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UAE businesses need to address unique tax issues

Since the announcement of corporate tax, terms like BEPS, OECD, Pillar 1, Pillar 2 etc. have become the buzzwords amongst the business and finance fraternity.

We continue our last week’s ‘Tax Conversations’ on corporate tax and transfer pricing. Just like all tax domains, corporate tax and transfer pricing is a vast field for study and specialisation. Since the announcement of corporate tax, terms like BEPS, OECD, Pillar 1, Pillar 2 etc. have become the buzzwords amongst the business and finance fraternity.

As with any new tax regime, it is likely to have a fear of the unknown. UAE businesses need to steer away from such fears and smartly handle tax compliance.

BEPS

As per OECD, Base erosion and profit shifting (BEPS) refers to tax planning strategies, used by multinational enterprises, to artificially shift profits to jurisdictions with no/low tax rates & economic activity. OCED estimates that BEPS results in an annual loss of about 4-10 per cent of global corporate tax revenue aggregating to $100-240 billion.

In year 2015, a detailed 15 action points were determined to counter BEPS and improve transparency. About 99 countries/jurisdictions are signatories to the implement measures to prevent BEPS. BEPS action plan has enjoyed a significant level international cooperation and information sharing.

Pillar 1 and Pillar 2

As a part of the BEPS action plan, a two-pillar solution to address the tax challenges arising from the digitalisation of the economy was proposed and has now been adopted by about 135 countries. The expression ‘pillars’ sounds very technical and complex. ‘Two pillar solution’ could be read as ‘two elements’ or ’two pronged’ solution for ease of understanding.

The first element i.e. Pillar 1 provides the principles for determining the allocation of taxing rights amongst different jurisdictions i.e. nexus and profit allocation on account of digitalisation of the economy.

The second element i.e. Pillar 2 proposes a global minimum tax i.e. a system whereby multinational enterprises (MNEs) pay a minimum level of tax on their global profits.

Pillar 1 and Pillar 2 would be applicable to MNEs of relatively high turnover of at least 750 million euros. We will discuss the BEPS action plan separately in our future tax conversations.

UAE businesses and Controlled Foreign Companies (CFC)

International transfer pricing aims at multinational enterprises (MNEs). It does not cover every transactions of a UAE business just because it is involved in international transactions. However, UAE businesses need to be also aware of the Economic Substance Regulations (ESR). ESR is aligned to Action No. 3 out of the 15 action plan.

BESP Action 3 covers Controlled foreign company (CFC) rules. CFC rules covers a scenario wherein a taxpayer shifts its income into a foreign company that is controlled by the taxpayer. Such planning assist the taxpayers to shift the tax base from their country of residence to the CFC’s jurisdiction. Action 3 proposes to attribute certain categories of income of CFC to the shareholder(s).

ESR requires that the UAE companies should demonstrate adequate economic substance i.e. people, assets, activities etc. in the UAE to justify the income earned in the UAE. At present, ESR covers 9 relevant activities. UAE companies which are wholly owned by one or more UAE residents are exempted from ESR upon two conditions – (a) it is not part of an MNE Group; and (b) it only carries out business in the UAE. Companies which are not doing business exclusively in the UAE may not be eligible for the ESR exemption.

It is likely that even after the implementation of the corporate tax, ESR compliance will continue to be a mandatory requirement. UAE businesses will need to address unique tax issues to manage tax compliances. The understanding of tax nuances would help in optimising tax implications and compliance.

Pankaj S. Jain is the managing director of AskPankaj Tax Advisors. For feedback and queries, you may write to info@AskPankaj.com. Views expressed are his own and do not reflect the newspaper’s policy.