Long term tax rate declines halted in Europe and Latin America With Many governments making active moves to boost indirect taxes

Saudi Arabia - An urgent need for more revenue is pushing many governments into active moves to increase the tax take from indirect taxes, and a worldwide broadening of the tax base for corporate income taxes, KPMG International’s latest annual survey of tax rates affecting business has found.

Figures from KPMG’s 2009 Corporate and Indirect Tax Rate Survey showed that the long term slide in tax rates applied to company profits in Europe and Latin America has come to a halt in 2009.

But while this may be a pause before competitive pressures continue to drive corporate tax rates lower, there are some clear signs that any further cuts are likely to be paid for by widespread restrictions on tax allowances and tighter enforcement.

The survey shows that in Latin America, the average corporate tax rate this year was unchanged at 26.9 percent, the first time there has been no cut in rates since 2004.

In Europe, average rates stayed at 23.2 percent, the first time in 13 years that they have failed to fall year-on-year.

Only in the Asia Pacific region has the average rate this year matched the cuts of previous years, falling from 28.4 percent in 2008 to 27.5 percent in 2009.

Looking at indirect taxes, mainly Value Added Tax (VAT) or Goods and Services Tax (GST), rates in Europe have risen from 19.5 percent to 19.8 percent and in Latin America 15.9 percent to 16.2 percent.

Among the Asia-Pacific countries there was a marginal drop in indirect tax rate from 10.9 percent to 10.8 percent.

“Indirect taxes are generally very stable.” said Muhammad Saloojee, KPMG in Saudi Arabia’s head of Tax & Zakat. “Up until this year, taxes on corporate profits have tended to decline each year while indirect taxes have stayed roughly the same. So for the past five or six years, revenues from indirect taxes have quietly been contributing a larger and larger part of many government incomes.

“But now we are seeing more active moves in this direction. The number of countries with indirect tax systems is now over 150 and rising annually. Those governments that already have these systems are widening the range of services that attract VAT. Rates in Asia-Pacific are expected to rise as their systems develop and mature, and increases already planned are likely to take the average in the European Union up to 20 percent next year.

“All this is clear evidence of a major long term change in the way that many governments are funded. For companies, it means that the management of indirect taxes will become much more important.”

Turning to taxes on profits, many countries have used them as a competitive tool to attract corporate investment. But the urgent need for tax revenues to plug holes in public budgets around the world, as a result of the global recession, seems to have forced a subtle change in this policy.

This year, many governments have acted to widen and strengthen their tax bases by measures including:

restricting the circumstances under which companies can use losses to reduce taxable profits, taking a more aggressive approach to enforcing transfer pricing rules,
reducing the tax deductibility of interest payments.

At the same time, there has been a significant increase in international co-operation among tax authorities, especially on action against tax havens and exchange of information. It remains to be seen whether that co-operation is converted into pressure on those countries with the lowest rates to move closer to the average.

“It is likely that headline corporate tax rates will resume their fall in time, but companies are likely to find themselves paying for the reduced rate in other ways,” said Muhammad Saloojee, Head of Tax at KPMG Saudi Arabia. Overall effective tax rates for global companies may well rise, due to the broadening of the tax base.

Whist the Middle East, and in particular Saudi Arabia, did not from part of the survey, there are a few interesting observations. Saudi Arabia’s corporate tax rate (which essentially applies to non-residents) has remained fixed at 20% since the New Tax Law came into effect during 2004. With an additional 5% withholding tax on dividends/distributions, Saudi Arabia’s effective tax rate is 24% on corporate profits. There is no VAT or other similar forms of indirect tax, although the introduction of VAT in Saudi, like in other GCC Countries, is on the cards, and if introduced, will increase Saudi’s tax base.

“In conclusion, Saloojee states that might also be seeing the beginnings of renewed discussion on worldwide rather than territorial taxation. If that occurs, then the financial crisis will truly have triggered a revolution in the way companies are taxed as well as altering the dynamics of tax competition.”