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Global Transfer Pricing Conference Critical Transfer Pricing Developments by Region – Middle East and Africa October 2013

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Managing multiple stakeholders in the new economy

PwC

Today’s presenters

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October 2013 Global Transfer Pricing Conference

Mohamed Serokh, Partner, UAE

Andrew Fairfoull, Partner, South Africa

Corneli Espost, Senior Manager, South Africa

Dan Axelsen, Director, US

PwC

Agenda

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BEPS impact on the Middle East and Africa

Tax structuring in the Middle East and Africa

Audit landscape in the Middle East and Africa

PwC


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PwC


Global Transfer Pricing Conference October 2013

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Top BEPS Action Points for the Middle East & Africa

Challenges of digital economy

Limit excessive interest deductions

Prevent treaty abuse

Avoidance of PE status

TP outcomes and ‘value creation’

Require taxpayers to disclose aggressive tax planning arrangements

Re-examine TP documentation

Make dispute resolution mechanisms more effective

1.

4.

6.

7.

8-10.

12.

13.

14.

PwC

Tax structuring in the Middle East and Africa

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PwC

Background

• Large group based in the UAE operating in the retail sector

• Presence across India, Middle East and Africa

• Retail arm operational in UAE, Oman, Kuwait, Qatar, Lebanon, Jordan, Kingdom of Saudi Arabia, Egypt and Bahrain

Objectives

• Restructure retail business arm to:

- Attract local investment and incentivize remuneration of the local sponsor

- Achieve a tax efficient group structure

- Ensure a tax robust and defendable outcome for RetailCos

Middle East case study Introduction

ME RetailCos

1 2 3 …

UAE HQ

SourceCo

Cost of goods sold

Local country partner

Current structure

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PwC

Current - Gross Margin Model

• RetailCos target specific gross (intake) margins

• No WHT exposure

• Low profit retention at local retail company level

• Customs applied at RetailCo level

Proposed – Multi-fee model

• RetailCos do not fix gross margin

• Adequate margin for SourceCo

• License fees charged by IPCo and management fees charged by ServiceCo

- Quantum of license fees charged subject to local RetailCos operating margins

- Potential large WHT exposure

• Additional profit retention at RetailCo level

- Increased incentive for local country sponsor

Middle East case study Transfer pricing models

ME RetailCos

1 2 3 …

UAE HQ

SourceCo IPCo ServiceCo

Supply chain fee License fee Management fee

Local country partners

Proposed structure

WHT exposure on payments

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PwC

Issues

• License fees and management fees attract significant WHT at RetailCo jurisdictions in the Middle East

- Depending on the quantum of the charge, WHT costs could be prohibitively high

- Need to undertake a tax structuring exercise to explore options for efficiently structuring these charges and choosing a tax efficient jurisdiction for the IPCo and ServiceCo to mitigate potential WHT exposure

• Manoeuvring around local ownership requirements and tax treatment of foreign investors

• Rationalizing the move from an intake margin model to a license fee model

• Standardizing transfer pricing policy across all local retail company jurisdictions

Our approach

• Prepared a transfer pricing model to test the financial outcome for client under both approaches

• Stress-tested projected P&Ls using Middle Eastern retailer profitability benchmarks

• Measured the impact of transitioning from one model to another on key tax and accounting metrics

• Enabled the client to make a “go” or “no-go” decision and proceed with implementing the license fee model

Middle East case study Tax & transfer pricing issues & approach

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PwC

Country CIT WHT Customs Issues considered

Oman 12% 10% 5%

• Related-party transactions usually scrutinized by the tax authority

• Basis of adjustment applied by the tax authority is very arbitrary (not robust)

Qatar 10% 5%/7% 5% • The Qatar Financial Center has recently issued its first

draft transfer pricing manual, signaling added scrutiny on related-party transactions in the future

Kuwait 15% 15% 5%

• Retention on payments made to non-residents (i.e. UAE HQ)

• Taxation based on the concept of Kuwait-sourced income; UAE HQ may have to file tax return in Kuwait to claim back retention

Jordan 14% 7% Depends on

HS code • Revised CIT law to be introduced in 2014 with

significantly higher 25% headline rate

Lebanon 15% 7% Depends on

HS code • None

KSA 20% 15% 5% • Prohibitive WHT expense with the license fee model • Difficult to justify intake margin model in KSA, if

license fee model implemented in other jurisdictions

Egypt 25% 20% Depends on

HS code

• High WHT expense on license fees and management fees

• Difficult to extract profits out of Egypt

Middle East case study Region-specific tax issues

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PwC

VCT the Africa way Case study: MNC growth pains in Africa


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• Incentive aligned local/ regional manufacturing or finishing or packaging

• Procurement

• Trade bloc aligned RDCs

• RHQ(s)

• Equity participation for local partners

• TP realignment

Country by country

Import-led Sub-optimal

supply network

PwC

VCT the Africa Way There can be no lift and shift of European VCT models to Africa


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Transfer pricing

• FAR profile

• Special comparability factors

Exchange control

• Limits transactions with Principal

• Limits on royalties and fees

Common operating model and pricing policy principles

underpinned with non uniform transactions and local TP differences

Withholding taxes

• Limited treaty networks

• Royalties and management fees

• Net costs may be manageable?

Indirect taxes

• Ad valorem duties

• Complex web of FTAs

• Irrecoverable VAT for non established Foreign Principal

• Manufacturing location choices

PwC

Free trade in Africa is an aspiration rather than a reality

Global Transfer Pricing Conference

ECOWAS

Conseil de L’Entente

WAEMU

Ghana Nigeria

Guinea-Bissau

Benin Togo Cote d’lvoire

Niger Burkina Faso

Guinea Liberia Sierra Leone

Mano River Union CILSS

Mali Senegal

SADC

Cape Verda The Gambia Chad

ECCAS

Cameroon Central African Rep Gabon Equatorial Guinea Rep. of Congo

Sao Tom & Principle

CEMAC

COMESA Nile Basin Initiative IGAD

EAC

SACU

Burundi* Rwanda*

DR Congo

Angola

Egypt

Djibouti Ethiopia Eritrea Sudan

Kenya* Uganda*

Tanzania* Malawi* Zambia* Zimbabwe*

Mozambique *= CBI

IOC

Somalia

Libya

AMU

Algeria Morocco Mauritania Tunisia

Reunion

Mauritius* Seychelles

Comoros* Madagascar* South Africa

Botswana Lesotha Namibia

Swaziland*

Source: World Bank.

Note: AMU: Arab Maghreb Union; CBI: Cross Border Initiative; CEMAC: Economic and Monetary Community of Central Africa; CILSS: Permanent Interstate Committee on Drought Control in the Sahel; COMESA: Common Market for Eastern and Southern Africa; EAC: East African Cooperation; ECOWAS: Economic Community of Western African States; IGAD: Inter-Governmental Authority on Development; IOC: Indian Ocean Commission; SACU: Southern African Customs Union; SADC: Southern African Development Community; WAEMU: West African Economic and Monetary Union.

October 2013

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PwC

VCT the Africa way Transactional structures used in Europe/Asia often do not work in Africa


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South Africa Nigeria Kenya

Distribution

Limited risk distribution Customs considerations and TP planning

Customs considerations and TP planning

Customs considerations, TP planning and WHT

Commissionaire Undisclosed agency Undisclosed agency Undisclosed agency

Commission Agent Generally PE risk and TP planning Generally PE risk and TP planning Generally PE risk and TP planning

Direct sale by Foreign Hub – local subsidiary may provide customer support and warehousing

Legal and regulatory constraints may apply

Customs issues and local subsidiary required if you trade in-country

Dependent agent PE, Indirect Tax and Customs issues

Contract manufacturing – foreign customers TP and currency controls TP and currency controls TP considerations

Contract manufacturing – local customers Exchange control planning needed Currency Controls and Indirect Tax compliance

Indirect Tax and PE

Toll manufacturing – foreign customer Currency Controls, Customs issues and PE risk

VAT and Customs issues

Toll manufacturing – local customer Exchange control planning needed Currency Controls, Customs issues and PE risk

Customs and VAT issues

Balancing payment (outbound for services) Currency Controls, Indirect Tax and TP impact

Currency Controls WHT & TP adjustment

Royalties (outbound) – fixed rate royalty Currency Controls, WHT & TP impact, royalty cap

Currency controls, WHT & TP royalty cap

WHT & TP considerations

Royalties (outbound) – variable rate royalty Currency Controls, WHT & TP impact, royalty cap

TP issues and WHT TP issues and WHT

Capital gains legislation Yes Yes No – suspended (except Oil & Gas)

Specific exit rules No No No, but compensating tax issues to consider

Application of OECD conversion principles Yes, but also consider the UN model Yes, but also consider the UN model Yes, but also consider the UN Model Ex

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PwC

Audit landscape in the Middle East and Africa

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PwC

Audit landscape in the Middle East and Africa Middle Eastern audit landscape

• Arm’s length principle basis of many Middle Eastern tax laws, in practice different from OECD

• Some jurisdictions use formulary rules rather than the arm’s length principle, especially for Head Office charges, and for branch structures

• “Form” of the transaction prevails over “economic substance” under audit

• Having some level of documentation to support charges (transfer pricing structure) is important, but form of documentation not necessarily “Western” style documentation

• Standard Western TP concepts such as the use of debit / credit notes, variable / tiered royalty structures, limited versus full risk entity characterisations, or pricing / migration of IP, not well understood

• The simpler the transfer pricing policy from a local country perspective, normally the better:

- Minimizing the number of outbound transactions, and complexity of transactions, is likely an optimal practice

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PwC

Audit landscape in the Middle East and Africa African audit landscape

• There is a gap between legislation and practice – tax authorities do not necessarily stick to the law and will usually opt for the alternative that provides them with the highest amount of revenue. Also, few countries have considered the application of the UN TP model.

• Inexperienced Revenue Officials and lack of capacity.

• Local country comparables are not readily available and there is no guidance on adjustments to foreign comparables (country risk adjustments).

• Management fees are routinely being challenged by the tax authorities.

• Royalty payments are sometimes queried, for example, whether the local entity should be paying royalties in respect of a globally recognised trademark where there is a separate local trademark that is dominant in the market.

• Authorities query year-end adjustments – this may also have withholding tax and customs implications.

• Because the authorities do not have extensive guidance on TP, it is sometimes difficult to know what the tax authorities need regarding TP.

• Exchange control regulations and their impact on the arm’s length pricing of transactions.

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Questions

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Global Transfer Pricing Conference - PwC: Audit and ... · PDF fileNote: AMU: Arab Maghreb Union ... Global Transfer Pricing Conference October 2013 . PwC ... care for any consequences