Tax Risks & Controversies – Current Trends in the Middle East

New tax legislation, more extensive compliance requirements and stringent tax enforcement in many countries are increasing tax risks for companies doing business in the Middle East and North Africa (MENA) region.
 
EY’s global 2014 tax risk and controversy survey confirms the above on-the-ground experience in the MENA region.
 
EY 2014 Tax Risk and Controversy Survey Findings
 
The EY report, “Bridging the divide”, analyses the responses from 830 tax and finance executives in 25 jurisdictions, who took part in the EY 2014 tax risk and controversy survey and presents key tax insights to help clients prepare to meet the challenges ahead.
 
Overall the survey reports that:
 
 - 81% of all companies surveyed agreed that tax risk and controversy will become more important for their companies in the next two years.
 - 74% of the largest companies say they feel that tax administrators are now challenging the existing structures due to changes in the law or changes in their enforcement approach.
 - 68% of the largest companies report that they feel tax audits have become more aggressive in the last two years.
 - 78% of the largest companies say that entering into or operating in an emerging market significantly increases their levels of tax and controversy risk.
 - 75% of the largest companies say that having insufficient resources to cover tax function activities is a potential cause of tax risk.
 
In terms of specific tax areas and matters of concern, the EY survey reflects:

 - A 21% increase in more frequent and aggressive tax audits
 - A far greater focus by tax authorities on cross-border transactions
 - Transfer pricing (TP) as the leading source of risk with APAs more difficult to negotiate and secure in some markets coupled with a lack of robust regulations setting out TP guidelines
 - Indirect taxes and permanent establishment risk as the second and third highest sources of tax risk, respectively
 
Latest Findings from the OECD BEPS Project
 
On 1 August 2014, the OECD released a report to the G20 Development Working Group on the impact of Base erosion and profit shifting (BEPS) in low income countries.  The report focuses on the main sources of BEPS in developing countries and the relationship to the BEPS Action Plan. 
 
The BEPS report indicates that developing countries and international organisations have identified the following areas of greatest concern:
 
 - Excessive payments to affiliates
 - Supply chain restructuring
 - Inability to obtain transfer pricing information
 - Improper treaty benefits
 - Treatment of sales of assets and
 - Pressure to offer tax incentives
 
The above concerns are consistent with the experience of multinational companies reported in the EY survey and the current on-the-ground experience in MENA summarised below.
 
In addition, governments in the MENA region are under pressure to increase their sources of non-oil and gas revenue.  In some countries like Oman, tax is becoming an important source of government revenue. 
 
Emerging Tax Compliance and Enforcement Trends
 
Greater Scrutiny Of Related Party Transactions
 
With the increasing number of foreign companies establishing business in the MENA region, tax authorities are looking to these companies, as a growing source for new or increased tax revenues.

Consequently, we are seeing increasing scrutiny of cross-border transactions and related party transactions in various jurisdictions, including Egypt, Saudi, Oman and Qatar.  Tax authorities in these countries are also in the process of implementing more definitive TP regulations and compliance requirements.
 
Application of More Technical Tax Concepts
 
In the past, the tax authorities in MENA used to take a much broader and, at times, subjective interpretation of tax law concepts and principles.  For example, in Oman, local business presence for a few days was deemed to create a permanent establishment (PE).  The new tax law in Oman has introduced well-defined PE and service PE provisions that are in line with more advanced tax jurisdictions. 
 
New tax laws have also resulted in more complex tax provisions relating to thin capitalisation, the movement of assets and expatriate employees between countries and tax avoidance being introduced and increasingly enforced.
 
Resistance to Deemed Profit-Based Tax Declarations
 
Throughout the region, we see tax authorities either issuing deemed profit assessments with arbitrary high taxable profit determinations (Oman, Kuwait) or introducing laws to bar deemed profit based tax filing (Egypt, Qatar).  Businesses would be well advised to prepare for tax filings on the basis of actual profits, supported by audited local financial statements.  Before doing so, it would be prudent to undertake analytical reviews of operating structures and arrangements and ensure appropriate substantiation of related party transactions. 
 
Increasing Scrutiny and Enforcement of Withholding Tax Compliance
 
Tax authorities in many MENA countries including Oman and Qatar are increasing scrutiny of withholding tax laws and enforcing compliance.  In Saudi Arabia and Qatar, authorities are also using pay and claim regulations to enforce compliance.  The interpretation of what constitutes royalties or payments for intellectual property are also being considered in a much broader context and applied to a broader range of payments to foreign companies, including payments for software and technical services.
 
Increasing Disclosure Requirements and Depth of Tax Audits
 
New tax return formats have been introduced in many countries including Qatar, Oman and Kuwait, to increase transparency of transactions and disclosures relating to cross-border and related party transactions.
 
Tax audits are now more frequent and aggressive, with tax assessments demanding additional tax payments.  Tax authorities are also using government information networks, to gain information regarding revenues derived in-country and transaction values of projects that are then used in tax audits.
 
In summary, many countries in the MENA region including Saudi Arabia, Kuwait, Qatar and Oman are taking steps to implement concepts related to BEPS in the form of new legislation, establishing “tax enforcement teams” to review and enforce tax compliance, and review TP and related party transactions.  These BEPS-related initiatives may threaten the soundness of the operating structure and business arrangements adopted by companies, creating more uncertainty and greater risk of controversy between tax authorities and taxpayers.  Consequently, it is imperative that companies undertake appropriate actions to mitigate risks with appropriate review and informed planning of cross-border operating structures and related party transactions.
 
The opinions expressed in this article are the personal opinions of the authors and do not necessarily reflect the views of EY.
 
Morris Rozario is an Executive Director responsible for tax technical communications with EY MENA.  Morris is a corporate tax professional with over 30 years of experience advising and working with multinational companies in Asia, East Africa and the Middle East. 
 
EY is the leading professional services firm in the Middle East with professional tax advisors and subject matter specialists in over 15 countries across the Middle East and North Africa. 
 
Morris can be contacted at Morris.Rozario@om.ey.com