Direct Tax
The UN approach to digital taxation
[Excerpts from The Tax Foundation, 22 October 2020]
The OECD’s approach shall be determined by mid-2021, but many countries have been unilaterally adopting digital services taxes and equalization levies. The UN seeks to change tax treaty language with special provisions for digital companies. A special approach to digital businesses is likely to introduce new distortions into an already complex system of crossborder tax rules. The UN Tax Committee will be considering a change to the UN’s model tax treaty that could result in more taxing rights to countries where customers of digital platforms are located.
If multiple countries adopt the new language into their bilateral tax treaties, digital companies could end up paying tax on 30% of their profits using the new UN approach. However, it is unlikely that the OECD countries could change their tax treaties to reflect the UN proposal.
OECD draft seeks GILTI exemption from global minimum tax
Global Intangible Low Taxed Income (GILTI) is a new provision enacted by the US Government as a part of tax reform legislation and made significant changes to the way USA multinationals’ foreign profits are taxed. Mechanically, it functioned as a global minimum tax and was introduced as an outbound anti-base erosion provision. GILTI heavily impacts USA residents’ foreign business where profit is high, relative to the fixed asset base like Services companies, Procurement and Distribution companies, or Software and Technology companies. The primary purpose of GILTI is to reduce the incentive for USA-based multinational corporations to shift profits out of the USA into low- or zero-tax jurisdictions.
GILTI is a newly-defined category of foreign income and is a tax on earnings that exceed a 10% return on a company’s invested foreign assets. It is subject to a worldwide minimum tax of between 10.5% and 13.125% on an annual basis.
With GILTI, USA companies fear having to comply with both the 2017 GILTI law and a global minimum rate under the OECD’s plan to rewrite international tax rules. The OECD has asked countries to provide feedback on the draft before the meeting this month.
Transfer Pricing
Oman: Introduces rules for Countryby- Country Reporting to assess BEPS risk3
As per the Ministerial Decision No. 79/2020, Country by Country Reporting (CbCR) has been introduced in Oman that applies to:
- a. Multinational Enterprise (MNE) headquartered or operating in Oman, effective for fiscal years commencing on or after 1 January 2020; and
- MNE groups having consolidated revenue of at least OMR 300 million in the fiscal year immediately preceding the reporting period reflected in the consolidated financial statements for such preceding year;
The rules define relevant terminologies and require the ultimate parent entity of MNE Groups that are residents in the Sultanate of Oman (for tax purposes) to file a CbCR to the Authority with respect to its Reporting Fiscal Year. The report shall be filed no later than 12 months after the last day of the Reporting Fiscal Year of the MNE Group. Further, the notifications state that the Authority shall use the CbCR for the purpose of assessing high-level transfer pricing risks and other base erosion and profit shifting(BEPS) related risks in the Sultanate of Oman.
It is being announced that the Council of Ministers of Oman has referred two draft laws to the Shura Council related to the VAT regime and amendments to the income tax law that would implement CbCR.
Our Comments
These measures signify Oman’s commitment regarding BEPS standards of the OECD and that the regulators are taking an active role in formulating the policies.
Zambia: Issues 2021 budget; amends Transfer Pricing documentation requirements
The Zambian Minister of Finance announced the 2021 budget to the National Assembly on 25 September 2020. There were few changes relating to current transfer pricing documentation requirements. Following are the key highlights:
- 1. Amend regulations for automatic exchange of the relevant CbCR with other tax jurisdictions for entities operating in Zambia that are part of the Multinational Enterprises group. The measure is one of the requirements under the Inclusive Framework on BEPs to which Zambia is a member;
- Increase the threshold for preparing transfer pricing documentation from K20 million to K50 million for local companies. This is a relief measure for small and medium-sized businesses.
Our Comments
Exchange of CbCR information between tax jurisdictions will allow transparent income and profit allocation. In recent years, Zambia has aligned its transfer pricing regulations with the OECD for ease and effective tax compliance for its taxpayers.
United States of America: Internal Revenue Service (IRS) issues audit considerations for IRS agents in relation to Cost Sharing Arrangement (CSA) With Stock Based Compensation4
Under the USA cost sharing rules, taxpayers under common control may enter into a CSA, which allows the group to share the costs and risks of developing one or more intangibles in proportion to each entity’s share of reasonably anticipated benefits.
The IRS Large Business and International (LB&I) division released a transaction unit named ‘Cost Sharing Arrangement With Stock Based Compensation’ as part of the evaluation of costs in costs pools chapter. This public issued document would aid the IRS agents in considering the tax impact of CSA between the group entities. The highlights of the document are as follows:
- To identify whether the group has any stock based compensation plan with CSA in place for intangible development. This can be done with the help of various tax compliance forms filed by the taxpayer;
- To confirm if entities participating in intangible development have reimbursed intangible owners for its share of reasonably anticipated benefits. This would be considered as an income for the owner entity and should increase the effective tax rate;
- Considerations for scenario where owner entity claims that participating entities have incurred own costs in respect of their share of intangibles development.
Our Comments
This document provides taxpayers with an opportunity to develop and maintain a proactive response mechanism in case of audits by IRS agents. The questions mentioned therein can form part of the transfer pricing policy and documentation for ease in facilitating audits. The document lays down various consideration in respect of the abovementioned assertions providing insights for relevant documents, audit questions, Potential issues, and arguments expected from the IRS agents.
UAE: Ministry calls for action time on the New Economic Substance Regulations
Why the UAE introduced ESR
Economic Substance is an economic activity to earn corresponding income/ profit in a particular jurisdiction. The United Arab Emirates (UAE) introduced ‘Economic Substance Regulations’ (ESR or the Regulation) in April 2019. The Regulation’s primary objective is to restrict the operation of shell/ paper companies in UAE who earn significant profit without carrying out any corresponding activity. In other words, covered licensees are required to demonstrate/explain that they are genuinely undertaking a certain economic activity, which resulted in income/ profits in the UAE.
Interestingly, this step of UAE was to honor the commitment as a member of the Organisation of Economic Cooperation and Development’s (OECD) Inclusive Framework on Base Erosion and Profit Shifting (BEPS) as well as in response to the European Union’s (EU) review of UAE tax framework. This also led to the removal of UAE’s name from the EU’s blacklist of non-cooperative jurisdiction for tax.
In August 2020, the UAE amended the Regulation retrospectively (to be applicable from 1st financial year commencing on or after 1 January 2019) wherein significant changes were made to the erstwhile Regulations such as a change in governance mechanism, scope and applicability, and also enhanced quantum of administrative penalties.
Which businesses are covered under the regulation?
Primarily, the UAE licensees (a juridical person on incorporated partnership) who have obtained the trade license (or permits of similar nature) to undertake certain prescribed activities need to evaluate the Regulation’s applicability. Relaxation is provided to a natural person, sole proprietorship, trust, foundation, etc. from complying with the Regulation.
Similarly, licensees that are tax resident outside the UAE or wholly owned by UAE residents are exempted.
Coverage of Regulation is very wide to include most of the business activities, explicitly covering the following:
- Banking business
- Investment fund management business
- Headquarters business
- Holding company business
- Distribution and Service center business
- Insurance business
- Lease-Finance business
- Shipping business
- Intellectual property business
What are the compliance requirements?
Firstly, businesses are required to reassess the applicability of Regulation owing to the extended coverage enunciated in the amended Regulation. Consequently, businesses need to undertake two-fold compliances:
- Furnish notification in the prescribed form, indicating whether the regulation is applicable and other factual details. The New ESR law mandates the filing of revised notification, regardless of the fact whether the notification is already filed.
- If it is determined the licensee is engaged in the relevant activity and has also earned income from such Relevant Activity during the reportable period, then the licensee is required to file ESR annual return. For the accounting year ended on 31 December 2019, the due date to file the annual return is 31 December 2020.
The template form for ESR annual return was published just last week. It appears to be very comprehensive with the kind of information that has been asked in the return. These tests are quite subjective in nature, and the licensee may need to consider their professional judgment to demonstrate the reasonableness of this aspect. Again, one business may vary from another in terms of business/operational model, size, functions, etc. Thus, it is crucial to adopt a pragmatic approach while assessing the substance test.
Penalties for non-compliance
Authorities have prescribed rigorous penalties in the range from AED 20,000 to AED 400,000 for non-compliance of Regulation. At the same time, noncompliance may entail cancellation or suspension of license in UAE.
Additionally, the Ministry may also notify the failure of a licensee to the competent Authority in the trading country, leading to larger consequences at the group level.
Way forward
The inaugural year of Economic Substance Regulation has already seen major changes in the last three months to the law that was introduced almost a year and a half ago. Pertinently, the due date for the first ESR annual return is 31 December 2020; the template forms for the annual return were released on 22 October 2020. The first year of any regulations (especially a regulation of this kind) always brings lots of uncertainties in business owners’ minds. The first year of compliance also holds importance from the perspective of setting the right precedent.
The information required in the ESR annual return appears to be very comprehensive, calling for financial information, employee details, and also information on the economic activity, risks, etc. This is likely to consume additional time in preparation of the return than what was originally anticipated on the basis of regulations.
Given the penal consequences for inaccurate data/information provided in the ESR filings, it would be prudent to carefully validate all the data after a thorough analysis before it is furnished to the authorities. While the ESR portal is yet to be launched on the Ministry's website, it is recommended to start the preparation of ESR return based on template form, given the time on hand.
Indirect Tax
Postponement of certain EU regulations
In view of the COVID-19 pandemic, the implementation of the European Union (EU) regulations in relation to the VAT treatment of goods and services supplied to non-taxable persons has been postponed to 1 July 2021. These regulations essentially aim to ensure that tax is paid in the member-state in which the consumption of goods/ services takes place. The regulations also impose obligations on electronic platforms and extend the concept of the One-Stop-Shop (OSS) scheme for VAT payments.