The Roadmap to Successful Ventures in the Middle East Series – No 4
Avoiding the Taxation Traps
By Hugh Fraser, managing partner
Welcome to my weekly note with some personal views on what does/does not work when structuring business ventures in the Middle East region.
My fourth theme is “Taxation”. Avoiding the tax traps and ensuring compliance is an essential facet of a successful business expansion venture otherwise unexpected and welcome taxation bills, profit margins turning to losses, fines and penalties, and damage to working relationships with Government authorities can all come to pass.
Here are my Top 5 golden rules on this theme:
- Tax aspects of Export Sales
During the early phase of a new market expansion, the business may commence its activities through export sales into the territory often with the support of a local partner. At this stage the key tax watch notes are import customs duties (typically 5% across the GCC countries), withholding taxes (charged as percentage of sales revenues and which can be high as 20%) and value added tax (which is a new tax to the region and which is being rolled out at 5% in general).
- Permanent Establishments
As the business grows and a local establishment is needed the structuring of the venture will need to be reviewed in a taxation context. Local subsidiaries tend to be easier than branches in segregating out local revenues and profits which is important given corporate taxation rates in the region are relatively benign (zero to 20% depending on the territory).
Engaging personnel locally typically means payroll taxes including social security contributions and often different regimes for local/national employees and expatriates. Indirect taxation in the form of visa costs and medical insurance cover should also be understood and budgeted for. Specific planning and compliance care and attention is needed when senior executives are transferring from one jurisdiction to another or where personnel have a cross-border or multi-territory role.
- Joint Ventures
Joint ventures with local partners will often need to reflect the fact that the profit shares of the foreign and local partners may be taxed at different rates or be free of tax in the case of the local partner. This raises the issue as to whether the tax burden is shared equally in the post-tax profit split or whether the foreign partner should fully bear the taxation rate imposed on its respective participating interest.
Taxation rates in the region generally remain lower than the corporate rates applying in most western jurisdictions. This means there may be a commercial driver towards allocating more revenues and profits to the lower tax territories but this of course will mean transfer pricing challenges from taxation authorities where such allocations cannot be commercially justified. A properly constituted intra-group Business Services Agreement can be a good technique to set down the basis for inter-company trading, management services, interest charges on loan capital and royalties on licensed-in intellectual property rights.