Gulf oil dilemma drives tax reforms to shore up deficits

The oil price slide is driving tax reforms across the region as Arabian Gulf economies seek to shore up a potential US$700 billion deficit.

All six Arabian Gulf states are planning to introduce Value Added Tax (VAT) collectively. Various other tax reforms are also underway.

The IMF warned in October that Gulf states would have a combined fiscal deficit between 2015 and 2019 exceeding $700bn if they did not undertake reforms.

Since then, several countries have cut energy subsidies, trimmed spending and talked about taxes and privatisation to shore up government revenue.

“Governments need to continue to spend and continue to develop key areas such as construction, housing, health care, education, etc,” said Nilesh Ashar, a partner at KPMG in the UAE.

“They can’t do this purely on the back of the oil prices particularly where they are at the moment. Some level of diversification and introduction of taxes is healthy for the governments and their economies in order to continue to sustain growth within the economies.”

It is no surprise then that governments and the IMF are touting the benefits of increased taxation.

The IMF has argued that introducing VAT at a low rate could generate between 1.5 to 2 per cent of GDP. Gulf states are aiming for VAT on goods and services that will range between 3 to 5 per cent when it comes online in 2018.

But individual countries are looking at other forms of taxes.

“With oil prices as low as they have been and no immediate signs of a rebound, we can expect fiscal reform to continue to be prevalent or a hot topic with tax authorities over the coming years as they look to develop sustainable alternative revenue away from hydrocarbons,” said Alex Law, the international and M&A tax leader for Deloitte Middle East.

Oman, for example, plans to broaden its corporate tax base and increase taxes to 15 per cent from 12 per cent. The country’s state council approved the new income tax law last month and needs approval from the cabinet to become law. While countries in the Gulf differentiate between foreign and local companies when it comes to corporate taxes, Oman treats them the same.

Oman, the largest oil producer in the Middle East outside of Opec, isgrappling with a fiscal deficit of 3.3 billion rials (Dh31.51bn) or 13 per cent of gross domestic product this year, compared with a deficit of 4.5bn rials last year.

Kuwait, one of the largest oil producers in Opec, plans to broaden its tax base while lowering the corporate tax rate to 10 per cent from 15 per cent.

Kuwait does not tax companies owned by Kuwaiti and Gulf nationals.

“Although the likely tax rates are expected to be low, global experience has shown that tax revenue collections tend to increase over time, especially with indirect consumption based taxes like VAT,” said Sherif El Kilany, the Mena tax leader at EY. “The increased tax collections will also enable governments to keep the corporate tax rate low, as a continuing incentive to attract foreign direct investment.”

In the UAE, there has been speculationof a new corporate taxation but no material developments have occurred. The UAE taxes oil and gas companies and foreign banks operating in the country.

The UAE and Bahrain are the only two countries in the Gulf that do not have corporate tax.

In Saudi Arabia, a G20 member, authorities plan to implement OECD recommendations for the base erosion and profit shifting (BEPS) project, a move that would help to counteract tax evasion and improve the country’s tax revenue streams.

Multinational companies often exploit gaps in tax rules and move profits to low- or no-tax locations. BEPS is gaining momentum as revenue losses amount to $100bn to 240bn annually, or between 4 and 10 per cent of global corporate income tax revenues, according to the OECD.

“Several countries in the region are actively involved in the BEPS discussions and see the BEPS programme as an opportunity to introduce changes to their domestic tax laws to preserve the tax base and limit tax avoidance,” said Mr Law. “In addition, the immediate effect of BEPS is likely to be for those outbound multinational groups, which are headquartered in this region but operating in jurisdictions across the world that have already introduced some BEPS changes. ”

The Middle East region has the lowest average Total Tax Rate, according to consultancy PwC’s 2016 Paying Taxes report.

But the implementation of tax reforms has its own challenges, particularly for the UAE where companies in free zones have a 50-year tax holiday.

“One of the challenges is on the coverage and scope of companies to corporate taxes and VAT,” said Mr Ashar. “It would be helpful if the free zones continue to enjoy the tax exemption so that a positive message is sent to the foreign business community about the stability of the policy of the government on tax exemptions.”

Other challenges relate to the ability of the authorities to collect taxes and monitor companies’ compliance with the new regulations.