By Raman Ohri, Direct Tax Manager, Keypoint, Bahrain
More than 140 countries, including the Kingdom of Bahrain, have committed to promoting international tax transparency by implementing certain minimum standards. In 2021, the Organization for Economic Co-operation and Development (OECD) set a global minimum tax rate of 15% on global profits for large multinational entities (MNEs), regardless of their head office. The global minimum tax framework agreement has created a dilemma for lower corporate tax regimes, as some of the six countries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – that make up the Cooperation Council for the Arab States of the Gulf (better known as the GCC). The current corporate tax rates paid by multinational enterprises in the GCC countries that have joined the framework (Kuwait is the exception) are as follows: Saudi Arabia – 20%; United Arab Emirates – 9% (from June 2023); Qatar – 10%; Bahrain – no corporate tax; and Oman – 15%.
Saudi Arabia and Oman respect the global minimum tax rate. At the time of writing, Bahrain does not tax personal or corporate income (except on hydrocarbon-related activities) or dividends or foreign investments. Three questions come to mind: What are the consequences if Bahrain does not introduce a global minimum tax? How could the economy benefit from the introduction of a corporate income tax? And would implementation change the attitude of foreign tax authorities towards Bahrain?
Loss of tax revenue
In January this year, the United Arab Emirates (UAE) announced that it was introducing a corporate income tax for fiscal years beginning on or after June 1, 2023. A headline rate of 9% will apply to all except for multinationals who will pay a higher (still uncertain) tax rate on their profits in the UAE, helping to ensure that income taxed on business activities stays in the UAE. Under the OECD’s two-pillar initiative, if Bahrain decides not to implement a corporate income tax, any tax revenue generated by Bahraini companies could be collected in a foreign jurisdiction. To prevent this from happening, Bahrain could implement either a national tax regime for all businesses and across all sectors (with some exclusions) alongside a specific mechanism for collecting additional tax from MNEs (such as the did the United Arab Emirates) or a tax regime that only taxes multinational companies doing business in Bahrain.
Regardless of the method, the overriding objective of the Bahrain Revenue Authority (the National Board of Revenue or NBR) will be to ensure that the effective tax rate on MNE profits meets the overall minimum tax rate of 15 %, avoiding tax revenue being lost to a foreign jurisdiction.
The Government of Bahrain continues to make concerted efforts to diversify its economy, which is heavily dependent on oil for state revenue, by developing small and medium-sized industries, supporting the commercial services sector and encouraging greater investment. from the private sector. The introduction of VAT in 2019 was a significant statement of its intent, albeit as part of a GCC initiative. Taxing businesses would also strengthen public finances, which have been hit hard by the impact of COVID-19 over the past 30 months. However, it could also have a negative impact, leading to job losses in the private sector, lower foreign direct investment and a general economic slowdown.
It is widely suggested that multinational corporations have been able to reduce the effective tax rate on their global profits by shifting their profits offshore to the GCC, where historically they have had minimal economic activity or substance. Internationally, Bahrain’s tax regime is considered relatively favorable, especially when compared to mature tax jurisdictions. In fact, believing that multinational companies were able to establish a presence in Bahrain and report profits despite minimal activity, the European Union blacklisted Bahrain as a non-cooperative jurisdiction in 2017. Bahrain has specifically committed to meeting globally set standards and as a result, in early 2018, Bahrain was removed from the list.
The introduction of a corporate income tax will impact businesses that are present in the region for tax purposes and may require them to review existing business models and pricing strategies. Bahrain has already taken some steps to demonstrate good tax practices by introducing regulations on economic substance, country-by-country reporting and rules on ultimate beneficial ownership. However, if, as expected, Bahrain implements a corporate income tax, the announcement would be nothing short of seismic. Bahrain’s network of double tax treaties is growing – more than 45 agreements are already in place. With the introduction of corporate tax, the amicable settlement process, used to resolve cross-border disputes, should also be improved and updated, thus strengthening Bahrain’s position in tax treaty negotiations.
The implementation of a corporate income tax will also in all likelihood lead to the introduction of transfer pricing, as is the case in the United Arab Emirates. Transfer pricing rules generally apply to cross-border intragroup transactions, but may also apply to domestic intragroup transactions in certain jurisdictions. Multinational enterprises operating in Bahrain should update their transfer pricing policies and documentation to align with OECD guidelines on the arm’s length principle. If Bahrain were no longer considered a low-tax jurisdiction, multinationals could argue with their national authorities about the commercial logic of doing business here.
Although there has been no official word from the Bahraini authorities, it now appears to be a question of when, rather than if, a corporate tax will be introduced. Having worked in multiple tax jurisdictions, setting up a new tax is rarely straightforward. Stakeholders, not just tax and finance functions, at all levels of organizations need to assess the potential impact of these tax reforms. At a minimum, companies should budget for expected tax cash outflows in their forecasts and projections. GCC tax regimes can and do change very quickly. The extremely volatile global economic outlook – from war in Ukraine to fluctuating prices for a range of commodities – suggests that the case for change is clearer than it has ever been.
Raman Ohri is Head of Direct Taxes at Keypoint in Bahrain.