Evolution of Tax related transparency in GCC: Nitty-gritty and safeguards

In this webinar, the present tax-related transparency and requirements with GCC are evaluated and the future trends are discussed.

The need for a Global Minimum Tax

With 130 countries coming together to build a consensus for global minimum tax rates, tax-related transparency discussions are gaining importance among corporate circles.

The recent OECD report on CbCR statistics, which involves 4000 multinational enterprises (MNEs) across 26 member jurisdictions, showcases the misalignment of how a majority of profits were reported from the jurisdiction with no or low tax. This has led to a high revenue per employee in these jurisdictions.

Hence, 130+ nations have come together in a historical event of adopting a Global Minimum Tax with the following attributes:

• The taxation rate decided is 15%
• To be implemented by 2023
• High-income businesses with global revenue of more than Euro 750 million are covered
• The tax is divided into two pillars:
  • Pillar-1: what would be the share of the corporate tax for each of the local jurisdictions
  • Pillar-2: what should be the minimum corporate tax rate at the global revenue of the MNC to ensure the overall groups don’t escape corporate tax

Tax planning strategies adopted by MNEs

When it comes to saving taxes, typical routes followed is via tax planning, tax avoidance, or tax evasion. These are differentiated as follows:

• Tax planning: using legal provisions and exemptions available to save taxes
• Tax avoidance: using loopholes in tax laws to avoid payment of taxes
• Tax evasion: using illegal methods to avoid taxes like inflating expenses

IP regimes, that provide tax benefits to promote research and development within certain nations also receive scrutiny. This is due to the common practice of corporates pooling their profits for tax avoidance at these nations in the name of IP.

Some popular structures adopted by MNCs to avoid taxes include:

• One can conduct sales and invoices of goods in a low jurisdiction country or a country that offers necessary tax rebates.
• One can misalign profit and value creation activities. For example - an R&D center can be opened in a nation that offers tax incentives to benefit research, manufacturing is done in another nation that offers necessary tax incentives, etc.
• One can also deploy critical functions of investment advisory services in a low jurisdiction country. But the main decision, that houses the actual value is driven by the parent company in high jurisdiction country.
• One can use contract manufacturing instead of license manufacturing structure and use another entity to distribute the goods in a low jurisdiction country.
• One can have an arrangement where the technology is developed at high jurisdiction nation but mentions how it does contract R&D for a company in a nation that taxes only local income due to which no taxes are charged. One can also transfer the IP to countries where royalties are not taxed.

All these various methods have got nullified since authorities have become aware of these tactics adopted by MNEs.

What safeguards can companies adopt?

With the Global Minimum taxation being implemented in coming years, here are some suggestions for corporates to safeguard the transition:

• Payment of royalty: limit the brand royalties paid in the name of profits at the market level, which can be somewhere around 3-6%.
• Payment towards management services: the cost-plus basis of remuneration may not seem justifiable for senior management fees. So one can opt for a performance, timesheet or revenue generation-based compensation approach that is well documented.
• Commission payment: a cost-based remuneration may not be adequate considering how much of the efforts to get sales, contribute to the revenues of the organization. Hence, the commission can be decided on a revenue share basis.

Using documentation as a safeguard

OECD has recommended a 3-tiered TP documentation namely:

• Master file: showcases key business operations and financing at group level who are maintaining intangible assets of the group.
• Local file: documents local intra-group arrangement and transactions
• Country-by-country reporting: accumulation of group-level data that provides a financial snapshot of the MNE group across revenues, employees, performance ratios, etc.

Some entities like an Investment fund, entities owned fully by UAE residents, etc. are exempted from Economic Substance Regulation (ESR). These exemptions have to be claimed by filing notification and sharing evidence.

In the end, corporates need to understand that the OECD’s BEPS project will affect taxation and immensely impact how an organization is structured and operations are designed.