UAE corporate tax: Implications of Pillar 2 rules for businesses

Today we are going to look at the third rate of corporate tax. You may be wondering, "three rates?" The more astute of you will quickly count two. The first tier consists of a zero per cent rate on the first $100,000 of taxable income, while a 9 per cent tax rate is applied to all profits exceeding that amount.

Just announced is the Pillar 2 compliant rate – 15 per cent. But what exactly is Pillar 2? It represents an ongoing international response to address the issue of large corporations leveraging their multijurisdictional locations and extensive knowledge to reduce their overall tax burden.

The acronym BEPS (base erosion and profit shifting) encompasses the various strategies employed to achieve this goal.

It is much simpler to unpick or slide through gaps in a complex system. By their nature they are prone to loopholes, arbitrage and uncertain or conflicting interpretations. Nations signing up to supranational treaties with bodies and organisations merely add to an ever-expanding collection of intricate texts.

Isn't it intriguing that instead of encouraging countries to simplify their tax codes, more layers of legislation are being added? Those of us who are passionate about tax policy find this trend truly fascinating.

The Organisation for Economic Co-operation and Development (OECD) has taken a lead in creating a level tax playing field for all countries. In 2021, it achieved agreement among almost two thirds of all countries to sign up to a core set of underlying rules.

These countries form the material monetary amalgam of the global economy. Over time the other nations can be encouraged to join this initiative.

Does this stop the race to become the most tax competitive environment and the first choice for domiciling profits? Sadly, it will not. That game of nations can in the long run deliver only sub-optimal societies, as non-commercial government support disappears due to a lack of funding.

While the two world wars were convincing enough to set aside armed conflict as a way of moving up the global rankings, a new field emerged in its place: geoeconomics. This refers to governments using their economic power, through financial and trade relationships, to achieve geopolitical and economic objectives.

While two branches of academia never lost focus on increasing our understanding of the field, these being international relations and political science, economics never embraced it. This was primarily because of a lack of theoretical frameworks to analyse data sets.

The recent return to a multipolar world has brought about a positive re-engagement, particularly in the economic realm where game theory has provided a framework for understanding state-level actions through iterative processes and algorithmic thinking.

Variations on a theme are how governments are going to flex their way around Pillar 2. If there were only one type of tax, my peers and I would have a lot less to do.

While VAT is technically a levy rather than a tax, it is still a cost of doing business and affects customer purchasing decisions. The UAE sensibly has only two chargeable rates, zero per cent and 5 per cent. India has 12, some of these being more rarely applied. The UK has only three, but its standard rate is four times than that of the UAE.

Taking the bureaucratic complexity and cost that having a dozen rates will cause, or between two countries whose standard rates are diametrically positioned, where would you logically prefer to do business? Keep in mind that the UK rate is only marginally higher than the international average.

Next comes mandatory employer payments for each employee. In Ireland this is called pay-related social insurance. There are two rates, 8.9 per cent on weekly earnings up to circa Dh2,000 ($544) and 11.15 per cent on the same above that value.

The closest equivalent in the UAE is the end-of-service payment. The difference is that in the UAE, the amount is payable only when the employee leaves the business. Also, the net cost is lower here.

So the UAE holds a cash movement advantage as well as a lower cost to a business. However, there is a contingent risk because there is no legal requirement to set aside funding for end-of-service payments. This can lead to settlement difficulties if a significant number of employees with high salaries depart simultaneously.

The UAE has been looking for some years at replacing the end-of-service system with a more sophisticated pension system. This would be a welcome innovation for businesses and individuals.

However, an incoming e-invoicing regime and the early days of corporate tax make it unlikely to occur any time soon.

As I have highlighted here, Pillar 2 may only shift the issue the OECD is trying to resolve. In the end, nations are better served when businesses achieve profits from delivering on their customers' consumption requirements, rather than their government’s bureaucratic frameworks, either home-grown or internationally sourced.