The Transfer Pricing landscape in the Middle East region has been continuously evolving in the last couple of years largely as a consequence of developments arising out of the OECD’s Base Erosion and Profit Shifting (‘BEPS’) project. Several countries in the ME have committed to implement minimum tax standards under the BEPS Implementation Framework (‘IF’), one of which includes Action 13 – TP documentation and Country by Country Reporting (‘CbCR’). As a result, countries such as Bahrain, Egypt, Jordan, Kingdom of Saudi Arabia (‘KSA’), Oman, Qatar and United Arab Emirates (‘UAE’) now have detailed TP and / or CbCR laws in place.
The complexity posed by new laws has meant that businesses operating in the region have more tax thinking to do. It has meant increased TP/CbCR related compliances, more scrutiny/disputes, need to create additional documentation and the need to remodel or do away with existing company structures and intercompany dealings which will no longer work.
The interplay of Transfer Pricing with the Economic Substance Regulations introduced in UAE and Bahrain under BEPS Action 5 – Addressing Harmful Tax Regimes is another factor that can’t be ignored. The more the substance housed in a particular location/entity, the more profits the entity needs to earn. Multinationals have all along made use of UAE & Bahrain’s zero tax regimes to have centralized hubs in terms of headquarter, procurement or intellectual property for their Middle East operations. With the introduction of the first set of BEPS reforms, multinationals in the region have already had to change their strategies but with the upcoming reforms expected as part of BEPS 2.0, their problems will be even more accentuated.
On 1 July 2021, most of the BEPS IF member countries committed to a new overhaul tax reforms referred to as BEPS 2.0 which consist of two Pillars.
Pillar One is initially expected to be applicable only to multinationals with global turnover above EUR 20 billion. It calls for a certain pre-determined share of the consolidated profits of such multinationals to be allocated to markets where proportionate sales arise. Where consolidated profits exceed 10% of revenues, the profit to be reallocated (Amount A) will be 20 to 30% of the excess profit. This profit reallocation is expected to happen regardless of any intra-group Transfer Pricing mechanisms the group may have set in place. Another Amount B aims to set standard margins for group entities that perform low risk marketing and distribution functions.
Under Pillar Two, member countries agree a system whereby multinationals are to be taxed at a global minimum tax rate of 15%. This would apply to groups with global turnover above EUR 750 million (same threshold as for CbCR) but jurisdictions could decide to apply a lower threshold. Pillar Two reforms could manifest as:
- A top-up tax in the jurisdiction of the multinational’s parent entity in respect of any lower-taxed income of a group entity (i.e., where income has not been subject to an effective minimum tax of at least 15%).
- Where such top-up tax has not been applied, a secondary rule ensuring that lower-taxed group entities pay an effective minimum tax rate of at least that 15%.
- An additional tax on royalties, interest and other defined payments made to a member jurisdiction that applies a corporate tax rate lower than the minimum prescribed rate of between 7.5 – 9%.
The application of Pillar One and Pillar Two appears restricted to the largest multinationals initially however actual implementation needs to be awaited. In addition, certain exemptions areas have been factored under both Pillar Oneand Pillar Two. Initial indications are that both Pillars could become effective as early as 2023.
BEPS 2.0 – ME Impact
Middle East countries such as Bahrain, Egypt, Jordan, KSA, Oman, Qatar and UAE have expressed support for these proposals. UAE in particular issued an official statement issued on 26 July 2021 stating its support for Pillar Two.
- Through Pillar One, excess profits of multinationals based in Bahrain/UAE could be reallocated to jurisdictions with higher tax rates, resulting in increased group taxes.
- Through Pillar Two, there is higher potential impact for multinationals headquartered/operating in the ME. Profits of businesses in Bahrain/UAE, where statutory tax rates are currently below the proposed global minimum tax of 15% could become subject to the top-up tax in an overseas jurisdiction. ME countries will in all likelihood themselves introduce local legislation to ramp up tax rates in order to protect their tax base.
For large multinationals operating in the region, firstly we recommend that they track and address all the new country-specific tax compliance requirements that have arisen in the last couple of years and factor in the consequences of non-compliance i.e., adjustments and/or penalties into their tax planning. Secondly, we recommend that businesses be closely aware of the constant developments in the BEPS, TP and CbCR space so they are fore-warned and pre-prepared to develop appropriate future-oriented policies in response to these shifting variables.