Oman – new treaties with Portugal and Spain, taxable income calculation and other updates

Oman – new treaties with Portugal and Spain

Updates from KPMG in Oman include important details about Oman’s new tax treaties with Portugal and Spain and a recent administrative ruling in which the Tax Committee accepted accounting standards as the basis for calculating taxable income. KPMG in Oman also presents highlights of the Central Bank of Oman’s Financial Stability Report and expected enforcement action related to Oman’s new Wage Protection System.

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New treaty with Portugal

On 2 July 2015, Oman ratified the new tax treaty signed with Portugal on 28 April 2015. Once Portugal has ratified the treaty and ratification instruments are exchanged, the treaty will have from 1 January of the following year. Details of the treaty were recently published, and highlights are as follows.

Reduced withholding tax rates

The treaty provides for maximum withholding tax on dividends at the rates of:

  • 5 percent where the beneficial owner of the dividend is the state or the government, specifically including the Oman State General Reserve Fund, Oman Investment Fund, and any other wholly-owned statutory body or institution
  • 10 percent where the beneficial owner is a company holding at least 10 percent of the share capital
  • 15 percent in all other cases.

The treaty provides for a maximum withholding tax on interest at the rates of:

  • 0 percent where the beneficial owner of the interest payment is the state or the government, including the bodies specified above for dividends
  • 10 percent in all other cases.

Because the Oman income tax law does not impose withholding tax on dividends or interest payments, these provisions will not affect outbound payments from Oman.

The treaty provides for a maximum withholding tax on royalty payments at the rate of 8 percent on royalties (defined to include payments for the use of, or the right to use, industrial, commercial or scientific equipment). This will reduce withholding tax on outbound royalty payments from the 10 percent domestic withholding tax rate.

Permanent establishment measures

The treaty extends the definition of permanent establishment (PE) to deem a PE to exist where a person (who is not otherwise a dependent agent) habitually maintains a stock of goods or merchandise, from which goods or merchandise are delivered on the foreign enterprise’s behalf.

In calculating a PE’s profits1,  the treaty protocol provides specific guidance on contracts for survey, supply, instillation or construction of industrial, commercial or scientific equipment or premises, or of public works. The protocol clearly states that the profits of any PE should calculated by reference only to that part of the contract that is effectively carried out by the PE (and not total contract revenue).

That being said, when calculating the taxable profits of the PE, the protocol permits each state to apply its domestic tax law and regulations. In the case of the Oman income tax law, this could restrict the deductibility of PE’s indirect costs to 3 percent of the PE’s revenue (increased to 5 percent and 10 percent in certain cases).

The protocol further states that payments for technical services2, or for management, consultancy or supervisory services, would be taxable as either business profits or income from independent personal services. . With no further guidance available on this point, KPMG in Oman assumes this statement aims to clarify that such payments do not fall within the definition of royalty payments.

Entitlement to benefits limitation

A general ‘entitlement to benefits’ condition in the protocol would restrict treaty benefits where the income recipient is not the beneficial owner, or where the main purpose (or one of the main purposes) of the arrangements is to access the treaty’s provisions. This condition also makes it clear that the treaty will not prevent the application of either country’s domestic anti-avoidance rules.

Oman-Spain tax treaty – more details

The Oman – Spain Income Tax treaty (2014) (“the treaty”) has been ratified by Oman and Spain, and the treaty is subject only to the notification procedures, between the two States. The treaty will come into force three months after both notifications have been made and shall have effect:

  • for withholding tax purposes: from that date; and 
  • for other taxes: for tax years commencing on or after that date3

KPMG in Oman presented some of the highlights of this treaty in a previous article. Now that the English text of the treaty is available, KPMG in Oman summarizes these additional key details:

  • The 0 percent dividend withholding tax rate will be available to companies with a direct shareholding of at least 20 percent, and to dividends paid to the government of either country (including the Oman State General Reserve Fund, Oman Investment Fund and any other statutory body or institution wholly or mainly owned by the Omani government.
  • The availability of treaty benefits in connection with dividend, interest or royalty payments, or capital gains, is subject to an anti-treaty shopping condition, included in the protocol to the treaty. 
  • Where, for example, income is derived in Spain from a country with which Spain has not concluded a tax treaty, and amounts are exempt from tax or not subject to tax in Spain, treaty benefits will be denied for any onward distribution of those amounts to Oman (and vice versa). A taxpayer may seek4 agreement  that its primary purpose in structuring arrangements in such a way was not to obtain treaty benefits.
  • The treaty definition of independent agent5 limits the classification of an agent as ‘independent’ where the agent is devoted (wholly or mainly) to the business of the principal, and the commercial and financial arrangements under which the agent operates differ from those that an independent agent would have made. This is a broader test than the ‘dependent agent’ test used in certain other treaties, which requires the agent to have, and habitually exercise, an authority to conclude contracts in the name of the principal.

Accounting standards accepted as basis for taxable income

In a recent administrative ruling, the Tax Committee accepted accounting standards as the basis for calculating taxable income.

The taxpayer in this case generates electricity through a power plant that the taxpayer constructed and operates, providing electricity to the state power authority under a 15-year power purchase agreement (PPA).

Initially, the taxpayer accounted for the power plant as a fixed asset of its business, subject to accounting depreciation, while recognizing all of the components of PPA tariff revenue through its income statement, as they became due in each year. The taxpayer then adjusted its taxable income for the differences between accounting depreciation and tax depreciation.

Following a change of the taxpayer’s ownership on 1 February 2007, the new management gave consideration to Interpretation 4 of the International Financial Reporting Interpretations Committee, which came into effect for accounting periods beginning on or after 1 January 2006, to provide guidance on those arrangements which, although not in the nature of a lease, should be regarded as a lease, or as containing a lease.

It was decided that the arrangements should be regarded as a lease, and would be accounted for (under IAS 17 Leases) as a finance lease, with effect from 1 January 2007. Accordingly, fixed assets were de-recognized on the taxpayer’s balance sheet and a finance lease receivable was recognized with effect from 1 January 2007. The taxpayer prepared its tax return for the period ended 31 December 2007 on the basis of its audited, IFRS-based income statement for the period, reflecting the finance lease classification.The tax authority rejected the change in accounting treatment and sought to re-calculate taxable income as if the power plant were still a fixed asset of the taxpayer’s business.

The tax authority’s challenge was based partly on the fact that the PPA did not classify the arrangements as a finance lease. Looking to the legal ownership of the power plant, the tax authority asserted that the taxpayer should continue to claim tax depreciation and recognize taxable revenue on the historic basis. The tax authority also asserted that a change in tax treatment could not be effected in the absence of any change to the income tax law.

On considering the taxpayer’s appeal, the Tax Committee decided in favor of the taxpayer that:

  • The taxpayer was not the owner of the power plant for accounting purposes and, as such, should not be regarded as the owner of the assets for tax depreciation purposes•
  • The taxable income should be calculated based on the taxpayer’s accounting profit or loss – prepared in accordance with IFRS – but that the Tax Department would adhere to accounting standards only where those standards agree with the income tax law. In the present case, the Tax Committee regarded the application of finance lease accounting as being in line with the income tax law and that adjusting the accounting result for income tax purposes (to claim tax depreciation on the power plant) would not reflect the taxpayer’s true position.

The Tax Committee’s decision in this case final and should be binding on the tax authority in future cases.

Central Bank of Oman’s Financial Stability Report

The May 2015 Central Bank of Oman Financial Stability Report considers the macro financial scenario of Oman. The highlights of the report are as follows:

  • The IMF has estimated Oman’s budget deficit for 2015 to be approximately OMR3.6 billion, equal to 13.2 percent of Oman’s GDP. This is against the government’s deficit projection of OMR2.5 billion and is caused by falls in oil prices during the second half of 2014, and consequent pressures on the fiscal space. The IMF has further estimated that the debt to GDP ratio is set to rise to around 8 per cent in 2015. 
  • Oil prices are expected to continue to fall below the fiscal break-even price (which reached $108.2 0 in 2014), and it is expected that the shortfall will be covered by domestic and international borrowings, reserves and own savings, and by reducing expenditure on price subsidies. 
  • Oman’s excellent credit rating will help increase local and international borrowing, but local borrowings will reduce money supply, which could adversely affect GDP in the short term. On the other hand, international borrowing will increase the long-term interest rate. Domestic and international borrowing could put upward pressure on Oman’s currency, with potential adverse effects on GDP growth.
  • The IMF forecasts a current account deficit in 2015. Earnings from the non-oil sector exports are expected to increase by 7.3 percent. The deficit is affected, though, by a decline in oil sector exports of 5.3 percent (which still accounts for 66 percent of total exports), thus suppressing the overall growth in exports, which declined by 4.8 percent.

Wage Protection System – compliance enforcement expected

The Ministry of Manpower’s Wage Protection System (WPS), introduced in January 2014, aims to ensure timely payment of wages to workers and help the ministry keep an electronic record of salary payments.  The WPS requires the private sector to make wage payments only through authorized banks and financial institutions, and to pay wages within 7 days of the end of the month worked. The WPS is intended to track employers who violate the law, protect workers’ rights and help avoid salary disputes.

For the government, the WPS aims to provide a comprehensive, real-time database of accurate and reliable information on private sector wages that contributes to the development of statistical studies and economic planning. The WPS can also be used to monitor private sector companies’ compliance with labor-related policy, such as Omanization policy, and to identify the employment of illegal workers.

However, nearly 18 months after the WPS was introduced, KPMG in Oman has learned that only 50 percent of the expatriate workers are receiving their salary through banks. Further, only a few companies have linked their wage distribution system to banks.  

As a result, the government will likely to put more focus on enforcing compliance with this system so it achieves the intended aims. This will result in stricter monitoring of domestic and multinational companies operating in Oman to ensure those that have not adopted the new system take the needed steps to do so immediately.

Footnotes

1 See Article 7, Business Profits. 

2 Under Article 7 or Article 14.

3 Under Article 29. 

4 Under the Article 25 Mutual Agreement Procedure. 

5 Included in the definition of permanent establishment at Article 5.

 
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