The global project to address tax base erosion and profit shifting (BEPS) is in full swing, and the Organisation for Economic Co-operation and Development’s (OECD) Action Plan on BEPS1 is progressing quickly. What the OECD will ultimately recommend and how individual countries will translate these recommendations into law are unknown.
“As the OECD’s work continues, companies in the MESA region should prepare for the coming wave of change by reviewing their existing tax transactions and structures to identify potential weaknesses and by taking steps to make improvements,” says Ashok Hariharan, KPMG’s Regional Head of Tax for the Middle East and South Asia.
The OECD’s goal is to achieve consensus on a coordinated implementation of uniform international taxation principles for the modern age. Its Action Plan on BEPS identifies 15 specific actions that will give governments the domestic and international instruments to prevent corporations from paying little or no taxes.
On 16 September 2014, the OECD released seven documents totaling 720 pages and covering Action Plan items in several areas, including the digital economy, transfer pricing for intangibles, transfer pricing documentation and hybrids. In reality, these deliverables are interim reports for the broader work-in-progress, which is expected to be completed by the end of 2015. Many projects have significant interdependencies that will require skilled coordination, and so the deliverables to date need further work.
Sometimes, this extra work reflects a need to gain greater consensus among the high number of countries involved. Despite skepticism that such consensus can be achieved, there are encouraging signs. No participating country has decided to opt out of the process. And while the degree of flexibility and optionality within some of the Action Plan items leaves room for inconsistent implementation, it will enable the project to move forward.
“Governments in the Middle East may seem to be less active on BEPS than those of some other regions,” says Mr. Hariharan. “It is significant, however, they also have not opposed the OECD project. In fact, many countries in the Middle East and South Asia region are closely monitoring the international taxation changes that are under review.”
Mr. Hariharan explains that compared to many Western countries, governments in many Gulf Cooperation Council countries have a longer history of concern over BEPS. Until recently, headline corporate tax rates in countries like Saudi Arabia, Oman and Qatar were quite high – up to 55 percent in the case of Kuwait – and foreign investors in the oil and gas and other industries had ample incentive to optimize the tax they paid in the region.
“Tax authorities in the region were much more alert to BEPS techniques as a result, and they have more of a tradition of striking down tax planning arrangements that divert profit flows to tax-favored jurisdictions like Mauritius and Cayman Islands,” says Mr. Hariharan. “However, such challenges tended to be based on general anti-abuse measures rather than, for example, detailed transfer pricing rules.”
In light of this history, it’s not surprising the countries in the Middle East are more interested in some aspects of the Action Plan than others. Transfer pricing, for example, has become a high priority in the region. Egypt, for example, has started auditing companies to check compliance with the transfer pricing rules introduced some years ago. Saudi Arabia is expected to come out with new transfer pricing regulations shortly. These and other countries may introduce or reform their transfer pricing regimes in accordance with the outcome of the OECD Action Plan.
Given the keen interest of Middle Eastern tax authorities in following profit flows, exchange of information measures are also attracting their attention. United Arab Emirates, for example, is strengthening its fiscal and regulatory frameworks to enable exchange of information on tax matters through inter-government agreements in connection with the US Foreign Accounts Tax Compliance Act and the OECD Global Forum on tax information exchange (for details, see the related article). As Middle Eastern countries expand their treaty networks, they are entering into more bilateral tax information exchange arrangements as a part of these agreements.
Some less developed countries in the Middle East and South Asia are uninterested in the OECD’s project. With relatively low international activity and less developed taxation systems, these countries do not perceive BEPS to be a significant problem. For example, even thoughBangladesh has a network of tax treaties with 32 countries, they are neither widely understood nor readily applied. Bangladesh also recently introduced transfer pricing legislation, but there has been considerable confusion and hesitation over its application.
Other developing countries are monitoring the debates and actively engaging with the OECD and will likely adjust certain aspects of their tax systems in response to any new international norms. For example, Lebanon has not implemented any specific action in relation to BEPS, but its tax authorities maintain continuous communication and cooperation with the OECD in order to foster economic growth and financial stability.
Similarly, the tax authority of Pakistan is keenly monitoring international developments on BEPS rules. The Pakistan tax law contains specific provisions in line with the global practices to address matters of tax avoidance by multinational companies, including cap on deduction of certain expenses and general transfer pricing rules. Pakistan may look to the OECD deliverables as a benchmark in the future, depending on domestic economic developments. Internal capacity building measures in this regard are underway.
Sri Lanka’s government is concerned about base erosion and, while it is not participating in the OECD project, the country has introduced a number of its own BEPS-related measures in recent years – for details, see the article in this edition of MESA Tax Update.
How permanent establishments are defined is one area where the OECD Action Plan could have significant impact. Middle Eastern countries tend to define permanent establishment more broadly than the OECD norm, and many of the exceptions to the definition allowed in other countries do not apply. For example, Oman recently amended its law to assert that a permanent establishment exists even where services are provided in the country for a period exceeding 90 days.
Kuwait has no permanent establishment definition in its tax law to date – any sort of economic activity in the country is taxable there, regardless of whether or not the activity is conducted through a fixed place of business. Such approaches to the existence of permanent establishments are likely to conflict with changes to international tax principles made at the OECD level.
Another area of special concern in the region is how the BEPS Action Plan will affect the taxation of sovereign wealth funds and pension funds. “Sovereign wealth funds and pension funds differ from operating companies in important ways, and changing tax policies may have different effects,” says David Neuenhaus, Global Lead Tax Partner - Pensions, Sovereigns and Infrastructure. “Comparisons of the headline income tax rates and structures that apply to operating companies versus sovereigns and pensions may be flawed and can result in misguided attention.”
This highlights how important it is for affected taxpayers to take a proactive role in BEPS consultations. “Whether your organization is a sovereign wealth fund, corporation or other affected entity, there are still opportunities to engage with the OECD and government representatives to ensure practical business issues are raised and considered,” says Mr. Neuenhaus.
What can tax directors in the MESA region do now to help prepare for the coming wave of international tax change? In examining their existing tax arrangements, companies in MESA should give high priority to five specific areas:
Above all, given the quick pace of the BEPS project, companies should closely monitor developments and their potential impact on their tax processes and planning arrangements. They should also take a proactive role in BEPS consultations to ensure practical business issues are raised and considered early in the process.
1Organisation for Economic Co-operation and Development (2013), Action Plan on Base Erosion and Profit Shifting, OECD Publishing (referred to herein as “OECD Action Plan’).