Paying the piper: An overview of the nation’s tax laws

A TRANSITIONAL PERIOD: The sudden and unprecedented collapse of former president Hosni Mubarak's regime plunged Egypt into a period of significant economic uncertainty. The lack of political clarity for a long time has severely affected business and consumer confidence, as well as having significant influence on the influx of foreign investment.

Whilst the economy had (prior to the revolution in January 2011) shown signs of recovery, it now seems likely that, in light of the prevailing global financial crisis, for the majority of Egypt’s commercial sector 2012 will be another “lost year” in terms of economic progress and business growth. Tourism remains badly affected, construction (and all associated supply industries) is operating well below optimum levels and structural issues in the oil and gas industry all contribute to these concerns. In addition, debt levels, reserves and deficits have worsened during 2011 and early 2012. Moreover, a significant threat to growth and currency likely exists unless some external funding is introduced into the economy.

However, the outlook may be less bleak. As Egypt has already managed to elect its first civilian president and power was handed over, we expect to see a positive impact on the economy and the investment climate by the third quarter of 2012.

TAXATION DEVELOPMENTS, 2011-12: In light of the prevailing uncertainty, with the ruling Supreme Council of the Armed Forces (SCAF) performing a mainly stewardship role rather than moving the economy in a definitive direction, there has been a shortage of any proactive fiscal reform in the last year.

In 2011, the now former finance minister, Samir Radwan, announced a draft budget and reasonably significant fiscal reforms for fiscal year 2012. The reforms proposed by Radwan included:

• The introduction of a new minimum wage;

• The increase in the headline rate for corporate income tax (to 25% for taxable profits in excess of LE10m, or $1.67m);

• Changes to the taxation of capital gains and potentially also to tax restructuring provisions set out in domestic law; and

• The creation of a new dividend withholding tax. The proposed reforms were widely greeted with both domestic and international opposition. Criticism related largely to the sudden nature of the announcement and short proposed lead time until proposed implementation dates.

In the face of the prevailing criticism, the SCAF finally refused to ratify the above proposals. Ultimately the most significant yet contentious reforms (the dividend withholding tax and the capital gains reform) were not implemented.

Certain of the proposed budgetary reforms did survive, however, such as the increase in the corporate income tax rate and proposals regarding the new minimum wage.

Overall, the only significant fiscal reforms in the 12 months from June 2011 to May 2012 can be summarised as follows:

• The introduction of 25% corporate income tax and salary tax rate for earnings in excess of LE10m ($1.67m), under Articles 49 and 8 (respectively) of Law 91 of 2005, as amended by Law 51 of 2011;

• Amnesty arrangements to reduce tax payable in consideration for early voluntary settlement of disputed taxes (as set out by Law 11 of 2012);

• The revision of credit and discount rates applied to over and underpaid tax liabilities; and

• The reform of the controversial clay tax law applied to the Egyptian cement industry (as announced in the Official Gazette in April 2012).

PREVIOUS EFFORTS: The previous proposed tax reforms which were making their way towards becoming law prior to the fall of Mubarak have since stalled. As of time of press there was no information on whether certain positive elements of proposed tax reform (such as the introduction of a European-style value-added tax system to replace Egypt’s current sales tax regime) would remain on the agenda of officials at the new Ministry of Finance.

It is certain, however, that the incoming Egyptian government will face significant challenges as it seeks to address the widening budget deficit, balance of payments problems and currency issues, while also looking to stimulate internal growth and attract a fresh influx of new investment.

Additional funding into the economy looks likely to come from a combination of international aid (such as a proposed IMF loan to Egypt) and lending and aid from other nations. However, in addition to this direct external funding, it is likely that an increase in the tax base will have to comprise an essential source of funds for any new government.

A number of parties strongly represented in the Egyptian parliament elected after Mubarak’s departure (including, significantly, the Muslim Brotherhood’s Freedom and Justice Party) proposed several policy aims meant to increase taxation revenue. Providing the necessary reforms to implement such policies will very likely increase both the scope and potentially the rate of taxes in Egypt.

CALLS FOR POTENTIAL TAX REFORM: A comprehensive reform of Egyptian tax law was previously undertaken in 2005 with the introduction of a new tax code (set out in Law 91 of 2005).

Law 91 (governing corporate and individual income tax, salary tax and withholding tax) was introduced as a step towards bringing Egyptian tax practices in line with internationally accepted taxation principles.

Domestically, Law 91 also aimed to rebuild confidence and trust between the taxpayer community and Egyptian authorities, with a general reduction in rates of taxation. This was meant to help gain wider compliance by taxpayers and ultimately help with increasing the national tax base.

The intention of the government was to create an economic stimulus by maximising after-tax profits for businesses and disposable income for individuals.

The new law has achieved many of its intended goals. It has increased the number of taxpayers and significantly boosted tax collection, despite having abolished almost all tax holidays and reduced tax rates. It has also significantly improved the investment environment by increasing clarity for investors on a number of points in many areas, like the application of double tax treaties and residency rules.

On the other hand, Law 91 has also attracted some criticism from taxpayers and the tax advisor community alike. The principal criticisms of the law relate to the relative simplicity of the provisions it contains.

When the 2005 law was enacted, all previous jurisprudence and precedent relating to income taxes, withholding taxes and payroll taxation were put aside. Subsequent to the new law’s issue there has been a relative shortage of newly concluded taxation rulings (in both Egypt’s courts and issued by Egypt’s tax authority) via which taxpayers can seek to interpret the application of the tax code and either apply or distinguish their commercial facts from those set out in rulings and judgments.

The combination of such shortcomings and the current economic difficulties faced by the country have led to calls for a further reform of Egypt’s core tax law to improve it and make it more relevant to the country’s current economic development stage.

AUTHORITY ACTIVITY ON THE RISE: Since the introduction of Law 91, Egyptian Tax Authority (ETA) inspections have been conducted mainly on a risk-based sampling approach (where either previous compliance issues, the type of industry/activity or the size of an entity may lead to a taxpayer being selected as part of the inspection sample).

From 2005 to 2012 it was not uncommon for a large proportion of Egyptian corporate taxpayers to have been subjected to very minimal (if any) tax inspections across the taxes to which they were subject.

Despite the fact that no official new direction with regard to its policies around tax inspections has been publicly announced by the ETA, most companies have been reporting a significant increase in tax authority inspection activity in 2012.

Since the first quarter of 2012, a large proportion of Egyptian tax-resident companies (and branches) have reported having been notified of the ETA’s intention to initiate tax inspections for all periods open to inspection across most (or all) taxes to which the companies are subject. In light of the economic difficulties facing the country, this is not a surprising policy shift by the authorities, but it does represent a very significant change in the manner and frequency of the ETA’s inspection strategies.

CORPORATE INCOME TAX: The current corporate income tax framework (as set out in Law 91 of 2005) comprises a self-assessment regime where the authorities select taxpayers for inspection using a risk-based sampling approach.

Corporations, branches and Egyptian permanent establishments of overseas companies are all taxed in the same manner (with the exception of oil and gas exploration activity, free zone companies and those entities still operating under legacy tax holiday or exemption arrangements). Domestic law sets out a clear definition of what constitutes a “permanent establishment” for Egyptian taxation purposes (as well as clearly stating the precedence of the definitions set out in the relevant double taxation conventions to which Egypt is party over domestic law).

A graduated rate of corporate income tax is applied to taxable profits (20% for profits up to LE10m, or $1.67m, and 25% for all taxable profits in excess).

Egyptian Accounting Standards (EAS) are set out as the formal basis for the calculation of taxable profits. It should be noted, however, that EAS are closely aligned with international standards with only a small number of minor deviations.

The domestic tax code features the Middle East’s most advanced transfer pricing regime. The arm’s length principle is embedded in the tax code and supplemented by detailed transfer pricing guidelines, which set out guidance around pricing methods, how to document a transfer pricing study and requirements around transfer pricing documentation.

There is a straightforward basis of taxation, with all types of income and gains realised by companies, branches and permanent establishments are treated as a single pool of taxable income.

Any capital gains realised on the disposal of Egyptian listed companies’ shares are specifically exempted from tax. However, gains realised on the disposal of non-listed Egyptian company shares by Egyptian-resident corporate shareholders are fully taxable as ordinary income. All gains realised on the disposal of Egyptian companies’ shares (both listed and unlisted) by non-Egyptian resident shareholders remain outside the scope of Egyptian taxation.

Dividend income received by Egyptian companies from their shareholdings in Egyptian tax resident companies is treated as exempt income for corporate income taxation purposes. A standalone (and explicit) taxation regime applies to oil and gas production activity, applying a 40.55% tax rate to profits. The Egyptian corporate income tax regime also sets out:

• Controlled foreign corporation provisions;

• Thin capitalisation requirements in relation to debt finance;

• An advance ruling mechanism;

• Accelerated depreciation allowances as a capital asset investment incentive; and

• Tax geared penalty and late payment interest provisions.

NON-DEDUCTIBLE EXPENDITURE: In order for expenses to be deductible for corporate income tax purposes they must be genuine business expenses of the company in question, properly invoiced and supported by any necessary documented contractual arrangements. Certain expenses are explicitly stated as non-deductible for corporate income tax purposes. Currently, these include:

• Excess interest in line with Egypt’s thin capitalisation restrictions;

• Interest on loans where the interest rate is more than two times the official interest rate announced by the Central Bank of Egypt each year;

• Amounts charged to provisions and reserves;

• Fines and penalties;

• Dividends paid to employees in line with Egyptian profit sharing regulations;

• Remuneration of corporate chairman and executive directors; and

• Income tax payable.

TAX LOSSES: Tax losses driven by trading losses, interest costs, foreign exchange losses, capital losses and other types of loss are treated (as in the case of income) as one single pool of tax loss and these aggregate losses are available to carry forward for a period of five years in which they may be offset against future profits. The tax losses of each financial year must be separately tracked in order to demonstrate clearly when such losses are available for offset and when their availability has lapsed.

Tax loss carry forward (in relation only to non-listed companies) can be restricted in the event of a change of ownership (broadly defined as a transfer of 50% or more of a company’s shares and/or voting rights), accompanied by a change in the principal activity of the company in question.

TAX DEPRECIATION: There is a mismatch between the accounting rates of depreciation applied by entities following EAS and those set out as tax deductible for Egyptian taxation purposes.

The resultant differences give rise to the need for corresponding deferred tax assets and liabilities to be recognised for financial reporting purposes. Two basic depreciation regimes currently exist for the purposes of taxation:

• Standard depreciation (as set out in Articles 25 & 26, Law 91 of 2005); and

• Accelerated depreciation (Article 27, Law 91).

STANDARD DEPRECIATION: Three classes of assets are governed by the standard depreciation regime and the rules applicable to each of three asset classes are as follows: Long-term asset: These long-term capital intensive assets are those with an extended useful economic life. Accordingly, depreciation is available on tangible long-term assets (which include, but are not limited to, the purchase, development and renovation of buildings, ships, aircraft and other similar assets) at a rate of 5% of cost per annum on a straight line basis.

Long-term intangible assets (which include the purchase, development, improvements to and renovation of any purchased intangible assets, including goodwill) are depreciated at a rate of 10% of cost per annum, also on a straight line basis.

Short-life asset: Recognising the need for regular replacement of such assets and their inherently short useful economic lives, depreciation on assets such as computers, information systems, software and data storage hardware is applied at a rate of 50% per annum on a reducing balance basis.

Other asset: Any assets which fall outside the above asset classes (not including land, antiquities, artistic works, jewellery and other assets determined to be non-depreciable in nature) are pooled together and depreciated at a rate of 25% per annum on a reducing balance basis.

ACCELERATED DEPRECIATION: In order to encourage capital investment, significant tax incentives are available for companies during the first period in which new (or purchased used) assets are brought into use for the first time.

These incentives are available for assets defined as “machines and equipment used for production” and the incentive is in the form of an additional 30% of cost deduction for tax depreciation in the year in which such assets are first employed.

This accelerated depreciation is applied by first deducting 30% to the cost of the asset and then applying the standard rate of depreciation (for “other assets”) of 25% to the net balance of the cost after deduction of the first-year accelerated allowance. The effect of this is that in the first year of use, such assets are depreciated by an effective 47.5% of cost.

TAXATION OF DIVIDENDS: Dividend income from an Egyptian source is exempt from tax for Egyptian taxation purposes. Foreign source dividend income is included in overall taxable income and is taxed at the normal rate of corporate income tax. Credit for overseas withholding tax suffered may be available.

Dividends paid by Egyptian companies to both domestic and overseas shareholders are currently not subject to withholding tax.

However, it should be noted that such a withholding tax was proposed in former finance minister Radwan’s 2011 budget. As such, this is an issue that may again be proposed and legislated.

CONTROLLED FOREIGN CORPORATION: For Egyptian tax purposes a controlled foreign corporation (CFC) is a non-resident company in which:

• An Egyptian company has a shareholding in excess of 10%;

• More than 70% of the non-resident company’s income is made up of “passive” income ( specifically defined as dividend, royalty, interest, management fee or rental income); and,

• The profits of the foreign company are either not subject to tax or subject to tax at a “low” rate (defined as being less than 75% of the equivalent Egyptian rate of tax that would be applied on such an income). Insofar as an Egyptian company has an investment in a company which satisfies the above criteria, the profits of the non-resident become taxable upon the Egyptian shareholder.

Taxation of such CFC income in the hands of the Egyptian company would be on a revenue recognition basis. This is to say the percentage of the non-resident’s income taxable in Egypt would be determined by applying the percentage shareholding of the Egyptian company to the non-resident’s net profit.

TAX TREATY NETWORK: Currently, Egypt has in excess of 50 concluded double taxation treaties in force. This has assisted the country in creating a relatively attractive framework via which foreign direct investment can flow into the country and via which returns can be expatriated.

The tax treaties in force generally create a system of reduced withholding tax rates applied to payments of royalties, interest and dividends being made from Egyptian tax residents to overseas counterparties.

However, the efficiency and transparency of the tax treaty network remains affected by a 2010 Ministerial Decree that related to payments of interest and royalties. This decree (No. 771) introduced the requirement for payments of interest and royalties to be subject to a full (20%) rate of withholding tax when made to an overseas resident, irrespective of whether relief via double tax treaty may potentially be available to reduce the rate of withholding tax applicable.

If treaty relief is available, the decree specifies that, subsequent to any payments having been made, the recipient of the interest/royalty income must then apply for a refund of tax “overpaid”. This decree was seen as unfavourable to cross border transactions by virtue of the fact that:

• Placing the treaty refund process obligation on a non-Egyptian resident company complicated the refund process; and

• To date, the ETA has not been able to expatiate processing such applications and issuing refunds of overpaid withholding tax; Calls have been made by business communities for there to be a revision of the decree.

TRANSFER PRICING: Egypt is currently the only jurisdiction in the Middle East and North Africa region which has both explicit transfer pricing provisions in its tax code and accompanying detailed transfer pricing guidelines setting out how such provisions should be applied in terms of:

• Determining what transactions should be subject to the arm’s length principle;

• Providing guidance as to suitable pricing methods;

• Setting out tax authority expectations in terms of what analysis ought to be carried out in order to: a) Help to determine the most appropriate pricing methodology; b)Illustrate analysis conducted in order to test the reliability of data used; and c) Arrive at the appropriate arm’s length price and put in place a review structure to ensure that any future variations in pricing method or underlying commercial structure is captured and that suitable adjustments are made. In practical terms the provisions and guidelines in Egypt dictate that taxpayers with transactions with affiliated parties must have analysed such transactions to determine whether they are carried out on arm’s length terms and document such an analysis.

To date, tax authority activity in terms of specific transfer pricing enquiries and inspection exercises remains somewhat limited.

However, pressure is being placed upon Egyptian companies from auditors and tax advisors to ensure that the above analysis has been undertaken in advance of accounts being signed off and/or tax returns being filed with the government.

One of the principal areas of uncertainty, however, in relation to the thorough application of Egypt’s transfer pricing guidelines, remains the lack of appropriate publicly available benchmark data against which Egyptian taxpayers might test their own pricing methodologies and assumptions.

To date the ETA has not confirmed what benchmarks it may accept and which it may reject as constituting suitable comparable data. In the absence of guidance, some taxpayers are conducting their studies utilising comparable data drawn from databases in a number of other geographic areas.

This remains as something that needs immediate attention from the tax administration in order for the transfer pricing regime to be rigorously and fairly applied for both taxpayers and tax authorities alike.

GROUP RESTRUCTURING: Certain corporate restructuring transactions are currently capable of being effected free from tax on capital gains resulting from the associated necessary revaluation of assets or liabilities (and disallowance also of any associated capital losses). The potential restructuring alternatives that are protected from tax include:

• Merger of two Egyptian-resident companies and demerger of a single company;

• Change of corporate form (such as from sole trader to company, partnership to company and limited liability to joint stock company);

• Acquisition (of more than 50%) of an Egyptian company via share for share exchange, which is to say regarding the consideration in the form of a new issue of shares in the acquirer; and

• Acquisition (of more than 50%) of an Egyptian company’s assets and liabilities in exchange for consideration made up of a new issue of shares by the acquiring company.

TAX ADMINISTRATION: The tax year is most commonly in line with a calendar year. However, any 12-month period is possible as long as this is explicitly set out in the company’s articles of association. Statues of limitation have generally been defined as five years. However, this period can be extended in the event of the commencement of inspection, as well as in cases of fraud or deliberate misstatement.

WITHHOLDING TAX: Egypt’s tax system sets out an extensive withholding regime applying to payments to both domestic and overseas counterparties. There are a number of distinctions, however, between the specifications for overseas and domestic payment.

Overseas payments: Payments to overseas recipients (where there is no double taxation treaty relief available) are subject to withholding tax of 20%. Such payments, under domestic law, include payments of:

• Interest;

• Royalties; and

• Services. Certain exemptions to the these basic rules are available as follows:

• Services that are in relation to transport or freight, shipping, insurance, training, conference/ exhibition participation costs, as well as most direct advertising/merchandising costs are usually not subject to withholding tax; and

• Interest in relation to loans with a term in excess of three years is not subject to withholding tax. The availability of double tax relief under a treaty between Egypt and the country in which the recipient is tax resident can often either mitigate (in the case of interest and royalties) or sometimes eliminate (in the case of services that may fall within the “Business Profits” article of the relevant treaty) withholding tax that may be due on payments made from Egypt to overseas recipients.

Withholding tax returns in relation to overseas payments must be filed (along with, of course, the associated payment of tax) the month following the date of the underlying payment being made.

DOMESTIC PAYMENTS: Egyptian tax residents must also routinely deduct withholding tax from payments made to local suppliers and service providers, as well as having withholding tax deducted from payments made by their own customers to them. Withholding tax is broadly applicable as follows:

• Purchase of goods at 0.5%;

• Supply of service at 2%;

• Construction at 0.5%;

• Professional services at 5%; and

• Commissions, discounts and gifts at 2-5%, depending upon the industry in which such items offered. Withholding tax returns in relation to domestic payments must be filed on a quarterly basis and should be filed (with the associated payment of tax being made) the month following the relevant quarter end.

INCOME TAXES: Salary tax is applied to employment, trading and professional income of Egyptian tax resident individuals. Salary tax on income is payable if the work to which the income relates is either undertaken in Egypt, irrespective of the source of payment, or undertaken overseas and paid from an Egyptian source. Income from trading and professional activity is only subject to Egyptian salary tax to the extent that such activities are undertaken in Egypt. For salary tax purposes tax residency is defined as either:

• Having permanent domicile in Egypt (defined as either being present in country in excess of 183 days in a year or having commercial premises in Egypt where business is conducted); or

• Being an Egyptian national working overseas and receiving payment from an Egyptian source. Salary tax is applied at progressive rates up to 25%, although this top bracket only applies to income in excess of LE10m ($1.67m) per annum. The first LE4000 ($670) is tax exempt and the following LE5000 ($837) is then taxed at 0%. In other words, actual tax is only payable on income over LE9000 ($1506) per annum.

In addition to salary tax, income in Egypt is also ( primarily only for Egyptian nationals) subject to social insurance contributions.

SALES TAX: The majority of transactions carried out in Egypt are subject to sales tax. This is applied at various rates which can be broadly summarised as follows:

• Supply of goods at 10-25%; and

• Supply of services at 5-15% There are extensive schedules in the sales tax law setting out a wide range of applicable rates to specific supplies. However, most goods and services are generally taxed at 10% The current sales tax system (which had been due for reform and to ultimately be replaced by a value-added tax system) does not usually permit the offset of input against output tax for services. As such, in its current form this tax often ends up constituting a cost to applicable businesses.

Sales tax registration is compulsory for businesses operating in service and manufacturing industries with turnover in excess of LE54,000 ($9038) per annum. Importers must register regardless of the amount of their level of turnover. Businesses registered for sales tax must file monthly sales tax returns.

STAMP TAX: Currently two types of stamp tax are set out in the Egyptian tax code. These are the “Ad Valorem” standard and the “In Kind” standard: Ad Valorem: This is applied upon the monetary value (at a rate of 0.04%) of dealings with banks (notably credit facilities and current accounts). This tax is also applied (at a rate of 15%) on the value of advertising costs, (at 20%) on trophies and (at 60%) on any winnings stemming from playing the lottery.

In Kind: This is a document tax and is charged on certain corporate documents. The tax is applied at a rate of LE0.30-0.90 ($0.05-0.15) per page of each such document. Furthermore, a state development levy of LE0.10 ($0.02) per page also applies to such items.

OBG would like to thank Deloitte for their contribution to THE REPORT Egypt 2012