The Economist – eRutledge | Arabian Gulf Economics

Oasis for the tax-averse

First published in:

The Economist. (2018, September 27). Sweet deserts. The Economist, 428(9111), 58.
https://www.economist.com/international/2018/09/27/how-the-united-arab-emirates-became-an-oasis-for-tax-evaders

An oasis for the tax-averse beckons in the Middle East

THE war on cross-border tax evasion, declared by America over a decade ago and since joined by other governments, has made life a lot more uncomfortable for anyone looking to squirrel away undeclared income. More than 100 countries have signed up to the Common Reporting Standard (CRS), which requires them to swap information on account-holders that may be relevant for tax purposes. But the enterprising and tax-shy can still exploit loopholes in the system. A popular one is to procure residence in the United Arab Emirates (UAE), set up a company there and use the tax residence that comes with it to block the flow of information to tax authorities elsewhere.

According to experts with knowledge of the scheme, it works as follows. A foreigner sets up a company in one of the UAE’s free-trade zones and rents office space. In return he gets a residence visa with a minimum-stay requirement of just one day every six months. Both the individual and the company, through which he may hold bank accounts, may then claim tax residence in the UAE, a country that levies no income tax.

Under the CRD, banks must share information with the country where an account-holder is tax-resident. If the account holder is an entity, then the bank must look through it to the “controlling person” and report on that individual. In the UAE, since both the individual and the company have local tax residence, neither need fear having any information passed on to other countries, regardless of whether their money is held in a bank account, a trust or an investment fund. And, of course, there is no local tax to pay.

No other haven works quite like this. Others, even Caribbean islands which have held out against the CRS, say foreign-owned enterprises and the people who control them cannot be tax-resident there. Under CRS rules, the firms are deemed to be resident where they are managed from. In the UAE, however, foreign-owned entities are permitted to be tax-resident, even though the owner would normally be tax-resident elsewhere.

The UAE’s documentation system also makes it easier for people to avoid tax inspectors. When dealing with banks, clients need to produce a Tax Identification Number (tin). This number is particularly important for any company that holds an account because it serves as an identifier for tax-information exchange between governments. Since the UAE levies no income tax, it does not issue tins. Instead, the experts say, it hands out registration numbers for value-added tax, which it does levy. Clients then try to pass these off as genuine tins to bolster the claim that they are tax-resident in the UAE. The ruse appears to be working. Whether because they cannot tell the difference or are turning a blind eye, many banks in other countries, when presented with the VAT-linked substitute tins, accept that the client’s tax affairs are a matter for the UAE and therefore do not pass information on to other countries.

Compared with most offshore tax-minimising schemes, this one is cheap. In the UAE, companies can be formed, office space rented and residence acquired for “the price of a decent suit and pair of shoes”, says an adviser. Unlike in most other countries that sell residence rights, a donation or property investment in the hundreds of thousands or millions of dollars is not a prerequisite for a visa.

The country’s first free-trade zone was established in the mid-1980s. It now has more than 40, with tens, perhaps hundreds, of thousands of companies between them. Ras al-Khaimah, one of the country’s seven emirates, has over 14,000. The number of UAE firms being used as vehicles to dodge tax is impossible to determine. “Judging by the talk among tax and wealth advisers, it’s many thousands,” says a tax expert.

The Organisation for Economic Co-operation and Development (OECD), which oversees the CRS, is worried about the tax-dodging possibilities of residence-for-sale schemes. Pascal Saint-Amans, head of the OECD’s tax group, says the UAE is a concern and argues that the country has not been “proactive” in curbing abuse. The UAE finance ministry replies that it is “committed to implementing international economic standards to the highest levels of [tax] transparency” and is “actively working with the international community” on data exchange. Asked to comment, the Ras al-Khaimah free-trade zone did not reply.

The OECD will unveil some new policies this year, says Mr Saint-Amans. These could include making banks ask tougher questions of anyone claiming to be tax-resident in a haven. Banks could be required, for example, to run through a list of questions to establish where a client’s personal and economic links are strongest: where he spends most of his time, where his children go to school, where his doctor is and so forth. In cases where banks see evidence of discrepancy, they could be required to send account information to all countries with a possible claim on the client’s tax domicile. Until then, the Gulf state will remain a tax-dodgers’ oasis.

📕 “Running from taxation” →

Changes in the Kingdom

Blog Publications Reports

First published in:

The Economist (2017, November 9). The world should push the crown prince to reform Saudi Arabia, not wreck it. The Economist. https://www.economist.com/leaders/2017/11/09/the-world-should-push-the-crown-prince-to-reform-saudi-arabia-not-wreck-it

In a kingdom where change comes only slowly, if at all, the drama of recent days in Saudi Arabia is astounding. Scores of princes, ministers and officials have been arrested or sacked, mostly accused of corruption. Many of those arrested are being held in the splendour of the Ritz-Carlton hotel in Riyadh. About $800bn-worth of assets may have been frozen. At the same time a missile fired from Yemen was intercepted near Riyadh, prompting Saudi Arabia to accuse Iran of an “act of war”.

Upheaval at home and threats of war abroad make a worrying mix in a country that has, hitherto, held firm amid the violent breakdown of the Middle East. The world can ill afford instability in the biggest oil exporter, the largest Arab economy and the home of Islam’s two holiest sites.

At the centre of the whirlwind stands the impetuous crown prince, Muhammad bin Salman, son of the aged King Salman. The prince has staged a palace coup—or perhaps a counter-coup against opponents seeking to block his sweeping changes (see article). Either way, at the age of just 32, he has become the most powerful man in Saudi Arabia since King Abdel-Aziz bin Saud, who founded the state. All this may be the precursor to profound reforms that the country needs. The danger is that it will just lead to another failed one-man Arab dictatorship.

Casting himself as a champion of the young, Prince Muhammad (known as MBS) understands that his country must reinvent itself to deal with the end of the oil boom, a burgeoning and indolent population, and a puritanical Wahhabi religious ideology that has been a Petri dish for jihadism. He has set out ambitious plans to harness private firms to reform the state and wean the country off oil. He has also eased some social strictures, promising to end the ban on women drivers and restraining the religious police. He speaks of returning to a “moderate Islam open to the world and all religions”.

All this is welcome. But the way the prince is going about enacting change is worrying. One reason is that his ambition too often turns to rashness. He led an Arab coalition into an unwinnable war in Yemen against the Houthis, a Shia militia, creating a humanitarian disaster. He has also sought to isolate Qatar, a gas-rich neighbour, succeeding only in wrecking the Gulf Co-operation Council and pushing Qatar towards Iran. With fewer constraints, he could become still more reckless. He is rattling the sabre at Iran over the war in Yemen, and may be challenging it in Lebanon. During a visit to Riyadh, the Saudi-backed Lebanese prime minister, Saad Hariri, announced that he would step down, and denounced interference by Iran and its client militia, Hizbullah (see article). What precisely the Saudis intend to do in Lebanon is unclear. But many worry about a return to violence in a country scarred by civil war and conflicts between Hizbullah and Israel.

Another concern is the economy. Prince Muhammad’s plan for transformation relies in part on luring foreign investors. But they will be reluctant to commit much money when someone like Alwaleed bin Talal, a prince and global investor, can be arrested on the crown prince’s say-so (see article). Last month Prince Muhammad made a pitch to foreign investors for a new high-tech city filled with robots, NEOM. The glitzy event took place in the same hotel complex that is now a prison.

A third cause for disquiet is the stability of the monarchy. Saudi rule has hitherto rested on three pillars: consensus and a balance of power across the sprawling royal family; the blessing of Wahhabi clerics; and a cradle-to-grave system of benefits for citizens. Prince Muhammad is weakening all three by concentrating power in his own hands, pushing for social freedoms, and imposing austerity and privatisation.

Much of this had to change. He could seek new legitimacy by moving towards greater debate and consultation. Instead, space for dissent is disappearing and executions are rising. The anti-corruption campaign is being carried out with little or no due process to determine who is guilty of what. Many ordinary Saudis are cheering for now. But the arrests look like Xi Jinping’s purges in China, not the rule of law. As he meets resistance and his base narrows, the crown prince may rely increasingly on the security apparatus to silence critics. That would only repeat the mistakes of republican Arab strongmen: socially quite liberal, but repressive and ultimately a failure.

Many have predicted the fall of the House of Saud, only to be proved wrong. The most likely alternative to its rule, flawed as it is, is not democracy but chaos. The country would fragment and, in the scramble for its riches, Iran would extend its power, jihadists would gain a new lease of life and foreign powers would feel compelled to intervene.

The world must fervently hope that Prince Muhammad’s good reforms succeed, while urging restraint on his bad impulses. President Donald Trump is wrong to cheer the purge on. The West should instead counsel the prince to act with caution, avoid escalation with Iran and free political life at home. Prince Muhammad may be heeding the dictum of Niccolò Machiavelli that it is better for a prince to be feared than loved. But this advice comes with a rider: he should not be hated.

Economic reform required

Blog Publications Reports

First published in:

The Economist (2016). Time to sheikh it up. The Economist, 420(9006), 11–12. https://www.economist.com/leaders/2016/09/08/time-to-sheikh-it-up

If Gulf citizens are to keep enjoying rich-world standards of living, they will increasingly have to find productive work in the private sector; this means overhauling labour markets that keep too many of the region’s citizens idle

THE people of Saudi Arabia have for decades enjoyed the munificence of their royal family: no taxes; free education and health care; subsidised water, electricity and fuel; undemanding jobs in the civil service; scholarships to study abroad; and much more. This easy life has been sustained by gushers of petrodollars and an army of foreign workers. The only thing asked of subjects is public observance of Islamic strictures and acquiescence in the absolute power of the sprawling Al Saud dynasty.

Similar arrangements hold in the other countries of the Gulf Co-operation Council (GCC), a six-member club of oil monarchies. But these compacts are breaking down. The price of oil has fallen sharply since 2014, and the number of young Gulf citizens entering the job market is growing fast. The maliks and emirs can no longer afford huge giveaways, or to pay ever more subjects to snooze in air-conditioned government offices. The monarchs know it. They say they are seeking to diversify their economies away from oil rents; they are also whittling away generous subsidies and plan a new value-added tax across the GCC.

But reforms have to go further. If Gulf citizens are to keep enjoying rich-world standards of living, they will increasingly have to find productive work in the private sector. That means overhauling labour markets that keep too many of the region’s citizens idle.

The pampering of Gulf citizens has made them expensive for firms to hire (see “Labour laws in the Gulf: From oil to toil”). By contrast, the third-class legal status of many migrant workers makes them extra-cheap (see “Migration in the Gulf: Open doors but different laws”) and puts them at the mercy of their employers. Given the choice between a hardworking foreigner and a costly local, private firms have long preferred the foreigner.

In response Gulf governments have imposed ever more stringent quotas on foreign companies to employ locals, especially in desirable white-dishdasha jobs. In Bahrain 50% of workers in banks must be Bahrainis; but only 5% of those in construction need be. (It’s awfully hot on building sites.) Quotas reduce the incentive for Gulf citizens to do a job well: why bother, when your employer has little choice but to keep you on? Firms often regard hiring locals as a sort of tax. Some pay them to stay at home.

The best policy would be to phase out quotas entirely, while also slimming the bureaucracy and making it clear that civil-service jobs are no longer a birthright. In Saudi Arabia two-thirds of citizens are employed by the state. Public-sector wages account for 12% of GDP in the Gulf and Algeria, compared with an average of 5% across emerging economies.

The way migrant labourers are treated needs to change, too. Gulf states deserve credit for letting in far more immigrants than almost all Western countries, relative to their populations. (In many cases, foreigners outnumber locals.) Migrants gain from earning far higher wages than they could back in India or Pakistan. But the coercive parts of the kafala system of sponsoring foreign workers should be dismantled. Migrant workers should not need their employers’ permission to leave the country. After a while, they should be allowed to switch jobs. Contracts should be clear and enforced by local courts. Long-term foreign workers should be able to earn permanent residence; ultimately those who wish to should have the opportunity to become citizens.

These reforms–less pampering for locals and more rights for migrants–would reshape the labour market. More locals would have to do real work. Migrants would be better treated, though inevitably fewer would be hired. Some new ideas are being tested. Bahrain is allowing firms to ignore quotas by paying a fee for each foreign worker they employ. As part of its ambitious economic agenda, Saudi Arabia is talking of issuing green cards to some migrants.

A new social contract
At a time of bloody turmoil across the Arab world, many royals fear undoing the social compact that has kept them in power. But cheap oil makes change unavoidable; doing nothing merely postpones the reckoning. Economic transformation should nudge Gulf states towards political reform. Perhaps, as their citizens are asked to do more to earn their living, they will demand that rulers do more to earn their consent.