The changing Middle East income tax landscape –Deemed profit basis tax declarations under threat
The advent of the Arab Spring civil unrest has brought about paradigm changes to the political and social economic landscapes in countries from Bahrain to Tunisia, with the bells ringing change continuing to toll in many countries. The promulgation of new tax laws with lower income tax rates and the impact of the continuing global financial turmoil are also contributing impetus for change. Consequently, over the last few months, we have noted that long standing tax policies and practices are undergoing an evolution if not a revolution. Over the next few months, we will review specific changes in tax compliance requirements and practice and consider trends that are likely to have significant impact on tax costs in the Middle East.
Over the last year, we have noted that there has been an increasing tightening of compliance practice and assessments relating to deemed profit tax declarations and presumptive basis assessments in almost all Middle East tax jurisdictions. In this article, we will review the tax law position and present attitude of tax authorities in Egypt, Iraq, Jordan, Kuwait, Saudi Arabia, Oman and Qatar and consider future trends and likely outcomes. Finally we will briefly outline measures that businesses may consider to prepare for and respond to these changes.
Tax law position and practice
Tax laws in Egypt (since 2005), Iraq, Jordan (effective 2010), Kuwait, Saudi Arabia (since 2005), Oman and Qatar (effective 2010) all require taxpayers to maintain statutory books and records and file tax returns on an actual basis, supported by audited financial statements. Within the context of the tax laws in Middle East jurisdictions, it is therefore important to appreciate that deemed profit basis tax declarations and assessments have been allowed either as a non-statutory tax practice concession or as a tax enforcement or penalty measure due to non compliance.
Tax laws in a number of Middle East countries include provisions or byelaws which allow the tax authorities to make deemed profit or presumptive basis assessments on taxpayers who are either non compliant with tax filing requirements (Iraq, Jordan and Saudi Arabia) or approved to be taxed on a deemed profit basis (Qatar). In Egypt, Oman and Kuwait, tax declarations (returns) on a deemed profit basis are accepted by the tax authorities as a tax practice concession.
Businesses where deemed profit basis is normally adopted
In actual experience, in the Middle East, deemed profit tax declarations or presumptive basis assessments have been used as an expedient and effective means of discharging income tax obligations by foreign branches, service contractors and professional consulting companies who conduct business on a project by project basis with work largely undertaken or supported from abroad, i.e. permanent establishments with little or no in-country presence.
Tax assessment experience
Generally, in the past, deemed profit basis assessments in Oman, Kuwait and Qatar were raised following a process of negotiation with the tax authorities taking into consideration profits derived by taxpayers in a similar business or industry or global operating margins disclosed in published accounts. Assessments were raised based on deemed profit margins which ranged from 15% to 30% in Oman, 20% to 35% in Kuwait and 18% to 30% in Qatar. Following the introduction of new tax laws with significantly lower income tax rates (10% in Qatar to 15% in Kuwait) the tax authorities are increasingly reluctant to approve or accept deemed profit basis tax declarations. Recent tax assessments are being issued with presumptive basis profit margins ranging from 25% to 50% in Oman and 25% to 40% in Kuwait. Under the new tax law in Qatar, there is a move to have taxpayers file tax returns on an actual basis and for these returns to be accompanied by a full set of audited financial statements. The tax authorities are now less willing to grant approvals for deemed profit tax filings and where approval is granted, the rates are likely to be higher than previously was the case.
In Jordan and Saudi Arabia, the tax authorities have indicated that deemed profit tax declarations would not be accepted for companies and permanent establishments with a commercial registration in these countries. In Egypt and Iraq, the tax authorities have been more accommodating with lower deemed profit rates being determined as a recognition that previous rates (100% of annual turnover in Egypt and 40% presumptive rate in Iraq) were considered too punitive.
Based on recent experience, it is clear that the profit margins assessed on a presumptive basis (or deemed profit basis) are likely to continue to increase to encourage businesses to make tax declarations based on actual results supported by statutory books and audited accounts.
Measures to take in preparation for tax declarations based on actual results
Although the income tax rates in most Middle East jurisdictions have been significantly lowered, tax laws include provisions that restrict deductions for expenses incurred by the head office and affiliate companies and expenses incurred out of country. The deductibility of expenses may also be restricted by substantiation requirements, subjective transfer pricing and thin capitalization determinations.
Consequently, companies preparing to file tax returns based on actual results would be well advised to ensure that all expenses incurred in deriving taxable incomes are appropriately substantiated with the required documentary evidence, intercompany expenses are supported by appropriate agreements and transfer pricing considerations are properly addressed. Finally, it is also important that compliance with withholding tax laws is considered when costs are taken up under various expense accounts.
It is advisable that appropriate tax advice is taken and tax health check reviews are undertaken before finalization of local statutory accounts and tax declarations based on actual results. Ernst & Young MENA has developed a comprehensive procedural framework and review process to assist clients to make the change from deemed profit basis tax filing to filing tax declarations based on actual results.
Morris Rozario is an Executive Director responsible for tax technical communications with Ernst & Young, MENA. Morris is a corporate tax specialist with over 30 years of experience advising and working with multinational companies in Asia, East Africa and the Middle East. Ernst & Young is the leading professional services firm in the Middle East with professional tax advisors and subject matter specialists in over 17 countries across the Middle East and North Africa. Morris can be contacted at Morris.Rozario@om.ey.com