The Future of Tax in Bahrain
We are witnessing tax regimes around the world evolve to not only the changing economic and social conditions but also to the rapidly changing global marketplace in the era of a digital economy. With the accelerated transformation over the past few years be it due to digital disruptions or even the pandemic, we need to ask ourselves the following questions:
- Have tax systems kept pace with the transformation we are currently seeing in the world?
- Will we see a global minimum rate of corporate tax?
- How will initiatives like the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Inclusive Framework, introduction of Economic Substance Rules (ESR), Country by Country (CbC) reporting and Ultimate Beneficial Ownership (UBO) rules in Bahrain drive tax reform?
- Will we see a more ethical and fair approach towards tax?
- Will the ‘future of work’ trigger potential tax risks?
The Kingdom of Bahrain currently has a limited corporate tax (46%) that only applies to companies engaged in the exploration, production or refining of hydrocarbons. For all other entities operating in the Kingdom the corporate tax rate is zero percent (0%). The Kingdom also does not impose personal income tax. In line with this, all profits, dividends and other income is ‘tax free’. The Kingdom has one of the lowest rates of VAT at 5% with an extensive list of exemptions and zero ratings. The Kingdom also has no ‘exchange control’ regulations with no restrictions on repatriation of capital, profits, dividends, interest and royalties.
The GCC region
In the GCC region, most countries currently have some form of corporate tax:
- Saudi Arabia at 20%;
- Kuwait at 15%;
- Oman at 15%; and
- Qatar at 10%.
In the United Arab Emirates, corporate tax at 20% is only applicable on branches of foreign banks. While Saudi Arabia, Kuwait and Qatar provide an exemption from corporate tax for the GCC shareholding component (subject to certain conditions being met), Oman has no such exemption.
All the GCC countries consistently impose a higher rate of taxation on companies engaged in certain oil and gas activities. Some of the GCC countries also impose withholding taxes ranging from 5% to 20% on payments to non-residents for services, dividends, royalties and interest.
‘Corporate Tax’ in Bahrain – hypothetical or theoretical?
Bahrain as a member of the OECD BEPS Inclusive Framework, has committed to align national regulations and processes with the international tax framework, and implement the BEPS minimum standards.
In 2015, the UAE Ministry of Finance made announcements on the potential introduction of VAT and corporate tax. VAT came into effect in 2018 but no further details have been released to date on a corporate tax. Whilst the Kingdom of Bahrain has not made any announcements on the potential introduction of corporate tax, we have witnessed the implementation of the following regulations:
1. ES rules: The ES rules impose substance requirements for Bahraini entities undertaking geographically mobile activities in, from or through Bahrain – in essence to target corporate structures that shift income or profits to entities in jurisdictions with no or low tax regimes. Click here to read more about the ES rules.
2. UBO rules: UBO rules identify who has a controlling ownership of an entity – ultimately, this is a natural person(s). The requirement for companies incorporated in Bahrain, and the branches of foreign companies (excluding CBB licensed entities) setup in the Kingdom to provide details of their UBOs is a tool that the Government has enacted to demonstrate transparency, and compliance with global regulations. Click here to read more about the UBO rules.
3. CbC reporting: CbC reporting requires multinational enterprise groups (MNE) to file a CbC report, setting out financial information for each tax jurisdiction where the group has a formal presence. The objective of a CbC report is for tax authorities around the world to assess risks related to transfer pricing and base erosion profit shifting for MNE groups. Click here to read more about the recently introduced CbC reporting in Bahrain.
The BEPS project on addressing the tax challenges arising from the digitalization of the economy consists of two pillars:
— Pillar One aligns taxing rights more closely with local market engagement - a portion of multinationals “residual profit” should be taxed in the jurisdiction where revenue is sourced.
— Pillar Two applies where, even after the effect of Pillar One (if any), multinationals are regarded as undertaxed by reference to an agreed minimum level of global taxation, regardless of the jurisdiction where profits may be recorded.
Under the ‘Pillar Two’ proposals, jurisdictions are granted additional taxing rights where other jurisdictions have not exercised their primary taxing rights or income is subject to low rates of tax, i.e. in countries such as Bahrain and the UAE.
Businesses in Bahrain – how will ‘Pillar Two’ impact you.
All multinationals can expect their effective tax rates globally to change in the coming years as a result of ‘Pillar Two’. However, the impact on groups in the Middle East is expected to be greater given the prevalent nil/ low tax environment they have benefited from till date.
Within the Middle East, groups having a significant presence in Bahrain, the UAE and KSA (zakat paying entities), i.e. the nil/ low tax jurisdictions, may lose substantial double tax treaty benefits/ overseas tax deductions on intra-group transactions. While the ES rules have been introduced in the UAE and Bahrain, Pillar Two proposals do not provide for any exemption where constituent entities in these countries are subject to local substance requirements.
Therefore, one of the key developments we may witness is that countries (such as Bahrain) in the region could incorporate Pillar Two principles into their domestic tax framework and more importantly increase tax or potentially introduce corporate taxes.
Scenario planning – is your business ready for the potential introduction of corporate tax in Bahrain?
What is corporate tax?
It is a tax that businesses pay on their taxable income.
Is taxable income the same as accounting profit?
The short answer is no. Accounting profit is the net profit before tax reported on a company's income statement in accordance with the relevant accounting standards. Taxable income is the portion of a company's income that is subject to corporate taxes in accordance with the jurisdiction’s tax laws. For example:
— Income and expenses may be recognized in different periods for tax and accounting purposes.
— Specific income and/ or expenses items may not be recognized for tax purposes but recognized for accounting purposes, or vice versa.
— As different depreciation rates will be applied for tax and accounting purposes, the tax base and carrying amount of assets/ liabilities may differ.
— The treatment of capital gains/ losses will vary for the purposes of income tax and accounting.
— Tax losses in a particular year may be available to offset the future taxable income in later years. This will also result in the differences between accounting profit and taxable income (or the carry forward tax loss).
For example: A business that is reporting an accounting profit of BD.10 million may report a higher taxable income of say BD. 12 million. If the Corporate Tax rate was 10% then the accounting profit after tax will be BD. 8.8 million.
The Future of Work
With most businesses transforming their business models to accommodate and leverage remote working/ work from home; it has also opened up opportunities for organizations to leverage talent across borders. However, with every opportunity, there is a potential risk(s); particularly for multinational enterprises, and/ or organizations that have resources working in countries that have stringent tax regimes and varying definitions for commercial activity. The practical implications of international remote working, both from an employee and employer perspective, include:
— Income tax: For employees working in foreign countries for a period of time, obligations will vary.
— Employer tax withholding requirements: Individuals working internationally may activate employer tax withholding obligations. There could also be company registration requirements for the employer, specific to the market from where the employee is working.
— Social security: Remote workers may trigger social security issues, even if the working arrangement is between countries with a reciprocal agreement. It is imperative that certain action is taken by employers to ensure compliance with local regulations.
— Immigration: Do employees have appropriate authorisation to do their job in the country where they are working remotely?
— Permanent establishment (PE): Employees may unintentionally create a permanent establishment (PE) for the employer in another location, triggering issues from a corporate tax perspective. It is not uncommon for tax authorities to challenge PE positions of companies.
— Transfer pricing: Any change to where functions are performed may result in a change of an entity’s functional characterization, affecting profit attribution. Any such shift may cause long-term transfer pricing/ value chain issues.
— Labor law and industry regulations: Remote working employees may expose their employer to labor laws (and other local regulations) that are not in the legal jurisdiction of the employer. This can be particularly problematic for highly-regulated industries, such as financial services.
Calls for greater tax transparency globally will no doubt continue, and increasingly, businesses will need to explain their tax positions. Simply ‘complying’ with the tax laws in each jurisdiction, without due regard to the true tax position may pose reputational risks and may not be adequate in today’s evolving global tax landscape. Above all, businesses have a responsibility to engage in the discussion and debate surrounding the tax system of the future.
Here are some questions to consider for decision makers at Bahrain businesses:
— If corporate tax was introduced do you know what your tax liability will be?
— Have you conducted a scenario planning exercise to estimate your tax liability?
— Will you need to rethink your pricing strategy, or at the very least should you be planning for that now?
— Will your return to shareholders be impacted?
— Will there be an impact on employee remuneration and benefits?
— Is your tax strategy sustainable and commensurate with your corporate goals, ambitions and ethics?
— Do you have the right controls to ensure that your tax policy is properly embedded across your organization and that you are paying the right amount of tax on time and in the right jurisdiction?
— To what extent do you already disclose tax payments on a country-by-country basis?
— Are you prepared for changes in international tax rules?
— Is your future of work/ talent strategy potentially putting your organization at risk in relation to your tax obligations?
Mubeen leads the Tax & Corporate services practice for Bahrain. He is a a corporate and tax lawyer with 20 years experience advising clients in Australia, Bahrain and across the GCC. Prior to joining KPMG, Mubeen established and led the tax team at a Bahrain based consulting firm.
His key areas of tax expertise are tax structuring, international tax, M&A, due diligence, transfer pricing, tax disputes and VAT in the GCC. Mubeen also advises clients on compliance with the Foreign Account Tax Compliance Act (FATCA), Common Reporting Standard (CRS), Economic Substance Rules (ESR), Country by Country (CbC) reporting and other Bahrain commercial and regulatory compliance matters.
He is the lead tax partner on clients across a range of industries including financial services, insurance, private equity, real estate & construction, oil & gas and diversified family business groups. His combined experience as a corporate and tax lawyer allows him to provide commercially-focused, value-adding practical solutions to complex tax issues.