As tax rates across the region have fallen, tax authorities have increased the scope, sophistication and aggressiveness of their investigations. GCC countries apply different tax rules to domestic and foreign companies (except in Oman), and foreign companies are attracting the majority of the tax authorities’ increased focus. Tax inspectors are receiving specialized training in cross-border and international tax issues, allowing them to review and challenge treaty shopping and other tax planning strategies commonly used.
They are also taking a more proactive approach to identifying non-compliant taxpayers, for example, by sharing information with customs officials and by pursuing new business registrants in the country.
Reduce audit risk with a tax health check-up
In the Gulf region’s diverse and quickly evolving tax audit environment, the best defense is to be well prepared, well organized and in complete control of your facts and issues. The move toward tax filings based on actual results makes it even more important for companies to thoroughly document their transactions and arrangements.
Whether a company is new to the region or is already doing business there, the company can position itself to meet tax audit challenges by undertaking a ‘tax health check’ – a thorough tax risk exposure analysis that anticipates and addresses all possible questions and alternative arguments to determine whether all your bases are covered.
Analyzing the full scope of your tax risk exposure will help ensure that you:
- understand why transactions or tax positions were taken
- explain the technical basis of your understanding
- support your assertions through clear, comprehensive documentation.
- local documentation and reporting requirements
- transfer pricing policies
- onshore versus offshore allocations of profit
- potential creation of taxable presence
- on-going monitoring and review of transactions and arrangements.
Local documentation and reporting requirements
Performing a health check can help you identify and organize existing documents and records, and indicate what additional documents you may need to have on hand. Before starting business activities in a country, companies should investigate the specific tax documentation requirements so they can maintain adequate books and records at the outset.
For example, some countries in the region (such as Saudi Arabia) require tax documents and financial records to be kept and submitted in Arabic, which would be extremely difficult to create after-the-fact. Additionally, differences in the treatment of amounts reported for tax and accounting purposes (e.g. related to depreciation) can significantly affect a company’s tax position.
Further, tax inspectors in some countries may wish to see all documents, while tax inspectors in other countries, including Egypt and Saudi Arabia, are more likely to conduct their review on the basis of samples.
Companies need to manage their documentation accordingly.
As tax authorities in the Gulf region grow more sophisticated, they are sharpening their focus on cross-border transactions, and transfer prices are coming under increasing scrutiny. While GCC countries generally follow the OECD transfer pricing guidelines, there are some significant differences. For example, many countries have supplemented their transfer pricing rules with executive bylaws that disallow the deductibility of 15 percent of head office expenses and 10 percent of related party fees when these fees are paid to foreign parties.
Intercompany charges for materials are high on the tax authority’s radar. Companies should be prepared to show that their transfer pricing policies for material costs are in line with the OECD’s arm’s length standard. To ensure your transfer pricing policies are strong enough to withstand a challenge on audit, you should verify that:
- the transfer pricing method in use is recognized by the tax authority
- the business rationale for the method’s use is well documented
- the method is consistently followed in practice.
Onshore versus offshore allocation of profits
Tax inspectors in the Middle East are challenging treaty-based transactions on the basis of the allocation of profit between local and foreign entities. To guard against such challenges, contracts between parties dealing across borders should specify the domestic and foreign profit split, and the reasons underlying the allocation should be well documented. To verify that the allocation has been followed in practice, companies should ensure they obtain proper confirmation of sales from end users.
Defending against taxable presence determinations
Companies should take special care to investigate what level of activity in a country can create a taxable presence. This determination varies greatly among countries in the Middle East. For example, Oman’s tax law and all Saudi tax treaties contain permanent establishment definition, while in Kuwait even a limited presence (e.g. without a fixed place of business) can create a tax reporting obligation.
To assess the level of in-country activity, tax inspectors are paying particular attention to the terms, conditions and cost arrangements set out in employment contracts. If an arrangement with a relocated employee is not properly structured, there is a risk that the arrangement could inadvertently create a taxable presence in the country of relocation. In some cases, secondment arrangements lead to creation of a permanent establishment for the foreign company’s seconded personnel.
In order to help ensure tax deduction of employment costs, companies need to ensure their employees have entered into contracts with the right entity, with additional evidence to support the related salary payments. Timesheets and visas can also be used to substantiate the details of the employment.
On-going monitoring and review
As part of your tax exposure analysis program, completed transactions should be reviewed to help ensure they were properly implemented. Going forward, transactions and arrangements should be monitored to make sure they remain effective and continue to serve their intended purpose in light of business or regulatory changes.
Professional advisers – seek local knowledge, global reach
Given the varied requirements and sometimes subjective nature of tax inspections in the Middle East, understanding the local tax rules and how the tax authorities apply the law in practice is critical. Companies doing business in the region are well advised to engage local professional advisers with in-depth knowledge of the tax system and familiarity with tax authority personnel – advisers who can help you avoid missteps and optimize your local after-tax returns. Look for advisors who are versed in local tax laws, have strong working relationships with the tax authorities, and familiarity with the inner workings of the tax administration.
Global companies expanding into multiple Middle Eastern markets should avoid picking different professional advisers in each destination. Engaging a global organization with a strong network of local advisers can help ensure your tax affairs are in good shape in each location while ensuring your global tax obligations are managed with coordination and efficiency. They can also help you centralize your tax management systems and help you keep informed.
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