Double Tax Agreements– An invaluable framework for certainty of tax outcomes in the Middle East and North Africa region
By Tobias Lintvelt & Seema Sharma
Posted: 7th December 2012 10:10The tax environment in Middle East & North Africa (“MENA”)
In many MENA countries, the Arab spring has brought to the fore, the urgent need to substantially increase employment and improve the social well being of their population majorities. Governments in these countries are responding with the implementation of significant economic development plans and social subsidies and welfare programs.
Further, to reduce reliance on the Oil and Gas sector, diversify the economy, attract foreign direct investments and stimulate economic growth, many MENA countries have also implemented new tax laws with limited scope and complexity and low tax rates.
To address the fiscal pressures arising from the above government policy initiatives, the tax authorities are looking to increase tax collections. The challenge is exacerbated, due to the limited tax resources employed by the taxing authorities.
As a consequence of these compounding challenges, domestic tax laws are often applied with broad, subjective interpretation of tax concepts and principles. In these cases, the existence and application of overriding double tax treaty provisions provide necessary, and in many cases the only, protection against unintended tax consequences.
Common Domestic Tax Issues Addressed By Double Tax Treaties
Permanent establishment (PE)
In Saudi Arabia and Kuwait, a PE is construed to be created, if business is carried out in the country through a place of activity, without reference to any period of presence, i.e. a PE may be created even if business is carried through a place of activity for one day.
Under most Saudi and Kuwait tax treaties, presence of PE is determined with reference to the Period of activity in country in relation to the same or connected project.
In addition, in many MENA countries, there are far reaching dependent agent provisions that apply to the relationship between a foreign principal and in country agent, under domestic tax law that increase the risk of a PE being created. For example, retaining title to the goods located on consignment in country with distributor, risks PE.
Under tax treaties, the definition of a dependent agent is usually limited to those having authority to conclude contracts on behalf of the non-resident.
Income from rendering of services
Most tax treaties have a six months threshold period with respect to building sites or construction or installation projects and a presence threshold of six months or 183 days, within any 12-month reference period, for services
Tax treaties with a number of countries including China and Singapore may include minimum period of presence threshold (say, 90 days in a twelve month period) before a Service PE of the non-resident provider can be construed.
Withholding tax (WHT)
Taxpayers in Saudi Arabia and Qatar are required to withhold tax at domestic rates on specified payments (which usually relate to payments for dividends, royalties, interest and software), are made to non residents.
Where a lower rate or exemption under a tax treaty applies, the withholder may claim a refund by submitting an application letter certifying that WHT does not apply or withholding is excessive under applicable tax treaty, including Tax Residency Certificates and other prescribed documents.
Definition of Royalty
Domestic law definition of royalty in Oman and Qatar includes payments for the right to use industrial, commercial and scientific equipment. Treaty definitions may be more restrictive and limited to the right to use intellectual property.
Attribution of income
Many tax authorities in MENA seek to tax all incomes earned by a non-resident company from the MENA country including incomes earned by a non-resident attributable to activities undertaken offshore i.e., outside the MENA country concerned.
Most double tax treaties follow the attribution of income rules prescribed by the OECD tax treaty model.
In Saudi Arabia and Qatar, disposals of shares in a local company by a non-resident parent may be subject to capital gains tax regardless of where the transaction was completed.
The use of an appropriate entry point investment entity located in the Netherlands, Luxembourg or Cyprus may offer protection from capital gains tax on sale of shares in MENA companies. One needs to demonstrate business substance.
Ensuring certainty of tax outcomes
From a business investment perspective, tax outcomes need to be managed to ensure certainty of tax costs. Not just the tax payable based on tax declarations filed, but also costly taxes and penalties from assessments and disagreements.
So, in an increasingly complex and dynamic business environment, how do businesses ensure that tax outcomes arising from cross border structures, transfer pricing, leasing and asset movements are planned and achieved with certainty. Based on Ernst & Young’s experience of these issues in the MENA jurisdictions, the answer lies with good tax planning, use of DTAs, appropriate documentation to substantiate transfer price on intercompany transactions and sufficient tax compliance.
Most MENA countries have extensive DTAs that provide considerable tax benefits relating to PE, income attribution rules, withholding tax rates and exemptions for specific transactions.
It is clear that in MENA, DTAs provide an invaluable framework for structuring and managing cross border investments, transactions and operating arrangements.
Ernst & Young has the largest professionally qualified and experienced tax team of local tax experts and international tax, transaction tax and transfer pricing specialists located in most MENA countries including Egypt, Iraq, Kuwait, Libya, Oman, Pakistan, Qatar, Saudi Arabia and UAE.
Tobias Lintvelt is a Partner at Ernst & Young, specialising in Transaction Tax and International Tax Services in UAE and Kuwait. He can be contacted by phone on +965 2 295 5308 or alternatively via email at firstname.lastname@example.org
Seema Sharma is a Regional Transfer Pricing Leader in MENA for Ernst & Young. She can be contacted by phone on +971 4 701 0517 or alternatively via email at email@example.com