The taxation of income in Iraq: the current approach and what to expect

Patryk Karczewski
AMERELLER, Dubai
pk@amereller.com

Omar Abdullah
AMERELLER, Erbil
omar@amereller.com

Introduction

According to foreign direct investment (FDI) markets, inbound foreign direct investments into Iraq over the first nine months of 2023 hit a record $24bn, more than double the previous full-year record in 2008.[1] This is a sign that foreign investors are slowly regaining trust in the Iraqi economy and beginning to move away from seeing Iraq as a country in crisis and more towards seeing it as a country of opportunities.

Undoubtedly, Iraq still has a lot of heavy lifting to do to sustain this image. In light of the above, it is worth briefly having a look at what the tax landscape looks like for foreign businesses wishing to invest in Iraq and also for personnel who may be present in Iraq.

The residence criteria for legal persons and individuals

The main legal act that regulates income tax in the Republic of Iraq is Income Tax Law No 113 of 1982 (ITL), as amended by the Coalition Provisional Authority’s (CPA) Order No 37, 49 and 84.

Firstly, it should be emphasised that the ITL does not contain a clear provision indicating the circumstances according to which a permanent establishment (PE) is created in Iraq. Instead, the PE construct (or the taxation of a non-resident) is scattered within various articles. Such an approach is not uncommon in less modern tax jurisdictions in the region, with similar approaches taken in Kuwait (whose tax landscape is being modernised) and Jordan.

According to Article 1 of the ITL, a legal person, incorporated under the laws of Iraq, is considered to be tax resident in Iraq. Similarly, companies that are established outside of Iraq, but have a place of management and control in Iraq, are also considered tax residents.

On the other hand, non-residents are defined as those individuals/entities that do not qualify as being tax residents, but generate income according to which Iraq is the source of such funds. Under Article 5(2) of the ITL, a non-resident is subject to tax in Iraq if the income was generated in Iraq, even if the funds were technically received outside of the country.

In regard to natural persons, tax residency depends on several factors, including:

• the nationality of the individual;
• the duration of their stay in the country; and
• their employment status.

The following categories of individuals are considered to be residents in Iraq for tax purposes:

• Iraqis residing in the country for longer than four months during the year in which the income has arisen or residing temporarily outside Iraq, with a permanent domicile or place of business in Iraq;
• Arabs working in Iraq regardless of the period of their residence; and
• non-Arabs residing in the country, during the year in which the income was generated, for a total period of not less than six months, or residing in Iraq for a period of not less than four consecutive months, or residing in Iraq regardless of the period of their residence if employed by a juristic person in Iraq.

Permanent establishment in Iraqi tax law

Paragraph 3, section 3 of CPA Order No 49 indicates that Iraqi lawmakers recognise a permanent establishment concept, since the abovementioned provision stipulates: ‘Foreign companies that are registered in Iraq or otherwise have a permanent establishment in Iraq will be subject to tax at a fixed rate of 15% on their income in Iraq.’

The use of the term ‘permanent establishment’ in this regulation is problematic since no other provisions use the term; hence, the concept of permanent establishment remains undefined, despite being used in the aforementioned paragraph. Therefore, to maintain the completeness of Iraq’s income tax system, it appears that the term permanent establishment should be treated in a similar way to what is meant by being non-resident for tax purposes, which is defined in the ITL. In conclusion, non-residents that are subject to tax in Iraq are subject to a 15 per cent tax on their income that can be attributable to their activities in Iraq.

Article 21(1) of the ITL provides some guidance on what sort of activity involving a non-resident can result in being subject to a tax assessment in Iraq. According to this provision, the Iraqi tax authorities can request a tax assessment in relation to a non-resident if the non-resident in question receive any income generated in Iraq through, for example, an agent (disclosed or undisclosed), an agency or a branch.

Furthermore, clause 2 of this Article indicates that if there is a ‘special connection’ between a non-resident and a resident, which allows the non-resident substantial control over the resident and, due to this special connection, the resident is reporting lower income than it otherwise would, that non-resident may be subject to a tax assessment. In other words, Article 21(2) of the ITL hints at the existence of transfer pricing regulations in regard to the abovementioned scenario.

An example of PE in a double tax treaty concluded by Iraq

Recently, the Republic of Iraq concluded several double tax treaties, inter alia, with Cyprus, Hungary, the Netherlands, Pakistan and the United Arab Emirates (UAE) to name but a few. The network of tax treaties concluded and binding on Iraq’s tax authorities is growing.

One of the analysed tax treaties, that concluded with the UAE and published as Law No 10/2019,[2] contains a provision in Article 6 pertaining to what is meant by a permanent establishment. The definition of a permanent establishment in the treaty is heavily inspired by other tax treaties; however, certain deviations are apparent.

Mainly, the treaty introduces the concept of a service-related PE, which concerns the provision of services in the country related to the source of funds (other than the country of residence/registration) for more than six months within a 12 month period. However, this concept is not expressed in the Organisation for Economic Co-operation and Development’s (OECD) Model Tax Convention on Income and on Capital.

Furthermore, the tax treaty established between the UAE and Iraq includes a shorter period of time (when compared to the OECD Model Tax Convention) during which the construction of a particular place of business does not constitute a PE. Moreover, the OECD Model Tax Convention indicates that a PE is created when a construction site remains for more than 12 months, whereas the UAE–Iraq tax treaty indicates that a construction site will create a PE when the site remains for more than six months within a 12 month period.

Doing business ‘in Iraq’ and ‘with Iraq’ and the consequences of differentiation

The ITL indicates that it is the role of the tax authorities to differentiate between the tax consequences for non-residents of trading ‘in Iraq’ and trading ‘with Iraq’ (Article 21(7) of the ITL). Whereas the former results in an activity being subject to tax in Iraq, the latter does not.

The Iraqi Ministry of Finance issued Instruction No 2/2008, subsequently amended by Instruction No 1/2014 (effective from 1 January 2015), which provides some insight on what types of activity are considered by the authorities to be conducted ‘in Iraq’ (taxable) and ‘with Iraq’ (not taxable).

Article 1 of Instruction No 1/2014 stipulates that trading ‘in Iraq’ should cover the following activities:

• a non-resident having a branch or office in Iraq and a contract concluded by the said branch or office or representative or branch/office employees; and
• the authorisation of an Iraqi resident by a non-resident foreign supplier to sign and perform a contract on behalf of the non-resident. In this situation, both parties are taxable, the resident on their commission and the non-resident on the profit generated from the contract. Such a contract will be taxable in Iraq for non-residents, where:
  • it relates to the clearance of shipping lists, customs dues, charges of letters of credit and its procedures in Iraq (even if the non-resident has no branch or office in Iraq);
  • the contract value has been paid, wholly or partly in Iraq, in any currency;
  • the foreign supplier has been paid using a barter method; and
  • it relates to the installation or supervision of maintenance or engineering works and that activity is performed in Iraq by a non-resident.

On the contrary, the following activities conducted by a foreign supplier are considered as trading ‘with Iraq’ and, thus, are not subject to income tax in Iraq (Article 2 of Instruction No 1/2014):

• where the activities involve a foreign supplier residing outside Iraq and the signing and conclusion of the contract that takes place outside of Iraq in the name of an Iraqi entity and where the contract pertains to the opening up of credit or the clearance of shipment lists (or related procedures);
• where a non-resident has a branch or office in Iraq, but the contract has been concluded outside Iraq and the said branch or office did not participate in the conclusion or execution of the contract. However, if the commission is due to the branch or office as the result of the conclusion of the contract, this income should be taxed in Iraq; and
• where the actual services, such as the supervision of shipping, equipment testing or consultancy services, were rendered for the beneficiary outside of Iraq.

The taxation of non-residents in the Kurdistan Region (KRI)

It has to be noted that the KRI as an autonomous administrative entity within the Republic of Iraq has the right to introduce its own regulations related to taxation, which can differ from the ones binding on the rest of Iraqi territory.

In 2022, the Ministry of Finance and Economy, as part of the Kurdistan Regional Government, introduced Instruction No 7/2022, which organises the tax on non-resident companies and individuals and came into force in 2022.

Instruction No 7/2022 imposes a tax on Iraqi entities engaging with non-resident companies, Iraqi individuals engaging with non-resident individuals and the participation of a branch in relation to the costs shouldered by the parent company.

The instruction covers, in addition to taxing the non-resident private sector, all the contracts between the government and third parties, be it involving a company or an individual.

The non-resident tax is imposed on companies or individuals in certain cases. For example, when a non-resident company signs or implements an agreement through its branch, local representative or an employee. The branch is then subject to tax on the business conducted by the parent company.

The way the tax is imposed is as follows:

• the contractor must withhold ten per cent from the total contract value to be paid to the tax office. The amount is released when the subcontractor acquires a tax clearance letter for the contract in question;
• then the tax office assumes a certain percentage of profit from the total amount of the contract. For example, in regard to a marketing contract, the profit is set to 40 per cent of the total contract value; and
• from the anticipated profit, 15 per cent is subject to income tax. In terms of the marketing contract example, the 15 per cent tax is paid from the 40 per cent anticipated profit.

The powers of the General Commission for Taxes (GCT)

It should be noted that the GCT, the Iraqi tax administration, has a certain level of discretion in regard to its efforts to impose taxes on foreign entities.

The GCT always reserves the right to request a tax assessment, for example by invoking Article 21(3) of the ITL. This trigger allowing the GCT to request an assessment is rather subjective (‘where it appears to the Financial Authority that the actual amount of profits of a non-resident subject to tax in the name of a resident cannot easily be determined […]’), which can be exploited by the GCT.

It is not uncommon for foreign investors to try and minimise their tax footprint in Iraq by drafting contracts in such a way that enables them to argue that a significant portion of the income generated comes from trading ‘with Iraq’ rather than ‘in Iraq’.

However, it should be noted that the GCT also has the right to examine not only ‘the true income’ of the taxpayer, but also to determine the source of the funds (Article 28(2) of the ITL). Hence, it is likely that any attempts aimed at tax ‘optimisation’, by carving out a portion of the contract that is not related to on-shore works in Iraq, could be considered trading ‘in Iraq’ by the CGT, as long as it can be argued that Iraq is the source of the income.

Furthermore, we were verbally informed that as of 2025, the corporate income tax department of the CGT will begin strictly implementing the tax regulations in regard to the audit of financial statements. Currently, the corporate income tax department does not apply all of the available penalties (eg, for failing to keep ledgers, submitting false reports, etc). However, as of 2025, we expect that the CGT’s approach to taxation will become stricter and its enforcement of the tax rules and obligations will increase.

The standard rules on income tax calculations and deductions

The ITL foresees a standard tax rate of 15 per cent that is payable on the income determined, based on the income statement. Income is generally worldwide income for tax residents and income attributable to the branch, in case of a branch.

It is important to have proper documentation regarding all deductible expenditure, as the GCT tends to raise tax assessments related to ‘deemed profits’ if the documentation to support any deductions is deemed to be insufficient.

The ITL follows the standard approach to the deductibility of expenditure, ie, as long as the taxpayer can prove that the spending led to the generation of income and sufficient documentation is in place, then generally the expenditure can be deducted.

In addition, Article 8 of the ITL lists certain expenditure that is deductible, inter alia:

• interest paid on money borrowed and invested in the production of the income or its increase;
• the rental of the place occupied for the purpose of earning income;
• depreciation of the building owned by the taxpayer and used by the taxpayer to earn income; and
• the proportion, determined by the relevant regulation, of the cost of tangible fixed assets (excluding building and land), such as machinery and other equipment, in regard to their depreciation or consumption due to their use during the year in which the income was generated.

A tax return needs to be submitted and payment made within five months from the end of the applicable fiscal year.

The special rules on income tax calculations and deductions

It should be noted that foreign entities working in the oil and gas industry are subject to special taxes imposed based on Law No 19 of 2010 on Imposing an Income Tax on Foreign Oil Companies Contracting to Work in Iraq (OGTL).

Income generated in Iraq from contracts with foreign oil companies contracting to work in Iraq, their branches or offices, and subcontractors involved in the production and extraction of oil and gas and related industries, is subject to a tax rate of 35 per cent.

The following types of contracts are covered by the abovementioned tax rate pursuant to the OGTL:

• contracts for the exploration, development and production of exploration spots and oil and gas fields;
• seismic surveys;
• well drilling;
• well reclamation;
• technical operations related to wells, including lowering linings, cementing, well revitalisation, electrical sounding and activities related to the completion of wells;
• surface facilities for oil and gas extraction and production operations and industries related to them;
• water injection facilitates;
• flux tube-related activities;
• gas processing plants;
• cathode protection-related activities;
• engineering examinations and quality control assessments related to the oil industry;
• water well drilling; and
• activities related to extraction to the extent that oil or gas is ready to be pumped to export outlets.

The abovementioned tax rate applies to specific contracts where the contracting party is a foreign entity.

A tax return needs to be submitted and payment made within five months from the end of the applicable fiscal year.

Withholding tax (WHT)/tax retention

Instruction No 2/2008 stipulates that all the contracts for works assessed as having been conducted ‘in Iraq’ are subject to tax retention.

Firstly, the contract generating the work ‘in Iraq’ has to be presented to and registered with the GCT. Secondly, the taxpayer is obliged to retain part of the payments made to the foreign entity (non-resident). The rate applicable to this retention varies from 1.8 per cent to ten per cent, with the last payment to be withheld until clearance is given by the GCT.

It should be noted that the application of the retention rate by the GCT is inconsistent and often arbitrary, typically ranging from three to five per cent.

The retention rate for contracts covered by the OGTL is set at seven per cent for contracts listed in the OGTL, whereas other contracts that relate to oil and gas are subject to a 3.3 per cent retention rate.

It is not clear how the GCT differentiates ‘other contracts’ from those subject to the seven per cent retention tax, making it difficult to provide hypothetical calculations.

It should be emphasised that dividends paid by Iraqi entities are not subject to tax.