Think About Transfer Pricing While Getting Ready For VAT
VAT is at the forefront of current tax reforms and soon to be a reality for many regional businesses, as it is expected to be introduced across the GCC from 1 January 2018.
The GCC countries have signed up to a unified framework, which will form the basis of the domestic legislation that will bring VAT into force.
This will have an impact on systems, personnel, vendors and customers, but there will also be implications for the interaction with direct taxes through Transfer Pricing (TP).
VAT is an indirect tax applied on the consumption of most goods and services, though some supplies such as financial services, healthcare and education are typically exempt.
As a consumption tax, VAT is ultimately incurred and paid by end consumers. However, it is levied at each stage of the supply chain and collected by businesses on behalf of the government.
Businesses are sometimes able to avoid VAT because whatever “input VAT” they incur on their purchases from suppliers can be claimed against “output VAT” collected from customers and remitted to the government.
Sometimes businesses are unable to recover VAT because the input VAT incurred cannot be recovered via the VAT return for several reasons. For example, the costs incurred by a business may be specifically disallowed for VAT purposes.
TP refers to the setting of prices for transactions between related companies, and applies to tangible goods, services, intangibles and financing-related transactions.
Many countries have introduced TP regulations because governments are concerned that they can be artificially set to reduce taxable profits and the amount of corporate tax that would be due.
These rules require transfer prices to be set at “arm’s length”, i.e. prices would be determined by independent companies.
TP is also kept at arm’s length for regulatory and reporting purposes, and as a matter of good corporate governance. For example, for businesses involved in M&A activity, TP is a critical part of the due diligence.
Individual countries have typically introduced their own domestic TP legislation. In the Middle East, several countries have TP rules or provisions in their laws, including Egypt, Saudi Arabia and Qatar.
And because numerous countries around the world have some form of TP rules, Middle Eastern businesses engaging in transactions with foreign-related parties are also affected.
VAT and TP interactions arise where related-party transactions constitute “taxable supplies” on which VAT is levied. The absolute amount of VAT due depends on the value of the taxable supplies.
The price charged for the transaction affects the level of taxable profits, so the amount of VAT and corporate tax due depends on the transaction value.
Where transactions are between related parties, the tax authority may be able to substitute market value for transaction value for the purposes of calculating VAT liability, if the pricing of the transaction is not arm’s length.
Rules for this sort of anti-avoidance provision of tax often feature in VAT legislation, which is yet to be published for the GCC.
As the value of supplies for VAT purposes generally depends on the transaction value, any changes to the transaction value may have VAT consequences.
To manage the interaction between TP and VAT, businesses that are preparing for the introduction of VAT should consider TP at certain critical points of their implementation strategy.