A foreign investor’s tax guide to the CIVETs

Before 2009, if someone mentioned the word CIVET, it may well have conjured an image of the small cat-like mammal which resides in the tropical forests of Asia and Africa. And for many people, this may still be the case.

Yet if you say BRICS to anyone in international business, they probably know you are not talking about the building blocks of a house, and that term did not exist until a decade ago.

Colombia, Indonesia, Vietnam, Egypt and Turkey are now being touted as the second wave of emerging economies, set to become the most investable jurisdictions for multinationals. And if their economies replicate the BRICS' astronomic growth, the term CIVETs will no doubt also become synonymous with the world of international investment in the decade ahead.

The constituent countries were selected by economists because they supposedly share common ingredients for such rapid growth: a relatively young, fast-growing population; diverse economies; improving infrastructures; reasonably sophisticated financial systems and controlled inflation.

But multinational groups have other factors to consider before they decide to invest and expand into these territories, and tax features high on that list.

The tax regimes of the CIVET countries are all undergoing profound changes. Much of the tax reform is attempting to align legislation and practices with those of developed countries, which will be encouraging for potential investors. But inevitably, as with all developing countries, there is uncertainty in the CIVETs' tax environments, and multinationals will need to weigh these risks before they invest.

Over the past decade, as Colombia has tried to manoeuvre itself to become one of the most attractive emerging economies for foreign investors, its tax policy has followed an outward-looking approach.

Double tax treaties are in place with Canada, Chile, Mexico, Portugal, South Korea, Spain, Switzerland and the Andean community. Further treaties are being negotiated with Belgium, the Czech Republic, France, Germany, India, Japan, Netherlands and the US – all targeted at encouraging foreign investment.

Other notable developments in tax policy include: abolition of the branch remittance tax on profits distributed abroad; reduction of withholding tax on interest payments to non-residents derived from long term credits from 33% to 14%; and the implementation of an aggressive transfer pricing compliance programme by the tax authorities.

An overhaul of Colombia's tax code is expected soon, with the government announcing its intentions to simplify the tax system last year.

Ximena Zuluaga, of Ernst and Young, says while no official text of the tax bill is available, the government has announced its intention is to reduce the corporate income tax rate, amend the capital gains system and introduce thin capitalisation rules.

"This reform is expected to take place in fiscal year 2013, with other changes that would align the tax rules with the IFRS that will be gradually applicable in Colombia, starting 2014," says Zuluaga.

Carolina Rozo, of Prieto Carrizosa, says it is likely the government will also introduce rules to tax companies on indirect sales of assets, though no controlled foreign company regime is expected.

Colombia's increased participation in tax treaties and its reduced withholding tax rates are nods towards multinationals' desired investment criteria, but the fact these steps coincide with a more stringent approach from the authorities shows awareness that Colombia's economic stability and market size alone create a strong draw for investment. And similar to the BRICS countries, the Colombian government wants to ensure it extracts significant tax revenue from multinationals when they expand into the jurisdiction.

Rozo says the tax administration's interpretation of the law and audits have become stricter in an attempt to improve tax collection.

"However, to attract foreign investment, the Colombian government is considering establishing a holding companies regime and a special tax treatment on services rendered within Colombia and for abroad," says Rozo.

Although Colombia is not an OECD member (it recently applied to become one) its tax rules for income and capital mostly follow the OECD Model Convention and its transfer pricing regime is based on OECD guidelines.

Vicente Torres, of KPMG, says the Colombian government has also shown recent interest in negotiating advance pricing agreements (APAs).

"Evidence of this is Decree 1206 of 2012, in which it [the government] mentions its interest to optimise, streamline and simplify compliance for taxpayers subject to the transfer pricing regime, if they enter into an APA," says Torres.

Although Colombia has yet to execute an APA, Rozo says the tax authorities issued new regulations this month regarding the requirements taxpayers must fulfil to apply for APAs, with deadlines and substantial conditions having been made more flexible.

Indonesia has a vast tax treaty network with 59 bilateral treaties in force. Its corporate tax rate is 25% and the withholding rate on dividends paid to non-residents is 20%, though it is commonly reduced to 10% for treaty countries.

The jurisdiction also operates a tax holiday regime for entities with capital investments in certain sectors to try and attract more foreign business.

Tax incentives available are: exemption from corporate tax for five to 10 years; a two-year 50% reduction in corporate income tax after the tax holiday ends; and the possibility to extend the exemption or reduction period.

However, Firdaus Asikin, of Deloitte, says despite the tax holiday rules being more than two years old, very few companies have received the benefits because of a lack of understanding of the rules and uncertainty concerning who is actually entitled to the tax holiday.

A beneficial ownership test and non-tax treaty abuse test have also been introduced to help bring Indonesia into line with global standards for substance requirements in international tax structuring.

There are still ambiguities in Indonesia's tax regime, such as how particular tax code or international treaty clauses will be interpreted, which will cause concern for multinationals, but it seems the authorities are working to address this.

Asikin says the government has initiated a project aimed at harmonising contradicting tax rules, meaning potential investors can look forward to a clearer tax code in the next few years.

"The tax system itself is a bit complex to comply with as to a large extent taxes are collected through a withholding mechanism and not purely paid by the company itself in instalments during the year," says Asikin.

"The fact the Indonesian revenue authorities have actually started a project to clean up contradictions and to some extent clarifications in the tax act clearly demonstrate the willingness to make it easier to comply with the Indonesian tax act," he added.

Vietnam is perhaps the most dubious choice for inclusion in the CIVETs. Although it possesses a soaring young population and strong economic growth, it faces intense competition from other aspiring countries in Southeast Asia, which might just as easily have featured in the grouping.

A stable and attractive tax environment could be a key ingredient for Vietnam to establish itself as the best investment opportunity among its competitors.

On one hand, Vietnamese tax reform is very much geared to encourage foreign investment. The withholding tax rate on interest paid to non-residents was cut to 5% in March, while dividends paid to foreign entities are tax exempt.

Nam Nguyen, of KPMG, also points to attractive tax incentive schemes available to business sectors such as manufacturing and hi-tech businesses.

"For example, a manufacturing or hi-tech business may enjoy up to four years of tax holiday, 50% tax reduction for up to nine years, a reduced tax rate as low as 10% for 15 years or indefinitely, or 20% for 10 years, depending on the location and size of the business," says Nguyen.

These incentives are a clear effort to court new international investors since they are only available to newly established enterprises, and income derived from the expansion of an existing enterprise is generally not entitled to tax incentives.

Nguyen says the Vietnamese tax authorities are also engaging more with large taxpayers.

A special department for the management of large taxpayers was recently established by the national tax authority.

"The tax authority is also offering invitations to large taxpayers that wish to volunteer in entering into an APA with the tax authority on an experimental basis," says Nguyen.

Thomas McClelland, of Deloitte, says indications from policymakers also suggest the corporate tax rate will be cut from 25% to 20% in 2013.

Certainty in the tax legislation has improved significantly over the past few years but uncertainties arising from inconsistent interpretations of provisions remain. Also, the tax code continues to undergo considerable reform which creates difficulties for multinationals in planning operations in the jurisdiction.

Transfer pricing regulations were introduced in 2006, though Nguyen says it is only now that the authorities are really increasing their vigilance and aggression in this area.

New VAT regulations implemented in March impose VAT on interest paid to all entities apart from financial institutions, which will include interest on foreign loans.

And McClelland also says the government intends to introduce thin capitalisation rules, possibly in the new law on corporate income tax, which takes effect in 2013, though the likely debt to equity ratio is uncertain.

CIVETs are not to be confused with the Civet; a tropical forest-dwelling cat

In late 2009, when the term CIVET was first coined, Egypt had yet to undergo its revolution.

The political instability resulting from the Arab Spring has delayed the reform of Egypt's tax regime and introduced uncertainty regarding the direction it will take.

However, there were significant measures adopted before 2011, which aligned Egypt's tax code with global standards, and several tax advisers predict further positive steps will be taken in this respect, as the new government will be desperate to woo foreign investors to boost depleted public finances.

Egypt's income tax law number 91 of 2005 halved the corporate tax rate to 20% and introduced transfer pricing legislation and thin capitalisation rules.

Since 2005, the major tax policy developments have included: introduction of advance rulings from the tax authority for certain transactions; the introduction of an APA system; and a random sampling system for tax inspections.

Last year, the Supreme Council of the Armed Forces (SCAF) issued a law to raise the corporate tax rate to 25%.

Egypt has also substantially extended its tax treaty network and, despite not being an OECD member, such treaties are based on the OECD model and interpretation.

Multinationals will be encouraged by Egypt's implementation of policy measures aimed at providing greater certainty and taxpayer protection, such as advance rulings, APAs and the formation of a High Tax Council which secures taxpayers' rights.

Until recently, South Africa had been considered part of the CIVET group but it has subsequently been elevated to BRICS status in acknowledgement of its rapid economic development.

Morris Rozario, of Ernst & Young, says South Africa's tax modernisation strategy has played its part in this progression and could be replicated by Egypt.

"South Africa has based its strategy over the past decade on its compliance model of improving service quality, effective enforcement and increased taxpayer education. Effective use of technology is also explicit in South Africa's tax agenda, for instance in introducing e-filing," says Rozario.

"During recent years, the ministry of finance has focused on improving Egypt's tax laws with new legislation in line with similar laws in more advanced jurisdictions and we think Egypt is likely to adopt the South African approach in focusing on its human resources and technologies to make similar improvements.

"By adopting this approach, we expect the business and investment community's trust in the tax system and administration will increase and this, in turn, will have an impact in both foreign investment and the tax revenue," Rozario added.

The Turkish government has been actively encouraging foreign investment for the last 15 years and its tax policy reflects this.

The low corporate tax rate of 20%, foreign participation gains exemption on dividends and a favourable capital gains exemption regime all help to drive investment from multinationals.

Niyazi Comez, of Deloitte, says the new capital gains taxation regime eliminated the tax registration and associated tax return submission and bookkeeping requirements by introducing a final and simple withholding tax system.

"This provided international investors easy access to Turkish capital markets with a competitive tax advantage," says Comez.

Of the CIVET group of countries, Turkey is the only OECD member.

And Comez says Turkey's OECD membership should reassure multinationals and provide certainty when they analyse the tax regime for potential investment since reliable OECD data and research is more readily available than for non-OECD jurisdictions.

Turkey has also adopted OECD guidelines in relation to its new transfer pricing rules, which took effect in 2007.

Akin to other developed and emerging economies, the Turkish tax authorities are taking an aggressive stance on transfer pricing issues.

However, Comez says the tax authority is trying to develop its capability to meet complex APA requests.

"The biggest transfer pricing issue that creates uncertainty is the lack of a local database that can be used for transfer pricing studies and because the tax authority does not share its transfer pricing database with the public; it is not certain whether they have a reliable database yet," says Comez.

"Recent tax audits on transfer pricing issues suggest there is ambiguity over the tax courts and tax auditors accepting use of foreign transfer pricing databases in the absence of a local one," he added.

When he coined the term BRICS over a decade ago, even Goldman Sachs economist Jim O' Neill had not predicted the rate at which the emerging economies of Brazil, Russia, India, China and (South Africa) would grow, and the influence those countries would assert over global investment in such a short space of time.

It cannot be denied that each constituent of the CIVET group offers excellent opportunities to foreign investors.

And from a tax perspective, the common progression towards implementing APA systems, advance rulings, OECD-modelled legislation and competitive corporate tax rates will certainly be ticking boxes for multinationals looking for the right conditions to invest.