In order to understand fully the position of foreign investment in Kuwait, i.e. the restrictions that surround the ability of foreign persons to engage in economic activities in the country, which in general are the insistence upon domestic participation, this is done either by demanding that a foreign enterprise carries on business in Kuwait through a national Kuwaiti agent349, or demanding a wider domestic participation i.e. requiring that 51% of the foreign enterprise carrying on trade in Kuwait is owned by Kuwaiti nationals350; there is a need to study other laws linked to the Income Tax Decree 3/1955 such as Company Law 15/1960 which restricts foreign participation to certain forms of enterprise and also restricts the percentage of a foreign shareholding in an enterprise351. There are also other technical restrictions to foreign investment in Kuwait such as limiting the ability to import goods to Kuwaiti nationals; all such restrictions will be discussed in more detail below.
i. Other Laws pertinent to the Income Tax Decree 3/1955
349
Article 24 Kuwaiti Commercial Law 68/1980.
350
Article 23 Kuwaiti Commercial Law 68/1980.
351
116 For a better understanding of the commercial activities which raise taxable foreign income under the Income Tax Decree 3/1955, and the restrictions which foreign investments face in Kuwait, there is a need to look at other laws involved i.e. The Kuwaiti Commercial Law 68/1980, Kuwaiti Company Law 15/1960, Kuwaiti Industrial Law 56/1996, the Kuwaiti Importation Law 43/1964, and Agency Law 36/1964.
1. Commercial Law 68/1980
All commercial activities in Kuwait are subject to the Commercial Law 68/1980, Article 23 provides:
“No person other than a Kuwaiti may carry out trade in Kuwait unless he has one or more Kuwaiti partners, provided that the capital investment by the Kuwaitis in the joint trading firm is no less than 51% of the total capital of the trading firm”.
In addition, Article 24 provides:
‘No foreign company may establish a branch thereof nor carry on trading activities in Kuwait except through a Kuwaiti agent’.
2. Industrial Law 56/1996 and Importa on Law 43/1964
Article 6 of the Industrial Law No. 56/1996 provides that only enterprises with a 51% Kuwaiti ownership may receive a licence or be registered under that law352, and Article 1 of the Importation Law No. 43/1964 stipulates that:
“A licence shall be necessary for the importation of all goods (except a small excluded group of goods). The right to import goods, material, and equipment however, shall be confined to the citizens of Kuwait, and Kuwaiti partnerships; if all the partners hold Kuwaiti nationalities, and joint stock and limited liability companies where Kuwaitis hold 51% or more of the total capital”.
352
117
3. The agency Law 36/1964 and Company Law 15/1960
In effect, therefore, foreign enterprises in Kuwait are restricted to carrying on trading activities in Kuwait in one of the following forms:
1. Activities carried out through an agency: a foreign enterprise may sell its goods in Kuwait through a local commercial agent. Here the Agency Law 36/1964, provides that only Kuwaiti citizens or Kuwaiti legal persons may act as commercial agents. Thus a foreign company can operate in Kuwait through a branch. This is subject to Commercial Law 68/1980 which states in Article 24 that a foreign branch must be established through a commercial agent who is a Kuwaiti national and the liability of the branch to Kuwaiti tax will depend on the scope of the agent’s activities and authority. The definition of agent, and what constitutes an agency relationship liable to corporate income tax in Kuwait is discussed in more detail below353.
2. Partnerships and joint ventures: the Kuwaiti Company Law of 15/1960 contains provisions permitting the formation of joint ventures in Kuwait. A joint venture does not have a separate legal personality, but takes the
353
118 form of a partnership contract between the joint venture parties354. In the case of an integrated joint venture between a Kuwaiti and a non-Kuwaiti entity tax is imposed on the non-Kuwaiti share of the profit355. However a set of financial statements covering the full operations of the joint venture is required to be submitted to the Department of Income Tax (DIT). For divided joint ventures (where each partner’s responsibilities and share of contract revenue is specified in a joint venture agreement)356 between Kuwaiti and foreign entities, only the foreign partner is required to submit a tax declaration and pay tax, and in this case the foreign partner’s status for tax is that of a branch of a foreign company357. See below358 for types of partnership i.e. General and limited partnership.
3. Participation in a Kuwaiti legal entity: There are three types of legal entities in Article 2 of the Company Law 15/1960 which are open to foreign participation all of which (with the exception of a joint venture) enjoy separate legal personality. The forms of legal entities which may be established under Company Law 15/1960 are:
a. Shareholding Companies:
354
Article 2 of the Kuwaiti Company Law 15/1960.
355
Circular No. 02 of 2005 provides that in the event of a partnership, a joint venture or any other form of enterprise where a foreign shareholding exists tax is imposed only on the foreign share of income. This is computed by taxing all the profits as if the entity is fully foreign owned, then compute 49% of the taxed profits in order to show the foreign share of the income.
356
See Ernst &Young (note 310 supra)
357 Id. 358
119 1. Public shareholding company: also called an open joint stock company, where the company’s shares are available for public subscription. Under Article 68 of the Company Law 15/1960, shareholding companies are generally restricted to Kuwaiti ownership, although the same Article allows as an “exceptional measure” of non-Kuwaiti participation if it is “necessary to invest foreign capital or use foreign expertise”. However a foreign share may not exceed 49% of the company’s share capital and in the case of banks and insurance companies the national share of the company must be no less than 60%. Any income attributable to the foreign shareholding is subject to corporate income tax359. When there’s a foreign shareholding the tax liability is computed by taxing all the profits as if the entity is fully foreign owned, then compute the foreign share which in this case is 40% (in most cases its 49%) of the taxed profits in order to show the foreign share of the profit.
2. Private Shareholding Company: also called a closed joint stock company, As opposed to the Public Shareholding Company, the shares of the Private Shareholding Company are not available for the public’s subscription. The maximum foreign ownership in this type of company is again 49%360. All income attributable to the foreign shareholder is subject to Kuwaiti income tax361. A Private Shareholding Company can be With Limited Liability362 (WLL), or With Unlimited Liability. In the former, the shareholder’s liability is limited to their share in the company. In the latter, shareholders
359
Gerald, J. (1991), Legal Aspects of Doing Business in Kuwait, Arab Law Quarterly, Vol. 6, No. 4, p. 325.
360
Article 23 of Commercial Law 68/1980. See also p. 111.
361
See pp. 110-111.
362
Holding shares in a WLL used to be restricted to natural persons until Article 195 of the Commercial Company Law 15/1960 was amended in 1995 to allow corporate shareholding in a WLL.
120 are all equally liable for all the company’s debt. In both cases, Kuwaiti nationals are required to hold 51% of the shares363.
b. Partnerships: Partnerships are treated similarly to Joint Ventures discussed above364. They are not popular in Kuwait, except with respect to certain small businesses where unlimited liability is not of primary concern. Foreign companies seldom use partnerships as a means to conduct or invest in business in Kuwait, since partners generally have unlimited liability. There are two types of partnerships in Kuwait:
1. General Partnership: in this partnership, partners “shall jointly be liable to the extent of all their property for all obligations of the partnership365”. A general partnership may include non-Kuwaitis. However 51% of the partnership must be owned by Kuwaiti nationals366.
2. Limited Partnership: in this partnership there are partners with limited liability367 who are liable to cover the partnership’s obligations (debts) to the amount of the share of the capital for which they own in the partnership. However such partners are not allowed to participate in the management of the partnership368. There are also general partners who are liable with all their property for all obligations of the
363
Article 23 of the Commercial Law 68/1980. Also in Kassim, A., Joint Venturing in Kuwait Company Law Explained, (1986), Arab Law Quarterly, Vol.1, No.4, pp. 432-435.
364
See p. 118.
365
Article 3 of chapter 1 of the Company Law 15/1960.
366
Article 23 of the Commercial Law 68/1980.
367
The Limited Partnership can also be a partnership limited by shares, also called “commandite partnerships by shares” in which the capital of the partnership is divided into shares.
368
121 partnership. Income tax is imposed on the foreign share of partnership income and Kuwaiti nationals must own at least 51% of the partnerships capital369.
The above discussion provides guidance on the meaning of tax, taxpayer and the definition of a body corporate liable to tax under the Income Tax Decree and shows the restrictions surrounding the carrying on of trade and business by foreign enterprises in Kuwait. In this section it has also been concluded that when a foreign entity carries on trade or business in Kuwait through a minority shareholding (usually 49%) in a national enterprise, a tax liability will only arise in regards to the foreign share of income. However, there is a need to identify the second method by which a foreign entity can carry on trade or business in Kuwait i.e. through a national agent; what is an agent under the Income Tax Decree? And when does an agency relationship cause a tax liability to arise under the Decree? This is what the forthcoming discussion provides.
ii. Article 2 of Income Tax Decree 3/1955 and the definitions of agent
Article 2 is another critical article in the Income Tax Decree 3/1955. Its importance lies in the definitions it provides for the terms used in the Decree, such as the definition ‘agent’. It also sets out incidents which raise tax liability, whether
369
122 they were commercial activities370 or an agency relationship between a foreign company and a national agent.
iii. The Agency Relationship between a Foreign Enterprise and a Kuwaiti =ational Agent
Article 2 (f) of the Income Tax Decree provides:
“...a body corporate carrying on trade or business in Kuwait either directly or through an agent provided such an agent is a body corporate, and also anybody corporate carrying on trade or business in Kuwait as an agent for others.”
It must be established here that a body corporate carrying on trade or business in Kuwait directly, when a foreign company owns 49% of the shares in a domestic company; this method of undertaking business in Kuwait by foreign businesses has been discussed above371. Understanding the meaning of the term ‘agent’ and the agency relationship that may exist between a Kuwaiti national and a foreign enterprise is important in terms of distinguishing between taxable and non-taxable corporate income. The Interpretive Notes at the end of the Income Tax Decree 1955define an agent as:
“a person authorised by a principal to enter into a binding contract with a third party on the principal’s behalf within the scope of that authority.”
The interpretative notes continue:
“Income derived by a foreign body corporate from carrying on trade or business in Kuwait through an “Agent” who is not himself a body corporate is not liable to tax under this Decree, provided that the “Agent’s” authority is in accordance with the terms of the definition given above.
The payment of commission or other remuneration will not of itself be deemed as constituting an “Agency” under the Decree. Similarly, in the case of a partnership
370
See p.114.
371
123 between a foreign body corporate and a person who is not a body corporate the latter will not necessarily be considered as the “Agent” of the former for the purposes of the decree unless he has full authority to enter into a binding contract on behalf of the partnership.
Income derived by a foreign body corporate from carrying on directly any trade or business in Kuwait will be liable to tax under this Decree notwithstanding the appointment of an “Agent” in Kuwait for the conduct of other business”372.
Taking the first part of the interpretative notes for the meaning of agent:
“Income derived by a foreign body corporate from carrying on trade or business in Kuwait through an “Agent” who is not himself a body corporate is not liable to tax under this Decree, provided that the “Agent’s” authority is in accordance with the terms of the definition given above373...”
When reading this definition with the definition provided in Article 2 (f)374 a confusion may stem from the wording; the statement that: “income derived from a foreign business through a national agent who is not himself a company i.e. a natural person will not be liable to tax Provided he has the authority” is unclear. The reason being, that the word ‘provided’ changes the meaning, using the word ‘provided’ here may lead to the interpretation that foreign enterprises deriving income from Kuwait through an agent, who is not himself a company, are not liable for tax. This is misleading because the tax law imposes income tax on a foreign enterprise whose income is derived through an agent. However, when the agent is not a body corporate, the Income Tax Decree 3/1955 does not tax the principal Unless this agent has authority to sign binding contracts with third parties on behalf of his principal.
Thus, instead of using the word ‘provided’, the legislator should have used the word Unless, changing the interpretative note to:
“Income derived by a foreign body corporate from carrying on trade or business in Kuwait through an “Agent” who is not himself a body corporate is not liable to tax under this Decree Unless the “Agent’s” authority is in accordance with the terms of the definition given above”
372
Definition of ‘Agent’ in the Income Tax Decree 3/1955, p.9.
373
i.e. a person authorised by a principal to enter into a binding contract with a third party on the principal’s behalf within the scope of that authority, see Tax Decree 3/1955 interpretative notes, p. 101.
374
124 This leads to the conclusion that where an agent, who is a natural person, has authority to sign binding contracts with third parties, the foreign enterprise will be liable to income tax in Kuwait.
Further, reading Article 2 (f) in isolation may lead to the understanding that there is no tax liability upon a foreign enterprise engaging in business in Kuwait through an agent where the agent is not a body corporate. The reality is that an income tax liability rises when a foreign enterprise undertakes business in Kuwait through an agent whether that agent is a body corporate or a natural person as long as - the agent - has the authority to enter into a binding contract with third parties.
So without the interpretative notes, it might be argued that a natural person as an agent for a foreign principal yielding income in the state of Kuwait will lead to the exemption of such foreign principal from income taxation in Kuwait. This could not have been the intention of Article 2 (f) as it has been established earlier375 that domestic companies were not established in Kuwait until the Kuwaiti Company Law 15/1960 came into practice in 1960, thus there were no domestic body corporates to begin with in order for them to serve as national agents for foreign enterprises. Also the insinuation that foreign enterprises with natural persons for agents are exempt from tax liability would have created a loophole and provided a very easy opportunity to avoid taxation by hiring a Kuwaiti natural person as an agent for the foreign enterprise to carry on business or trade in Kuwait. This interpretation is supported by Circular No. 34 of 2002 issued by the Ministry of
375
125 Finance, entitled “On Unifying the Base of Tax Inspection, Regarding the Agent and the Guarantor”376. The Circular provides the following definition of “Agent”: “He is the person, who is continuously negotiating for concluding the deals on behalf of the principal for fees. His engagement may include entering into these deals and execution thereof in the name of the principal and on behalf of him or his engagements shall be restricted to negotiating with the others as introduction for including the deals for the account of the principal. The agent may be the sole distributor of the industrial and commercial products in certain area377”
The Circular does not confine the meaning of “agent” to a legal person, so that a foreign principal may be taxed on the corporate income yielded in Kuwait whether the national agent is a natural person or a legal person as long as such an agent has authority to negotiate and conclude business deals on behalf of the principal.
Later in 2006, a binding resolution by the Council of Ministers was issued to confirm that in a distribution relationship, a foreign principal merely supplies the Kuwaiti sole distributor with goods for the latter to sell inside Kuwait i.e. the distributor does not have the authority to enter into binding agreements with third parties on behalf of his principal (the foreign enterprise). Such a distributor was excluded from the statue of agent for tax purposes, the Resolution provides: “an agent in the 1955 tax decree, refers to the person authorized by the principal to conclude contracts on his behalf with third parties within the given authorities, which will exclude the sole distributor from the scope of the Income Tax Decree implementation378. The status of a sole distributor will be discussed later in this chapter379.
The Kuwaiti Courts have also confirmed that it is the authority which the agent has that determines whether or not the relationship between him (the agent) and foreign enterprises yielding income in Kuwait is an agency which raises income
376
Circular No.34/ 2002, issued by the Ministry of Finance on 11th September 2002.