Financial Services Tax & Legal Update - April 2024 - PwC Middle East

Saudi Arabia - Regional Headquarters Program and Transfer Pricing

In brief

Effective January 1, 2024, inbound multinational companies (MNCs) intending to do business in the Kingdom of Saudi Arabia (KSA), with the KSA government, are required to establish their Regional Headquarter (RHQ). Qualifying RHQs will benefit from a tax incentive program offering a zero percent corporate tax and withholding tax rate for 30 years applied on the RHQ activities, as well as other benefits such as a 10 year exemption from Saudization requirements. 

To qualify for this regime, the RHQ is required to employ certain executive or senior-level individuals, and to perform strategic management activities on behalf of its related party branches and affiliates in the region. These services performed by the RHQ constitute related party transactions and will, therefore, need to be conducted on an arm’s length basis. Given the tax incentives available to RHQs, tax authorities in the jurisdictions transacting with the RHQ will likely place a higher degree of scrutiny on the transfer pricing arrangement due to the potential opportunity for tax arbitrage. Furthermore, failure to engage in dealings at arm’s length could jeopardize the RHQ’s status and license which could, in turn, disrupt the MNC’s ability to conduct business in the KSA. 

Considering these aspects of the regulations, the transfer pricing policy and documentation for the RHQ should be robust and comprehensive, and aligned with the regulatory requirements set out by the Ministry of Investment of Saudi Arabia (MISA). 

In detail

Transfer pricing for RHQs 

MISA has announced on their website, that RHQs will be subject to Transfer Pricing regulations. However, there have been no special transfer pricing rules or guidance released that deal specifically with RHQs. As such, MNCs must reference existing transfer pricing regulations in KSA contained within the Transfer Pricing ByLaws and the associated Guidelines issued by the Zakat, Tax, and Customs Authority (ZATCA). Some of the key considerations for conducting a transfer pricing analysis for RHQs are below. 

Qualifying activities and the functional analysis 

The first step when conducting a transfer pricing analysis is to perform a functional analysis, the purpose of which is to evaluate the functions, assets, and risks of the related parties. The personnel and functions of an RHQ are restricted to mandatory activities around strategic direction and management functions as well as optional activities such as sales and marketing (further details can be found here). As such, the functional and transfer pricing analyses for the RHQ should align with the requirements and restrictions. The legal agreement and local file documentation for the RHQ should also be carefully worded to ensure compliance with the RHQ requirements. 

Challenges may arise whereby certain individuals employed by the RHQ also conduct client facing / commercial activities. In such cases, these individuals will need to ensure their activities are limited to those that are “qualifying activities” for the RHQ which can potentially be managed via dual contracts. Further, the activities undertaken should be carefully captured in the functional profile, legal agreements, and transfer pricing documentation of the RHQ. 

Selecting the transfer pricing method 

The transfer pricing regulations allow for several methods to price intercompany transactions depending on which method will produce the most reliable measure of an arm’s length price. In the case of the RHQ, it may be appropriate to apply the Transactional Net Margin Method (TNMM) and compensate the RHQ at cost, plus a margin. However, depending on the facts and circumstances, other methods may be more appropriate. 

For example, the Comparable Uncontrolled Price (CUP) method may be appropriate where reliable data is available to price the RHQs services on a rates and hours basis. Further, in case the Profit Split Method (PSM) method is being considered, it must be assessed whether the RHQs activities are conducted in an integrated manner with the group, and are considered to be non-routine activities generating key value or cost savings for the business. 

Regardless of the method selected, the best method analysis will need to carefully consider the RHQ restrictions to align with the regulations around the required personnel and qualifying activities. 

Remunerating the RHQ at arm’s length 

Once the best method is selected, this method will be applied to determine the arm’s length pricing of the arrangement. In applying the best / most appropriate method for an RHQ, some key considerations are as follows: 

• Selection of comparables: In the case the TNMM is applied, given the expected strategic nature of some of the RHQ activities, it is likely a markup will need to be determined by reference to third party comparables. It is imperative that the comparables selected align with the functional profile of the RHQ and allowable activities. In addition, the benchmarking analysis to calculate the arm’s length mark up will need to apply KSA specific criteria and search filters which differ from the OECD Guidelines. 

• OECD Safe Harbor: The Organization for Economic Cooperation and Development (“OECD”), in its TP Guidelines, proposes a safe harbor mark-up of five percent on the cost for “low value adding intercompany services”. However, the KSA TP bylaws have not adopted the OECD’s low value adding service principal “LVAS”) into its bylaws, and the list of activities for an RHQ is wider than the scope of OECD’s LVAS activities. Thus, absent any further guidance, we would expect that this safe harbor may not be applicable for RHQs, particularly for the mandatory activities. 

• Profit or Revenue Split: In light of the mandatory strategic functions of the RHQ, the profit or revenue split method may be considered and potentially applied. However, given that the MISA guidance states that RHQs should not perform commercial operations that generate revenue from customers, compensating an RHQ with a share of the profits or revenues may pose certain questions around whether the RHQ is directly engaged in revenue generating activities as is often the case in the entities involved in a profit / revenue split. As such, if the PSM is the best / most appropriate method, such concerns should be carefully considered and addressed. 

Transfer pricing documentation 

We expect that transfer pricing filings and documentation will be required for RHQs similar to other companies in the KSA. Thus, the intercompany legal agreements and transfer pricing documentation for the RHQ should be robust and comprehensive, and aligned with the regulatory requirements set out by the Ministry of Investment of Saudi Arabia (MISA) with careful attention to the above areas of consideration. 

Next steps 

To fulfill the regulatory requirements and avail themselves of the significant tax and business incentives offered under the RHQ program, MNCs will need to carefully consider the transfer pricing policy for their RHQ entity and ensure it is aligned with the regulatory requirements and restrictions for RHQs. Given the sensitive areas noted in this article, a transfer pricing analysis should be performed in conjunction with relevant legal and regulatory teams leading the RHQ set up. 

Finally, it is critical for MNCs to put in place robust and carefully worded intercompany legal agreement and transfer pricing documentation covering the related party transactions with the RHQ, both from a KSA, and foreign related party standpoint. 

UAE - VAT public clarification on SWIFT messages

In brief

The UAE Federal Tax Authority (“FTA”) published a Public Clarification (VATP036) on SWIFT messages on 5 February 2024. The clarification states the FTA’s position on the requirement of supporting documents in case of international bank charges paid by financial institutions like banks and exchange houses.

In detail

As per the UAE VAT legislation, where VAT is accounted for under reverse charge in case of imported services, the relevant VAT should be recovered only if it is used for making taxable supplies and the required supporting documents are retained for the recipient. 

According to the Public Clarification, the FTA will accept the SWIFT messages as a supporting document where such SWIFT message contains the following particulars ("Qualifying SWIFT message"):

• Name and address of the non-resident bank (SWIFT sender/supplier);

• Name of the UAE financial institution receiving the service (SWIFT receiver/customer);

• Date of the transaction;

• SWIFT message reference number;

• Transaction reference number;

• Description of the transaction;

• Consideration charged and currency used.

Based on the above, in case of international bank charges, it is important that the bank identifies whether the standard format of the SWIFT messages received contains all the required particulars mentioned above to ensure that the input VAT recovery is not affected.

UAE - Taxation on Partnerships

In brief

The UAE FTA has released the CT Guide on Taxation of Partnerships. This guide serves as a significant resource, providing clarifications and additional insights on various important topics in relation to the taxation of Partnerships as well as the associated compliance requirements.

In detail

Different types of partnerships

• In the UAE, partnerships can be incorporated or unincorporated. 

• An incorporated partnership has a separate legal personality, it is a Taxable Person subject to CT by default. The guide provides illustrative list of entities (e.g. including General Partnership, Limited Partnership, Limited Liability Partnership) considered as incorporated partnerships and are therefore, treated as juridical persons under the CT Law.

• An unincorporated partnership (e.g. consortium of companies or contractual joint venture) is typically considered “fiscally transparent”, whereby its partners are individually subject to CT instead. However, the partners in an unincorporated partnership can apply for the partnership itself to be treated as a Taxable Person “fiscally opaque” whereby it is subject to CT itself.

Tax reliefs

• Unincorporated partnerships which are “fiscally opaque” Taxable Persons, should not be considered as Free Zone Persons and may not qualify for 0% CT regime. This also applies to a Branch of an Unincorporated Partnership in a Free Zone.

• Participation Exemption (“PEX”) will be tested at the level of “fiscally opaque” partnerships (unincorporated or incorporated). For “fiscally transparent” unincorporated partnerships, the PEX will be tested at the level of its partners (applicable even in case a partner is a natural person). 

• Small Business Relief exempts eligible Resident Persons with revenue under AED 3 million from CT. For “fiscally transparent” partnerships, eligibility is assessed individually for each partner. In “fiscally opaque” partnerships, it is determined at the partnership level.

Deduction rules

• General CT rules on deductible expenditure apply similarly to partners and “fiscally opaque” partnerships. In “fiscally transparent” partnerships, partners' taxable income must account for their respective share of expenditure.

• The Interest Deduction Limitation Rule applies to the individual partners of “fiscally transparent” partnerships (natural persons excluded, juridical persons included), while “fiscally opaque” partnerships are directly subject to the rule (based on partnership’s EBITDA).

Foreign tax

• If the unincorporated partnership has suffered any foreign tax, a credit may be available against the CT by the Unincorporated Partnership where it is treated as a Taxable Person, subject to facts and circumstances. Where it is “fiscally transparent”, the Foreign Tax Credit is allocated among the partners in accordance with their distributive share in the Unincorporated Partnership.

Foreign partnerships

• A foreign partnership may be regarded as “fiscally transparent” unincorporated partnership if: 

(a) it is not subject to tax under the laws of the foreign jurisdiction where it is established;

(b) each partner is individually subject to tax on their distributive share of any income of the foreign partnership as and when the income is received by or accrued to the foreign partnership;

(c) the partnership submits an annual declaration to FTA to confirm (a) and (b); and 

(d) there are adequate arrangements for tax information exchange between the foreign jurisdiction of the partnership and the UAE. 

• If the foreign partnership does not meet these conditions, then it may be regarded as “fiscally opaque” for UAE CT purposes. It could be subject to CT in the UAE on the same basis as a Non-Resident Taxable Person if it has a Permanent Establishment (“PE”) or nexus in the UAE.

• Based on the guide, income from an investment into a “fiscally opaque” foreign partnership is eligible for PEX if all PEX conditions are met.

Transfer Pricing

• Transactions between related parties, including partners in unincorporated partnerships and any related parties of a partner in an unincorporated partnership, must follow arm's length standards.

CT compliance obligations

• For “fiscally transparent” partnerships, individual partners have to determine their CT obligations in relation to the partnership. However, such partnerships are also required to register for CT, although this compliance obligation does not mean the partnership itself would be subject to CT. 

• Unincorporated partnerships which elected to be subject to CT and partnerships which are considered as “fiscally opaque” should maintain financial statements and must obtain audited financial statements if the revenue exceeds AED 50 million.

• “Fiscally opaque” partnerships shall file a CT return by the standard deadline, i.e. 9 months after the end of the tax year.

General Anti Abuse Rules (“GAAR”)

• GAAR allows the FTA to adjust transactions aimed at gaining unjust CT advantages. For example, if a partnership is established or subsequent changes are made to obtain a CT advantage, this could be subject to adjustment under GAAR and the applicable penalties.

Oman - A Royal Decree issued in Oman ratifying the Double Tax Treaty with Russia

In brief

On 8 June 2023, Oman and Russia (“the Contracting States”) signed a Double Tax Treaty (“DTT”), the Royal Decree (RD 89/2023) was issued on 27 December 2023 by His Majesty the Sultan of Oman, ratifying the DTT which was published in the Official Gazette on 31 December 2023.

Given that Oman and Russia have both ratified and formally notified each other of the completion of the ratification procedures, the DTT will come into effect in 1 January 2024.

We note that the DTT adopts combination of provisions of Organization for Economic Co-operation and Development (“OECD”) Model and the UN Model Tax Conventions. Both Oman and Russia are members of the Base Erosion and Profit Shifting (“BEPS”) inclusive framework and have signed the Multilateral Instrument (“MLI”) agreement.

In this article, we provide our preliminary analysis of the DTT, which can be summarised as follows:

• Foreign national residents of Oman or Russia may benefit from the DTT; 

• The Permanent Establishment (“PE”) wording is mostly in alignment with the OECD Model. The DTT also provides that a PE would also arise if a building site, construction, assembly or installation project in the other contracting state lasts for a period of more than nine months and in case of furnishing of services, including consultancy services lasts for a period of more than six months; 

• The DTT provisions will become effective as of the first day of January of the calendar year following the entry into force of the DTT for withholding tax (“WHT”), while for other taxes from for any tax year starting from the first day of January of the calendar year following the entry into force; and 

• Below are the WHT rates provided in the DTT in comparison with domestic laws of the contracting states:

*Royal Directive issued by His Majesty Sultan Haitham bin Tarik on the occasion of Accession Day on 11 January 2023 called for the complete suspension of withholding tax on the distribution of dividends and interest on non-resident investors.

**10% applies if the beneficial owner of the dividends is a company that owns at least 20% of the company that pays the dividend for period of 365 days ending on the date on which entitlement to the dividends is determined . Rate capped to 15% in all other cases.

In detail

Summary of the key provisions of the DTT 

We have summarised below the key provisions contained in the DTT which could have an impact on the cross border transactions of businesses resident in both contracting states.

Persons covered (Article 1): Oman and Russia resident individuals and companies have access to the DTT. For individuals, residency for DTT purposes is not limited to Oman and Russia nationals only. Foreign national individuals who are tax resident in Oman or Russia can also benefit from the DTT.

Residents covered by the DTT include: (i) any person liable to tax by reason of domicile, residence, place of head or main office, place of registration or incorporation (ii) the contracting states or any statutory body, political subdivision or local authority.

The DTT contains a tie-breaker rule for corporate tax residence which is based on the place of effective management of the company. The current rule for determining DTT residence under the 2017 OECD Model Tax Convention is the mutual agreement procedure.

Taxes covered (Article 2): The DTT covers taxes on income and capital including taxes on profits resulting from the disposal of movable and immovable property, and taxes on the total amounts of wages or salaries paid by the projects, as well as taxes on capital appreciation.

PE (Article 5): The definition of a PE under the DTT is similar to the definition under OECD Model Tax Convention. This is also true in respect of the determination of a dependent agent PE.

The DTT also contain a “service PE” clause, it provides that a PE would arise in case of furnishing of services, including consultancy services by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue ( for the same or a connected project) within a contracting state for a period or periods aggregating more than six months within any twelve month period.

Business profits (Article 7): The DTT provides that profits of a company are not subject to tax in the other contracting state unless the company carries on its business in that other contracting state through a PE.

In addition, the DTT provides that items of income that are not specifically dealt with in the DTT are taxable only in the contracting state where the recipient is resident.

As such, income from services that are not delivered through a PE in the other contracting state should be exempt from WHT and other forms of taxation in that state. Where activities do give rise to a PE, the DTT provides guidance on the mechanisms to attribute profits to such PE.

International shipping and air transport (Article 8): The DTT provides that profits derived by an enterprise in a contracting state from the operation of ships and aircraft in international traffic are only taxable in that contracting state.

Dividends (Article 10): The DTT provides that a rate of 10% would be applied on dividends if the beneficial owner of the dividends is a company that owns 20% of the company that pays the dividend or 15% of the gross amount if dividends in all other cases.

Income from interest (Article 11): WHT on interest payments is capped at 10%. The definition of interest under the DTT includes interest from government securities, bonds and debentures, premiums and prizes, other bonds or debentures, and other income if the essence of the basic contract can be compared to a loan.

Royalties (Article 12): WHT on royalty payments (which includes payments for the use of or the right to use industrial, commercial or scientific equipment) is capped at 10%.

Capital gains (Article 13): No exemption on gains arising on moveable and immovable property from taxation in the other contracting state.

Elimination of double taxation (Article 22): Elimination of double taxation is provided in the DTT by way of a credit against tax payable in Oman and Russia to the extent of tax payable in respective jurisdiction.

Mutual Agreement Procedure (Article 24): Taxpayers are allowed to seek assistance from their local competent authority in resolving disputes relating to the interpretation of the DTT, within a period of three years (from the date of the “notification” of the dispute to the relevant tax authority).

Entitlement to benefits (Article 26): In response to the BEPS Action 6, which deals with treaty shopping arrangements, the DTT includes the so-called Principal Purpose Test (“PPT”) to provide that no benefit would be granted to the taxpayer under the DTT if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit unless the taxpayer establishes that granting that benefit was in accordance with the object and purpose of the DTT.

It is important that Oman and Russia entities seeking to claim relief under the DTT have appropriate operational substance and can support a principal commercial purpose.This is in addition to meeting the minimum substance and procedural requirements set by Russia (as of date, Oman has no clear guidance or specific regulations related to economic substance).

Entry into force (Article 30): Each of the two contracting states shall notify the other contracting state in writing, that the internal procedures required by each contracting state for the entry into force of the DTT have been complied with. The DTT shall be effective as of the date of the last of these two notifications. At that time, the DTT will be enforceable according to the following: (i) with regard to WHT: on amounts paid or credited to the account as of the first day of January of the calendar year following the entry into force of the DTT. (ii) with regard to other taxes: for any tax year starting from the first day of January of the calendar year following the entry into force of the DTT.

Oman - Oman Tax Authority announcement 0n Automatic Exchange of Information “AEOI” portal

In brief

On 28 December 2023, the Oman Tax Authority (“OTA”) has issued an announcement with relation to the non availability of AEOI portal due to rebuilding of new system in which it has announced several guidance including extension of the Country by Country reporting notification (“cbCr notification”) which was due by 31 December 2023 for taxpayers who have a year ending on the same day.

In detail

Due to the AEOI portal issues persisting on 28 December 2023, the Oman Tax Authority has announced the following key matters:

• The deadline for CbCR notifications for affected entities was extended until the AEOI portal becomes accessible. The portal is now available for necessary notification submission. 

• As part of the upgrades to the portal, it is necessary to re-register and submit CbCR notifications. 

• The OTA has notified that no fines or penalties will be imposed for delayed CbCR notifications resulting from the unavailability of the AEOI portal.

Detailed instructions, including guidance on re-registration, is available on OTA portal.

We strongly recommend that taxpayers required to comply with FY2023 CbCR notification requirements to do the needful at the earliest.