But, like other parts of its infrastructure, Iraq’s tax system has suffered from neglect over the past decades and is in need of modernization. Iraq’s international tax rules remain underdeveloped and its tax authorities lack experience in dealing with non-residents. As the Iraqi government works to make its tax system more attractive to foreign investment, the biggest tax challenges that investors currently face are set out below, along with our recommended approach to navigating these challenges.
- Unclear meaning of oil and gas related activities
- Uncertain tax treatment of assets under offtake agreements
- Difficulties in obtaining tax refunds
- Difficulties in obtaining credit for amounts withheld
- Unclear accounting treatment of DBO assets
- Taxation of sales of Iraqi company shares
- Over-application of retention tax
Iraq’s general corporate tax rate is 15 percent, but a higher 35 percent applies to oil and gas related activities. Uncertainty over what activities constitute oil and gas related activities could make it difficult to determine the corporate income tax and retention rates that apply to a company’s activities in Iraq. The Iraqi tax authority’s instructions and interpretation regarding what constitutes such related activities (e.g., ancillary activities, upstream services, subcontractors) are unclear.
Companies should seek written confirmation from the tax authority about the tax status of their activities where those activities are not related to upstream activities and not included in the predefined oil and gas related services.
When an oil and gas producer transfers completed assets under an offtake agreement, the appropriate tax treatment can be difficult to determine. For example, the tax authorities may treat similar companies differently, and the tax authorities’ position could cause a deemed sale to arise on the transfer.
To avoid uncertainty, contracts should pre-define the ownership of assets and payments, and the parties should confirm the ultimate tax treatment by obtaining an advance tax ruling.
Companies that are entitled to tax refunds under the law often struggle to obtain them from the tax authorities due to interpretive differences and bureaucratic hurdles.
To ease the process for obtaining refunds, companies should be prepared to satisfy all local compliance requirements (e.g., filings, local financial statements) and be ready to present the data necessary for tax clearance.
Like tax refunds, companies can have a hard time getting tax credit for tax amounts withheld from other taxpayers. Iraq’s tax system is not equipped to follow up on tax withheld from payment made by others, and so companies need to supply proof of the tax amounts withheld.
To ease the process and speed up the release of final payments, companies should always request payment receipts from the other party, as well as copies of the information schedule submitted to the tax authority.
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The lack of sophistication of Iraq’s accounting regime can create uncertainty over the accounting (and tax) treatment of the assets to be used by the project company in a design-build-operate (DBO) project. For example, whether such assets are subject to a finance lease for accounting purposes is unclear.
Again, to avoid uncertainty, contracts should pre-define the ownership of assets and payments, and the company should seek written confirmation of the acceptable accounting treatment from the tax authority.
When shares of an Iraqi resident company are sold, whether capital gains tax applies is uncertain. If the sale is in the ordinary course of business, capital gains tax does not apply as long as trading in shares is not the core business of the seller. However, Iraqi tax legislation lacks clear definitions, allowing for different interpretations of terms like “ordinary course of business” and “trading in shares”.
Investors are advised to obtain advance written confirmation from the tax authority related to the tax treatment of the sale.
Foreign companies doing business with Iraq (as opposed to in Iraq) are not subject to Iraqi retention tax (i.e., withholding tax). Due to uncertainties over the difference between doing business with and in Iraq and lack of experience among Iraqi tax officials and taxpayers alike, retentions are applied on all payments without regard to the nature of the foreign payee’s activities in Iraq.
Foreign companies should investigate the conditions for doing business with Iraq and negotiate these conditions with client companies and the tax authorities. Foreign companies can also obtain an advance tax ruling to avoid the complicated and lengthy process of obtaining the refund.
In the future, Iraq’s tax and regulatory regimes are expected to undergo reforms designed to internationalize the country’s economy. As revenues from oil and other sectors continue to fuel the country’s growth, there is little doubt that Iraq will continue to rise as a destination of choice for international investors. Therefore, it is critical that foreign investors not let current tax uncertainties and issues deter them. In the meantime, navigating the tax issues through active engagement with the tax authorities is important in gaining greater certainty on tax matters.