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Kuwait: New tax law for foreign firms seen boosting FDIs

Kuwait : In its latest economic brief, National Bank of Kuwait (NBK) reports that, a much-awaited amendment to Kuwait's tax regulations affecting foreign companies doing business in Kuwait finally became law after it was published in the official Gazette on Feb 3, 2008. The most important feature of the amendment is the replacement of the old progressive tax rate structure which saw companies charged between 5 percent and 55 percent on earnings above KD 5,250 Ñ with a flat rate tax of 15 percent. (See table)

The amendment also states that profit earned by foreign companies from trading in Kuwaiti shares, whether directly or through investment portfolios or funds, is not to be taxed, and excludes from taxation the profits of Kuwaiti agents earned on trading foreign goods for their own account. Neither the old tax law nor the new amendment subjects foreign individuals to income taxes. Only foreign body corporates with an independent juristic personality are subject to taxation.

Table:
Old and New Corporate Income Tax Rates
Tax bracket (KD) Old tax rate (%) New tax rate (%)
0-5,250 Nil 15
5,251-18,750 5 15
18,751-37,500 10 15
37,501-56,250 15 15
56,251-75,000 20 15
75,001-112,500 25 15
112,501-150,000 30 15
150,001-225,000 35 15
225,001-300,000 40 15
300,001-375,000 45 15
375,001-and above 55 15

N.B. Under the old system, the relevant tax rate was applied to the entire taxable profit.

Source: Al-Kuwait Al-Youm/NBK.

The ruling also makes more specific provisions as to the types of income which are subject to taxation and the allowable deductions, which used to be a source of uncertainty and inconsistent treatment in the past. It also establishes a limit to the number of years that losses can be carried forward, as well as defining for the first time a five year statute of limitations on tax claims.

The National Assembly approved the amendment on Dec 26, 2007, stipulating that the new tax rules shall go into effect at the start of the tax period to follow the law's publication in the official gazette.

The law provides for a period of six months for the Ministry of Finance to issue the implementing regulations, and as such, any new regulations will become effective only once they are issued.

NBK noted that these changes are welcome as the heavy tax imposed on foreign companies (although inconsistently applied) was seen to hinder the flow of foreign investment into the country. The value of foreign direct investment (FDI) into Kuwait has been pitiful in recent years, reaching just $110 million in 2006 Ñ which is by far the lowest in the Gulf region and far smaller, for example, than the $8.3 billion attracted by the United Arab Emirates or even the $2.9 billion attracted by Bahrain. As the chart shows, Kuwait accounted for just 0.3 percent of all FDI inflows into the region in 2006, which is way below its 14 percent share of regional GDP. A dramatic improvement in the investment climate will need to be seen if the government is to achieve its vision of establishing Kuwait as a regional trade and financial hub. The tax amendment is seen as a step in that direction.

Tax incidence and allowances
According to NBK, the tax is imposed on all foreign companies, that is, companies incorporated outside the State of Kuwait other than GCC companies that are wholly-owned by GCC nationals. (GCC companies with foreign ownership would be subject to taxation to the extent of the foreign ownership.) The tax does not apply to foreign individuals or to Kuwaiti companies with non-Kuwaiti partners or shareholders, unless those shareholders or partners are foreign companies, in which case the tax is imposed on the foreign company's share of the earnings.

Besides changing the tax rate structure, the new law adds some much needed clarity as to what income is to be taxed. Earnings from any of the following activities are subject to the tax:

1. Profits realized on any contract that is partially or fully executed in the State of Kuwait

2. Amounts received from the sale of, leasing, or from granting a franchise to use or utilize any trademark, patent or copyright

3. Commissions from commercial representation or intermediary agreements

4. Commercial or industrial activities

5. Profits realized from sale of assets

6. Trading in property or goods, or the rights to them, and the establishment of a permanent office in Kuwait to undertake such activities

7. Rental of property

8. Service provision

Expenses associated with the income to be taxed may be deducted as follows:

1. Wages, salaries and end of service indemnity

2. Other taxes and fees

3. Depreciation, subject to the specifications of the implementing regulations

4. Donations to Kuwaiti charities, subject to limitations specified in the implementing regulations

5. Head office expenses in accordance with the specifications of the implementing regulations

The law also imposes a limit on a company's ability to carry losses forward which are hereby limited to three years. Under the previous tax law, companies were able to carry losses forward for an unlimited period of time.

The law also clarifies that the profits of Kuwaiti commercial agents is not subject to taxation under the law and that only commissions paid to foreign companies as a result of an agency agreement are subject to tax. A Kuwaiti commercial agent's earnings are not taxed so long as the profits arise from the sale of goods for the agent's own account.

Impact on business and the economy
According to NBK, while the new tax rate reduces the tax liability of most companies, those with earnings below KD 37,500 will actually have a higher tax bill as the low tax brackets with 5 percent and 10 percent rates are done away with and replaced with the 15 percent flat rate. Although this may represent a problem for smaller investors, it is unlikely to have too serious an impact on the broader industrial landscape, for two reasons. Firstly, much of the foreign investment that Kuwait seems likely to attract is in the energy, petrochemical and tourism sectors. These types of large-scale commitments are unlikely to be affected by the slightly higher tax rates applicable in the lower tax bands.

Secondly, for those investors that might be affected, the tax environment will at least be smoother and more predictable. Under the old system, a rise in earnings that caused a firm's profits to move into a higher tax band would see the entire earnings being taxed at the new, higher rate Ñ resulting in effective marginal tax rates well in excess of 100 percent. For some companies, this represented a substantial disincentive to invest. The new flat rate tax, on the other hand, removes these distortions and offers a more straightforward basis for investment decisions.

Overall, NBK reports that the amending law is expected to promote foreign investment by reducing the tax liability in most cases. It is also expected to simplify matters for foreign companies by reducing disagreements which have arisen in the past as to what is or is not subject to tax by clarifying in more detail the types of income which are covered by the law. Importantly, the law's provision that income from trading in Kuwaiti shares is not subject to taxation will promote investment in Kuwaiti shares by international funds and companies, something that will indeed be welcomed by international fund managers.

Nevertheless, although helpful, the change is unlikely to inspire a wholesale improvement in the volume of foreign investment entering Kuwait. The local industrial landscape remains very narrow and there are plenty of non-tax barriers to foreign investment that still need to be addressed, from restrictive Labor regulations and limited access to land to slow progress in privatization and burdensome government bureaucracy. Moreover, even if the conditions are right, the government would still need to make a major effort to promote Kuwait as an investment destination. Even then it would still face major hurdles with international firms that have already established their regional corporate bases in neighboring Gulf countries, who would need much greater incentives to be persuaded to move.

It is also worth noting that there will still be a degree of ambiguity relating to the application of corporate income tax. As per the original foreign direct investment law, the Council of Ministers has discretionary powers to exempt foreign investors from income tax for a period of up to ten years from the start of the business enterprise. Furthermore, the explanatory note to the new rules acknowledges that the latest amendment is a temporary measure until a new comprehensive tax law can be issued.

Impact on budget revenues

In financial terms, NBK states that the tax change is likely to be of little significance to the government. Revenues from corporate income tax Ñ at KD 49 million in 2006/07 Ñ were worth just 5 percent of non-oil government revenues for the year and a miniscule 0.3 percent of budget revenues as a whole.

Moreover, to the extent that new companies are attracted to Kuwait as a result of the change, the immediate impact on corporate tax revenues is likely to be limited by the fact that large, capital-intensive projects are likely to run losses in the short-term, while many companies already operating in Kuwait are likely to see a reduction in their tax bills. Nevertheless, even if the net impact on the government's fiscal balance is small, the change represents a positive move in reforming the tax structure in a business-friendly manner.

© Arab Times 2008