reporting (‘CbCR’). As a result, countries such as Bahrain, Egypt, Jordan, Kingdom of Saudi Arabia (‘KSA’), Oman, Qatar and United Arab Emirates (‘UAE’) now have detailed TP and / or CbCR laws in place.

The complexity posed by new laws has meant that businesses operating in the region have more tax thinking to do. It has meant increased TP/CbCR related compliances, more scrutiny/disputes, need to create additional documentation and the need to remodel or do away with existing company structures and intercompany dealings which will no longer work.

The interplay of Transfer Pricing with the Economic Substance Regulations introduced in UAE and Bahrain under BEPS Action 5 – Addressing Harmful Tax Regimes is another factor that can’t be ignored. The more the substance housed in a particular location/entity, the more profits the entity needs to earn. Multinationals have all along made use of UAE & Bahrain’s zero tax regimes to have centralized hubs in terms of headquarter, procurement or intellectual property for their Middle East operations. With the introduction of the first set of BEPS reforms, multinationals in the region have already had to change their strategies but with the upcoming reforms expected as part of BEPS 2.0, their problems will be even more accentuated.

BEPS 2.0

On 1 July 2021, most of the BEPS IF member countries committed to a new overhaul tax reforms referred to as BEPS 2.0 which consist of two Pillars.

Pillar One is initially expected to be applicable only to multinationals with global turnover above EUR 20 billion. It calls for a certain pre-determined share of the consolidated profits of such multinationals to be allocated to markets where proportionate sales arise. Where consolidated profits exceed 10% of revenues, the profit to be reallocated (Amount A) will be 20 to 30% of the excess profit. This profit reallocation is expected to happen regardless of any intra-group Transfer Pricing mechanisms the group may have set in place. Another Amount B aims to set standard margins for group entities that perform low risk marketing and distribution functions.

Under Pillar Two, member countries agree a system whereby multinationals are to be taxed at a global minimum tax rate of 15%. This would apply to groups with global turnover above EUR 750 million (same threshold as for CbCR) but jurisdictions could decide to apply a lower threshold. Pillar Two reforms could manifest as:

1. A top-up tax in the jurisdiction of the multinational’s parent entity in respect of any lower-taxed income of a group entity (i.e., where income has not been subject to an effective minimum tax of at least 15%).
2. Where such top-up tax has not been applied, a secondary rule ensuring that lower-taxed group entities pay an effective minimum tax rate of at least that 15%.
3. An additional tax on royalties, interest and other defined payments made to a member jurisdiction that applies a corporate tax rate lower than the minimum prescribed rate of between 7.5 – 9%.

The application of Pillar One and Pillar Two appears restricted to the largest multinationals initially however actual implementation needs to be awaited. In addition, certain exemptions areas have been factored under both Pillar Oneand Pillar Two. Initial indications are that both Pillars could become effective as early as 2023.

BEPS 2.0 – ME Impact

Middle East countries such as Bahrain, Egypt, Jordan, KSA, Oman, Qatar and UAE have expressed support for these proposals. UAE in particular issued an official statement issued on 26 July 2021 stating its support for Pillar Two.

1. Through Pillar One, excess profits of multinationals based in Bahrain/UAE could be reallocated to jurisdictions with higher tax rates, resulting in increased group taxes.
2. Through Pillar Two, there is higher potential impact for multinationals headquartered/operating in the ME. Profits of businesses in Bahrain/UAE, where statutory tax rates are currently below the proposed global minimum tax of 15% could become subject to the top-up tax in an overseas jurisdiction. ME countries will in all likelihood themselves introduce local legislation to ramp up tax rates in order to protect their tax base.

Conclusion

For large multinationals operating in the region, firstly we recommend that they track and address all the new country-specific tax compliance requirements that have arisen in the last couple of years and factor in the consequences of non-compliance i.e., adjustments and/or penalties into their tax planning. Secondly, we recommend that businesses be closely aware of the constant developments in the BEPS, TP and CbCR space so they are fore-warned and pre-prepared to develop appropriate future-oriented policies in response to these shifting variables.

The Ministry of Finance (MOF) has released high level details on the proposed UAE Corporate Tax (CT) regime in the form of a press release and Frequently Asked Questions (FAQs) published on web portal of tax authorities i.e. UAE MOF and the Federal Tax Authority (FTA). This is motivated by UAE’s desire to integrate into the global business community and meeting international tax standards, while minimizing compliance burden for UAE businesses and shielding small businesses and start-ups.

His Excellency Younis Haji Al Khoori, Undersecretary of MOF, stated that “the certainty of a competitive and best in class Corporate Tax regime, together with the UAE’s extensive double tax treaty network, will cement the UAE’s position as a world-leading hub for business and investment”. The relevant legislation for the CT regime (UAE CT Law) is currently being finalized and is expected to be promulgated during 2022. Once released, the UAE CT Law will provide details and guidance on several critical aspects.

UAE businesses will be subject to UAE Corporate Tax in a staggered manner from Financial Years (FYs) beginning on or after 1 June 2023. An entity having a FY beginning on 1 July 2023 and ending on 30 June 2024 will be subject to CIT from 1 July 2023. While, entities having a FY beginning on 1 January 2023 and ending on 31 December 2023, will be subject to UAE CT from 1 January 2024.

Scope

UAE CT is a federal tax and consequently, will apply to all businesses and commercial activities in the UAE except for extraction of natural resources which will continue to be taxed at the Emirate level. Likewise, the UAE CT regime will apply to individuals to the extent that they hold (or are legally required to hold) a business license or permit to carry out commercial, industrial and/or professional activities in UAE. This includes income earned by freelance professionals for activities carried out under a freelance license or permit.

Rates and Computation

Adopting a slab rate system, the headline UAE CT rate has been fixed at 9% to be calculated on taxable income as below:

An increased UAE CT rate would be applicable for large multinationals that meet specific criteria set with reference to pillar two of the OECD BEPS 2.0. Taxable income for a tax year is to be computed based on accounting net profit/income of a business reported in financial statements prepared in accordance with internationally acceptable accounting standards, after the prescribed adjustments. With a 9% standard tax rate, UAE CT regime will remain one of the most competitive tax jurisdictions in the world.

Exemptions from UAE CT

As per the issued FAQs, certain incomes have been kept outside the ambit of the UAE CT including:

• Foreign investors will not be subject to UAE CT if income is not earned from a regular trade/business in UAE;

• UAE CT will not apply on capital gains and dividends received by a UAE business from ‘qualifying shareholdings’; and

• UAE CT will not be applicable to qualifying intragroup transactions and restructuring subject to certain conditions to be specified under the legislation.

It has also been announced that UAE CT will honour tax incentives committed to businesses located in Free Zones, to the extent that eligible entities comply with applicable regulatory requirements and do not conduct business in mainland UAE. Further, current business models for trade in goods and/or provision of services may need to be restructured once further guidance is released by MOF. Free Zone businesses will nevertheless have to comply with certain obligations under UAE CT regime, including the obligation to register and file a Corporate Tax return and claim exempt as applicable.

Other key noteworthy aspects from the announcement

The UAE CT regime will allow a business to utilize tax losses incurred (from the date UAE CT is effective) to offset taxable income in subsequent tax years. Based on current guidance, it seems that eligibility for tax losses would be applied on a prospective basis i.e. from the first tax year onwards. Further, a ‘Fiscal Unity’ concept would be implemented as part of UAE Corporate Income Tax (CIT) law i.e. eligible UAE group of companies may elect form a tax group and file a single (consolidated) tax return subject to conditions to be specified.

A tax withholding regime has not been included in proposed UAE CT law. In other words, there will be no withholding tax on domestic and cross border payments. This can be seen as a substantial relief to UAE business as introduction of a withholding tax regime increases compliance burden and other administrative complexities. Foreign Tax Credit (FTC) will be allowed against UAE CT liability. This is in line with corporate tax regimes followed by most of the countries across the globe.

UAE businesses will need to comply with international Transfer Pricing (TP) rules and documentation requirements contained in OECD TP Guidelines (as amended in 2022) for related party transactions. It would be interesting to see if domestic transfer pricing rules are introduced similar to other tax jurisdictions in the region.

Accounting considerations

As per the FAQs, accounting profits/income of a business (which is the starting point of a taxable income computation) should be as per internationally acceptable accounting standards. Hence, it will be obligatory for all businesses under UAE CT regime to maintain accounting records as per International Financial Reporting Standards or prevalent GAAP in UAE. It would be interesting to see whether UAE CT law mandate annual financial statements to be audited in the absence of a mandatory requirement under commercial law for a large section of businesses in the UAE.

Key takeaways and what business in UAE should do in the interim

The announcements and guidance released by UAE MOF has clarified key design features of UAE CT, however, several uncertainties remain awaiting clarity in UAE CT law and its implementing regulations. Whilst the announcement implicates that large multinational groups (MNEs) will be taxed at a higher rate, it remains to be seen how this will be implemented from a policy perspective (e.g., increase in tax rate or a domestic minimum tax/ parallel tax) which is yet to be announced.

Businesses operating in UAE should consider the following to get ready well in advance of the UAE CIT go-live date:

• Finance functions should begin preliminary assessment of existing business operations to identify broad areas which could pose challenges from UAE Corporate Tax perspective

• Discuss the issues identified with relevant departments and plan an approach/ methodology to be adopted for implementing UAE CT

• Identifying possibility to restructure business operations and optimize the current business structure to minimize the impact of the proposed UAE CT and envisaged TP regulations

• Perform gap analysis to identify required system changes to meet financial information requirements for UAE CT compliance.

Following an announcement on 31 January 2022, the UAE Government released Federal Decree Law No. 47 of 2022 on Taxation of Corporations and Businesses (UAE CT Law) on 9 December 2022. This follows a first of its kind public consultation drive which began on 28 April 2022 seeking feedback from stakeholders on key features and principles of the planned UAE CT regime. The UAE CT Law has been supplemented by 158 Frequently Asked Questions (FAQs) which provide further guidance regarding the intent and principles of the legislation.

Though largely in line with principles contained in the public consultation document, provisions contained in UAE CT Law have addressed issues on key aspects which is indicative of the positive approach of the UAE Government for implementing a cohesive, straightforward and transparent legislative framework.

UAE CT is applicable on taxable income of resident and non-resident persons for financial years beginning on or after 1 June 2023. UAE CT will be applied at a rate of 0 percent on taxable income upto AED 375,000 and a general rate of 9 percent for taxable income above AED 375,000. Resident entities are taxable on worldwide income whereas non-residents would be taxable on UAE sourced income which could include income from a resident in the UAE, income derived from the UAE or income from activities performed or benefitted in the UAE.

The personal income of natural persons has been kept outside the scope of UAE CT, however, business income of individuals is within the ambit of UAE CT. The meaning of business and commercial activities in respect of natural persons would be notified in a separate Cabinet Decision.

UAE CT Law provides for exemptions for businesses engaged in extraction of natural resources, Government and Government controlled entities, charities and public benefit entities, investment funds, pension and social security funds, subject to conditions. Certain exempted categories are required to claim the exemption through an application process to be notified.

Free Zones are a key economic driver for the UAE and this fact has been appropriately addressed in the UAE CT regime through an incentive to Free Zone registered persons being taxed at the rate of 0 percent on Qualifying Income. Qualifying Income would be detailed in a specific Cabinet Decision which is expected imminently at the time of going to press. However the Free Zone Person incentive carries stringent conditions including maintaining substance in the Free Zone License, satisfying transfer pricing requirements and other compliances. These conditions may not be straightforward for many businesses to comply given existing holding structures, business models and operations.

Provisions for taxable income and its computation largely follow internationally accepted best practices including exemptions to dividends from domestic companies and participation interests, a cap on net interest deduction at 30 percent of EBITDA and a cap on business entertainment expenses at 50 percent. Reliefs for small businesses, intra-group transactions and restructuring has been provided. It is important to note that UAE CT Law explicitly states that expenditure is deductible only if it is incurred exclusively for business purposes and accordingly, expenditure which is personal in nature, or incurred for exempt or incentivized income may not be deductible.

The parent entity of a resident group of companies can make an application to form a tax group with its UAE subsidiaries, subject to meeting strict conditions. These conditions include a 95 percent ownership requirement and neither the parent nor a subsidiary can be an exempt or a Qualifying Free Zone person. The parent company of a tax group is responsible for administrative mandates under law and would submit a single tax return.

The UAE CT Law has been generous in respect of tax losses providing for indefinite carry forward for setoff against future taxable income capped at 75 percent of such taxable income provided certain conditions are met. Tax losses may also be transferred between resident companies with 75 percent common shareholding subject to the specified cap for set-off.

Persons subject to UAE CT are mandated to register with the Federal Tax Authority (FTA) and obtain a Tax Registration Number. Early bird registrations have been activated by the FTA on the Emara Tax portal. However, it is understood from authorities that a registration should be obtained prior to filing of tax returns.

All Taxable Persons subject to UAE CT, including Qualifying Free Zone Persons, will be required to file a tax return and pay any due tax within 9 months from the end of a tax year (which is the current financial year followed by such taxpayers).

As per Law, transactions with associated enterprises (related parties) and connected persons are required to comply with the arm’s-length principle which would be in line with OECD Transfer Pricing (TP) Guidelines. However, the definitions of related parties and connected persons are customized to suit the socio-economic climate of UAE and include kinship up to the fourth degree which may trigger TP requirements. UAE CT Law requires UAE businesses to maintain TP documentation which will be prescribed under a Ministerial Decision. TP documentation must be submitted to the FTA within 30 days of a request. Further, all taxpayers would be required to submit a TP disclosure form along with the UAE CT return detailing the controlled transactions of a tax year.

As per UAE CT Law, documentary evidence supporting tax positions taken by the taxpayer should be maintained for at least 7 years from the end the relevant tax year.

Additionally, UAE business may be requested to submit financial statements and other documentary evidence including transfer pricing to the FTA.

UAE CT Law includes a detailed general anti-abuse rule (GAAR) intended to disregard transactions or arrangements undertaken with the purpose of obtaining a tax advantage. GAAR applies from the date of publication of UAE CT Law in the Official Gazette.

As part of transitional provisions, the UAE CT Law also provides that the opening tax balance sheet would be the closing accounting balance sheet for the financial year immediately before the first tax year and should conform to the arm’s length principle.

The impact of a new business law or regime are far-reaching for an economy and considering that tax legislation is relatively new for UAE businesses, additional care should be taken while assessing implications under UAE CT Law. As further details would be forthcoming over the coming months through a series of Ministerial and Cabinet Decisions, businesses should closely monitor developments and prepare for change management well in advance to mitigate the probability of unfavorable outcomes. As part of the run up to the effective date of UAE CT on business activities, investors and entrepreneurs alike may consider assessing the impact of UAE CT on as is basis, structural changes (keeping in mind GAAR), modelling cash flow implications, consider exemption regimes, and developing processes and related procedures to manage compliance.

Natural persons undertaking a business activity should assess whether income earned could be regarded as business or commercial in nature and take steps to structure such activities to be tax efficient.

Every change is an opportunity to become more efficient in the way we do things and I believe this is true even in the case of implementing UAE CT in your business activities.