Companies undergoing business structuring or restructuring in Gulf Cooperation Council (GCC) countries will have to consider VAT issues, now that value-added tax (VAT) applies in the United Arab Emirates (UAE), the Kingdom of Saudi Arabia (KSA) and Bahrain.
VAT treatment and the related deduction entitlement for VAT on costs related to restructuring have not yet been well tested or fully clarified by the GCC tax authorities. Transactions of this nature are generally high value, increasing the risk of high penalties for errors. Businesses can reduce the risk of penalties by seeking clarity from tax experts and tax authorities.
The VAT considerations will depend upon the transaction being undertaken.
Trading through a new entity in the region can make sense for foreign or GCC-resident companies. It can allow a company to ring fence activities; to create a local sales and marketing entity for a foreign parent; and enable a joint venture opportunity or special purpose vehicle to tender for local projects.
New Company Set-Up
The establishment of a new company in the region potentially creates a new “taxable person” for VAT purposes. If the new company makes taxable supplies exceeding the threshold of 375,000 in local currency, it would be required to register for VAT purposes and will be issued its own tax number (TRN or TIN, as appropriate for the region) by the local tax authority for compliance purposes.
As a VAT-registered taxable person a company will need to charge VAT to its customers where applicable, issue valid VAT invoices, and meet periodic VAT compliance obligations. There are penalties for failing to register and/or failing to meet other VAT obligations.
Where the new company is part of a larger local corporate group, its own TRN/TIN and VAT obligations are independent from any other local related entity’s VAT obligations, meaning that each legal entity is assessed separately. As a result, any supplies of goods and services between corporate group entities would be subject to VAT and tax invoicing rules, similar to third party transactions.
It may be possible to place this new local company within a local VAT group together with its related local corporate group members. This will be subject to conditions in each country’s local VAT laws and regulations, which might include obtaining the tax authority’s approval. Cross-border VAT grouping of entities resident in different GCC countries is not possible.
VAT grouping would reduce the administrative burden of VAT compliance and improve cash flow within the group as VAT will not be charged on intra-VAT group transactions and the VAT group will only need to make one return each period.
The establishment of a new branch of an existing legal entity does not create a separate “taxable person” for VAT purposes. Instead, the legal entity would now have a new “fixed establishment” from which it undertakes some of its activities, meaning a head office and a branch are viewed as the same “person” for VAT purposes.
If the head office is established in the same GCC country then the creation of a new local branch would not trigger a new VAT registration obligation. So the creation of a branch in Abu Dhabi of a Dubai-based head office would not trigger a new obligation—the activities of the branch would be part of the overall activities of the local legal entity.
If the branch makes any taxable supplies on which VAT should be charged or purchases any taxable goods and services on which a deduction of VAT may be claimed, this should be added to the head office’s sales and purchases transactions in order to assess the legal entity’s VAT registration and compliance obligations. The legal entity should have one valid TRN/TIN only, relevant for the head office and all local branches.
Any transactions between head office and branch domestically within one GCC member country would not be viewed as a “supply” for VAT purposes. VAT grouping is therefore not relevant where there are supplies between a head office and a local branch.
If the head office is a foreign company established and resident abroad (including in another GCC country) with no current physical presence in the GCC country in question, then the creation of a new local branch may trigger a new local VAT registration obligation for the foreign legal entity. This will depend on whether the foreign legal entity makes any supplies which are taxable for local VAT purposes and whether the local branch is more connected with the supply than the head office or any other foreign branch.
There are many ways in which a joint venture arrangement may be established and they can be complex from a VAT perspective.
Two or more parties may sign a contract which results in a “profit sharing” or “cost sharing” arrangement for a particular activity. This arrangement would not involve the creation of a new entity or branch but instead would simply involve supplies between the parties. These should all be individually assessed based on each party’s current local VAT registration status, the type of transactions and VAT treatment.
On the other hand, a new legal entity may be established with the joint venture partners owning the share capital of the company. In this instance the joint venture company is potentially a new “taxable person” with its own local VAT obligations.
Where a corporate restructuring involves external factors such as mergers, acquisitions and disposals, it is important to consider the VAT implications.
The issue, supply and transfer of shares is exempt for GCC VAT purposes. Any VAT incurred on costs directly associated with an exempt supply is non-deductible in a taxable person’s VAT return, becoming a real cost for the business, potentially affecting its profit margin.
If a corporate restructuring involves the sale or purchase of shares, then this will be an exempt transaction for VAT purposes. The seller needs to establish the correct VAT treatment, but both parties need to consider whether they can deduct any VAT incurred on costs associated with the restructuring, such as legal fees or tax advisory fees, as there may be a restriction on VAT recovery if the costs are directly related to an exempt share transaction.
The context of the share sale together with each party’s overall economic activity should be taken into consideration in determining deduction entitlement. This means looking at whether the share transaction was a one-off event or a frequent activity of each party; whether it was an investment or trade activity; and if the party’s main economic activities are fully or partially taxable or fully exempt.
Corporate restructuring can also involve complex share swaps, barter transactions of other goods or services in return for shares or deferred payment arrangements for share transfers. This creates much more risk for businesses as it is easy to overlook the VAT treatment or get it wrong, potentially resulting in outstanding VAT liabilities and penalties.
An alternative to selling shares is to transfer the main assets of the business between the relevant legal entities. The assets simply transfer from the balance sheet of the selling entity onto the balance sheet of the purchasing entity, in return for an agreed consideration—which could be in cash or could involve the issue of shares. The selling entity may subsequently be wound up.
The transfer of a business or an independent part of it to a taxable person, for the purpose of that taxable person continuing the business, is not a supply for GCC VAT purposes. The transaction is outside the scope of GCC VAT so no VAT should be charged and no VAT invoice should be issued.
In order for the “transfer of business” (TOB) rule to apply, the transaction must meet certain criteria. These criteria differ slightly from one GCC member country to another, but are generally as follows:
- the full business or a part of the business which is capable of being independently operated should be transferred;
- the buyer must be a taxable person;
- the buyer must continue to use the assets transferred to continue to operate a business.
Differences in Approach
There are differences in approach between GCC countries in relation to whether the transferred assets must be used for “the same” business post transfer, and in some countries the buyer must be a taxable person before the transfer, rather than becoming a taxable person as a result of the transfer.
There are also different requirements as to notification. In Bahrain, the parties must notify the tax authorities before the transfer occurs. In the KSA, the parties must agree the application of TOB relief in writing between them in advance of the transfer. Neither of these obligations exists in the UAE.
Although there are differences in rules between countries, if a number of assets (such as stock, computers, phones, printers, screens) were transferred in isolation without the full functions of the business (such as premises, sales staff, supplier or customer listings) this would not qualify as a TOB in any of the GCC member countries. Similarly, if the assets transferred were subsequently auctioned separately and not operated together as a business, this would not qualify as a TOB.
The lack of clarity and the differences in laws across the region creates a risk, particularly for high value transactions, that VAT may not be charged where it is in fact due, as a result of the misapplication of the TOB rules.
It is also important to identify any VAT on costs directly associated with the TOB and assess their deduction entitlement. Generally, VAT is deductible where it is directly associated with a taxable supply and non-deductible where it is directly associated with an exempt supply or non-business activities.
In this scenario the TOB itself is not a “taxable supply” or “exempt supply” but is a strategic transaction for business purposes. Generally, you would seek to “look through” to the overall activities of the business and take a deduction for VAT on costs associated with the TOB based on the business’s overall deduction entitlement, similar to overhead costs.
This “look through” principle is not set out within the local GCC member country laws although the KSA and Bahrain Tax Authority guidance notes are suggestive of this principle.
If a business transfer does not meet the criteria of a TOB, the overall consideration or price for the business sale or part sale should be attributed to the individual supplies of goods and services and the appropriate VAT treatment applied for each.
This allocation of consideration may pose some challenges as the value of the business as a whole may be greater than the individual value of the goods and services being supplied—there may be an element of goodwill or profit built into the price. As there is no strict procedure within law for this allocation process, a reasonable approach should be taken which reflects the value of each good or service in comparison to the full business and the sale price. The split may be within the contract. If there are multiple VAT rates applicable to the goods and services being transferred and therefore there is a risk that this allocation process if done incorrectly may change the overall VAT liability due, businesses may wish to seek confirmation from the tax authority that the approach taken is viewed as reasonable.
Under the capital asset scheme, the VAT input tax initially recovered on certain capital assets, such as buildings, is adjusted over a specified period depending on the use of the asset. Capital asset scheme adjustments may be required as a result of a business transfer.
Any VAT incurred on costs associated with the business transfer should generally be deductible on the basis that most goods and services which would form part of an asset transfer would be liable to VAT at 5% or 0%. If any good or service supplied as part of the business transfer is exempt from VAT, then an apportionment mechanism should be used for deduction of VAT incurred on associated costs.
Although the result of a local company wind-up is that the entity will no longer be in existence and so will no longer have VAT obligations in the region, the process of winding up and closing the company will generally attract some obligations from a VAT perspective, such as:
- transfer of business prior to company closure;
- property sales or lease assignment;
- fixed asset disposals;
- scrap or gifting of assets;
- filing of final VAT returns;
Each transaction should be assessed, its correct VAT treatment applied, VAT paid to the authorities where due and valid VAT invoices issued. Capital assets scheme obligations should be assessed.
The business should ensure that it deducts all VAT on costs associated with its business, but does not retain the VAT registration for any longer than required, to avoid unnecessary additional compliance costs and to avoid penalties for not de-registering on a timely basis.
Joanne Clarke is Tax Director (VAT) with Pinsent Masons, U.K.
The author may be contacted at: email@example.com
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners