Potential tax challenges for SMEs going global
With the UAE being a relatively tax-free environment, many SMEs often neglect accounting for potential tax-related issues when planning to expand overseas, says a KPMG official.
“They are so used to doing business without having to file tax returns that they don’t think about [the fact that other countries charge tax],” Ashok Hariharan, head of tax at KPMG for the Middle East and South Asia, tells SMEinfo.me.
This can prove a massive challenge for firms, unless they research and plan ahead, he adds. “For instance, you negotiate contracts with customers without realising that you will have to pay taxes and, all of a sudden, after the business is done and the goods are sold, you are told that you have to pay tax or there is a withholding tax. That becomes a drain on your returns. You were expecting to earn 20 per cent profit, but you find that there is a ten per cent tax and your return gets reduced to that extent.”
To avoid such situations, it is crucial for SMEs to understand the regulatory environment of the market they are planning to enter, conduct tax due diligence and feasibility studies, and be prepared for tax compliance once a presence has been established, he says.
Tax due diligence
According to Hariharan, there is a wide range of taxes that an overseas operation could be subjected to. “The obvious one is the corporate tax on business profits which you generate outside, but there are also a number of withholding taxes that are applicable on payments made overseas. You could be subjected to withholding tax on dividends that you receive from your operation outside…or be charged taxes on royalties, management fees and the like.”
Another form of tax can come when companies send their employees to work in overseas jurisdictions, he adds. “You could end up creating a taxable presence for that employee there. For example, most countries would say that, if you have been there for more than six months in a year, then you become a resident of that country. So, you may have to deal with personal taxes.”
Besides that, a host of indirect taxes could be applicable, such as customs duties, says Hariharan.
Below, he provides an overview of the tax environment and how SMEs can try to reduce taxes by taking advantage of agreements and treaties among countries.
What are the typical corporate tax rates?
The tax rates in our region are somewhat lower. Saudi Arabia…has a higher tax at 20 per cent, but Qatar will tax foreign businesses at ten per cent, Kuwait at 15 per cent and Oman at 12 per cent. Outside of the region, the tax rates can be high; typically, the average corporate tax rates tend to be 30 per cent.
It is not sufficient to know the tax rate, you need to know how taxable profits are to be computed, because there may be certain types of expenses that are not allowable as a deduction when computing profits in the overseas country. As a result, the effective tax rate can be much higher than the stated tax rate.
How do the tax requirements vary for onshore and free zone-based businesses?
With regards to customs duty, when a mainland business imports goods to, let’s say, Dubai, then, it is subject to approximately five per cent customs duty. However, if you import goods into a free zone, there is no customs duty applicable, so long as they are used within the free zone or are re-exported outside of the Gulf region. If the goods are meant for, say Saudi Arabia, then, when the goods leave the UAE free zone, the business would have to pay customs duty, because it is being consumed within the GCC. If it is being consumed within the GCC, then customs duty will apply.
What other factors should SMEs consider when preparing for taxes?
Once the effective tax rate is understood, you should see if there any mechanisms to try and reduce those taxes or if you can do business without some of the restrictions that could be imposed in the foreign country – such as through a free-trade agreement [between the UAE and the foreign country]… Restrictions don’t mean that you don’t have to pay taxes, but you can operate freely. For example, in some cases, you can import goods into the country without paying customs duty [or operate] without foreign ownership restrictions. You should also find out if there are any investor protection agreements and double tax avoidance treaties.
There can be situations where you find that the UAE doesn’t have the best double tax treaty with the particular country. Often, companies try to see if there is any other country located elsewhere – in Europe, for example – [that has such a treaty]. Take the example of doing business in the US. There is no tax treaty between the UAE and US, but there could be tax treaties between the US and some of the European jurisdictions, such as the Netherlands or Luxembourg, which are two countries that are often used by UAE businesses for setting up an intermediate holding company. So, instead of the investment going directly from the UAE, you set up an overseas holding company in, perhaps, the Netherlands, and from there you can re-invest into US. It helps you take advantage of a favourable tax treaty that may be there between Netherlands and the US.
However, many countries are trying to challenge such structures if they find that the only purpose of creating that entity is to reduce the taxes or is to take advantage of the double tax treaty. You need to make sure that you have some substance to the entity that is set up in the overseas country. For instance, you could ensure that the country becomes the focal point of not only investments in the US, but all of your overseas investments are also managed out of the Netherlands.
Are the requirements different for serviced-based versus trading businesses?
There could be different issues depending on the nature of your business. You could possibly carry out a trading operation without creating a taxable presence in the country, because you are only providing or exporting goods. You could operate through a distributor that would be taxable in its own right, but the UAE business does not have to pay tax as long as it just exports goods to the distributor. However, if the customer requires services in his country, you’ll have to have people there or a mechanism to provide on-ground support services. So, it could vary.
How can SMEs deal with tax compliance?
Once you have taken an investment decision, you need to plan your taxes. Often, there are particular requirements. For example, with corporate taxes, you have to file returns on an annual basis, so you need to be aware of the deadlines, what needs to go with the returns, what are the supporting schedules and if you could be subjected to a tax audit by the foreign jurisdiction, among other factors. In some countries, there are rules that are favourable to SME businesses or firms that are not large – where the turnover is not exceeding a certain threshold – then your compliance obligations are reduced; for example, instead of a monthly filing, you could possibly have a quarterly filing.