Modern Tax Reform: A Look at New Tax Regimes in the UAE, EU and USA

In the post pandemic era, which heralds the threat of large scale global economic and social conflict in light of the Russian invasion of Ukraine, many governments are struggling to balance budgets, maintain economic competitiveness, and fund their activities. Therefore, many governments are trying to make their economies more attractive to investors, in order to encourage businesses to settle in and remain within their borders. At the same time, tax reforms aim to ensure that various governments can maintain their tax collection efforts and retain a source of tax income in the long term. In this article, we look at recent tax reforms in the UAE, the EU and the US. It should be noted that changes in the UAE may be representative of wider changes coming to the Middle East/GCC region as a whole. In addition, the changes in the GCC/Middle East are heavily linked to EU, and even US tax reforms, which aim to standardize taxation and cut down on tax avoidance (via offshore jurisdictions like those in the Middle East), while still maintaining a “business friendly” tax regime. We explore how various governments approach this balancing act below.

The New UAE-Corporate Tax

When will it be introduced and general ruling?

-The UAE Ministry of Finance announced that it will introduce a federal corporate tax on business profits. Businesses will be subject to UAE Corporate Tax from the start of their first financial year on or after June 1, 2023. The UAE Corporate Tax system has used best practices globally to minimize compliance burden in terms of costs to businesses.

-Corporate tax will be payable on the profits earned through a company’s business activities in the UAE as reported in their financial statements, which are to be prepared in accordance with International Accounting Standards (IAS). 

-Corporate tax applies to all businesses and commercial activities alike, except for the extraction of natural resources, which will remain subject to Emirate level of corporate taxation.

-There is a standard statutory tax rate of 9%, and a 0% tax rate for taxable profits up to Dh 375,000 to support small businesses and start-ups. This will make the UAE corporate tax system amongst the most competitive worldwide.

Do individuals fall under the purview of this corporate tax in UAE?

·         As the name suggests, corporate tax will apply only to corporate entities/companies, and not to income earned by individuals via employment, real estate or other investments, or any other income earned by individuals that do not arise from a business entity.

Corporate tax incentives

·         The UAE tax system continues to honour the corporate tax incentives currently being offered to free zone businesses that comply with all regulatory requirements and that do not conduct business with mainland UAE. These incentives may include tax breaks for special purpose entities, or the enjoyment of various tax treaties which the UAE has entered into with other governments.

·         Given the UAE’s position as a Global Financial Center and an International Business Hub, the UAE will not impose withholding taxes on domestic and foreign payments, or subject foreign investors who conduct business within the UAE to corporate tax.

UAE businesses will be exempt from paying tax under the following circumstances

·         As an international headquarter location, a UAE business will be exempt from capital gains tax and dividends received from its qualifying shareholdings, and foreign taxes will be allowed to be credited against UAE corporate tax.

·         The UAE corporate tax system will have generous loss utilization rules and will allow UAE groups to be taxed as a single entity or to apply group relief with respect to losses and intragroup transactions and restructurings.

UAE Corporate Tax System only requires one corporate tax return each financial year

·         The UAE corporate tax system ensures the compliance burden is kept to a bare minimum for businesses that prepare and maintain adequate financial statements.

·         Businesses will only need to file one corporate tax return each financial year and will not be required to make advance tax payments or prepare/submit provisional tax returns.

·         Transfer pricing and documentation requirements will apply to UAE businesses with reference to the OECD Transfer Pricing Guidelines.

·         It is important to note that UAE business will be given enough time to prepare the introduction of corporate tax in the UAE. The UAE Ministry of Finance plans to issue more information on the UAE corporate tax system in the middle of 2022 to help business get ready and be fully compliant.

EU- Corporate Tax Reform in Light of Recent OECD Agreements

·         On 22 December, 2021, the European Commission proposed a directive ensuring a minimum effective tax rate for the global activities of large multinational groups.

·         The proposal delivers on the EU’s pledge to move swiftly, and be among the first, to implement the recent historic global tax reform agreement with the objective of bringing fairness, transparency and stability to the international corporate tax framework. With the global tax reform agreement, 137 OECD countries signed on to implement a minimum corporate tax rate of 15%, to apply globally.

·         The proposal follows closely the international agreement and sets out how the principles of 15% effective tax rate agreed by OECD countries will be applied in practice within the EU. It includes a common set of rules on how to calculate this effective tax rate so that it is properly and consistently applied across the EU.

Where does this proposal stem from?

·         Minimum corporate taxation is one of the two work streams agreed by the members of the OECD (Organization for Economic Co-operation and Development)/G20 Inclusive Framework, a working group of 141 countries and jurisdictions who have focused on the Two-Pillar Approach to address challenges in the digital economy.

·         The OECD worked on a global consensus-based solution to reform the international corporate tax framework which has resulted in a global agreement among 137 jurisdictions in October 2021. The discussion focused on 2 broad topics: Pillar 1: the partial re-allocation of taxing rights, Pillar 2: the minimal level of taxation on profits of multinational enterprises.

·         As pledged, the European Commission is now implementing Pillar 2 of the global agreement, making global minimum effective corporate taxation a realization for large group companies in the EU.

To whom do the rules apply?

·         The proposed rules will apply to any large group, both domestic & international, including businesses in the financial sector, with combined financial revenues of more than €750 million a year, and with either a parent company or a subsidiary situated in an EU Member State.

·         In line with the OECD/G20 Inclusive Framework agreement, the entities that do not fall under the scope of the rules are: Government entities, and  International or non-profit organizations. Pension funds or investment funds that are parent entities of a multinational group will not fall within the scope of the Directive on the OECD Pillar 2 either. Such entities are usually exempt from domestic corporate income tax to preserve a specific policy outcome. This may be because the entity is carrying out governmental or quasi-governmental functions or to ensure that the funds or pensions are not at risk of double taxation.

How will the effective tax rate be calculated?

·         The effective tax rate is established per jurisdiction by dividing taxes paid by the entities in the jurisdiction by their income.

·         If the effective tax rate for the entities in a particular jurisdiction is below the 15% minimum, then the Pillar 2 rules are triggered, and the group must pay a top-up tax to bring its rate up to 15%.

·         This top-up tax is known as the ‘Income Inclusion Rule’. This applies whether the subsidiary is in a country that has signed the international OECD/G20 agreement or not.

Who will make the calculations?

·         In the OECD/G20 Inclusive Framework agreement, a transparent method of calculating the effective tax rate was agreed upon by all 137 countries involved. The calculations will be made by the ultimate parent entity, unless the group assigns another entity.

US -Corporate Tax

·         US tax reform legislation enacted on 22 December 2017 (P.L. 115-97) moved the United States from a ‘worldwide’ system of taxation towards a ‘territorial’ system of taxation. Among other things, P.L. 115-97 permanently reduced the 35% Corporate Income Tax (CIT) rate on resident corporations to a flat 21% rate for tax years beginning after 31 December, 2017.

·         The United States imposes a tax on the profits for US resident corporations at a rate of 21 % (reduced from 35% by the 2017 Tax Cuts and Jobs Act). The corporate income tax raised $230.2 billion in fiscal year 2019, accounting for 6.6 percent of total federal revenue, down from 9 percent in 2017.

·         Taxable corporate profits are equal to a corporation’s receipts less allowable deductions—including the cost of goods sold, wages and other employee compensation, interest, most other taxes, depreciation, and advertising. US-based corporations owned by foreign multinational companies generally face the same US corporate tax rules on their profits from US business activities as US-owned corporations.

·         Most US businesses (Pass-through businesses) are not subject to the corporate income tax. Rather, their profits flow to their respective owners or members and are taxed under the individual income tax in the hands of owners or members. To further clarify, Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S-corporations. The share of business activity represented bypass-through entities has been rising for several decades.

Conclusion

Before setting up a business in any country, the corporation or business must evaluate the different types of taxation i.e., direct, and indirect taxes which may be relevant and applicable to their business. With new income tax regimes coming into effect in many jurisdictions, and with the implementation of sales/value added tax on almost a global scale, this is no simple endeavor. In addition, many governments are attempting to streamline tax procedures in order to make their economies friendlier for small businesses, at the expense of larger, and perhaps less efficient corporations.

We at Borderless Counsel can identify which taxes are relevant or applicable to your specific business, along with the relevant rules that must be complied with in terms of registration with the local authorities in the country of operation.

To receive our assistance, get in touch with us at info@borderlesscounsel.com today!