Revenue Share Agreements and Startup Tax Risks in Egypt
The tax treatment of “Revenue Share” agreements between startups and investors in Egypt is a new and controversial topic. While this financing model has gained popularity, especially in startups and technology sectors, its handling from a tax perspective remains unclear. With the absence of a well-defined legal framework addressing this type of financing, questions continue to arise regarding how the revenue shared between startups and investors should be classified under Egypt’s tax system.
What is the “Revenue Share” Model?
The “Revenue Share” model is an agreement in which an investor receives a percentage of the operating revenues of a startup in exchange for their investment, rather than acquiring a stake in the company’s equity or a share of its profits. This model offers flexibility for startups by allowing them to raise capital without giving up ownership of the company. Instead of the traditional model of equity investment, which involves profit sharing after a company generates income, “Revenue Share” focuses on distributing a percentage of the company’s revenues directly to the investor, typically on a recurring basis (monthly or quarterly).
This model is particularly attractive to early-stage startups that prefer not to give away equity or deal with profit distribution in the early stages. However, this flexibility comes with significant tax challenges, as it does not fit neatly into the existing legal and tax framework in Egypt.
Tax Challenges in “Revenue Share” Agreements
One of the main challenges in the tax treatment of “Revenue Share” agreements is how to classify the revenue. Under the Egyptian tax system, companies are subject to Corporate Income Tax (CIT) at a rate of 22.5% on their net profits. However, “Revenue Share” is not considered profit in the traditional sense; instead, it is part of the operating revenues, which makes it different from dividend distributions that are paid after corporate taxes have been applied.
Regarding the taxes on the revenue shared with investors, it could be argued that these payments are considered taxable income and should therefore be treated in a way that involves a tax on income. On the other hand, some may view these payments as financial returns that should be subject to additional tax. This lack of clarity leaves companies and investors uncertain about whether they should pay additional taxes on these payments or not, creating a situation of tax ambiguity.
Tax Risks Due to Lack of Clear Definitions
The lack of a precise legal definition of “Revenue Share” agreements in Egypt contributes to the confusion regarding their tax treatment. The Egyptian Tax Authority (ETA) might reinterpret these payments as dividends or personal income subject to income tax, even if the agreement doesn’t involve equity or profit sharing.
Typically, dividend distributions to individuals and non-resident companies are subject to withholding tax (WHT), generally at a rate of 10%. If the payments to investors are reclassified as dividends, the company could be required to pay tax on distributed profits, along with penalties for non-compliance or incorrect reporting of these payments.
On the other hand, if the tax authority rejects classifying the payments as “service payments” or operating expenses, companies may face difficulty in proving that these payments are part of operating income rather than dividends. This could lead to penalties for late payment or additional tax obligations if the funds are not properly documented and reported in the company’s financial records.
Tax Treatment of Operating Revenue
Under the Egyptian tax system, companies are required to pay income tax on their annual profits. In the case of “Revenue Share,” the revenue paid to investors could be classified as operating costs and thus deducted when calculating taxable profits. However, if the Egyptian Tax Authority does not accept these payments as deductible operating costs, the company may be required to pay additional tax on the gross revenue it generates.
Startups need to exercise caution when determining whether the payments made to investors can be considered “expenses” or “costs,” as in some cases, such payments might not be allowed to be deducted. In this case, the company would be liable to pay tax on its total profits, potentially leading to higher taxes than expected.
When dividends are distributed to investors, withholding tax (WHT) is imposed on these payments. The rate typically ranges from 5% to 10%, depending on the investor’s residency status. However, in the case of “Revenue Share,” which focuses on distributing revenues instead of net profits, it remains unclear whether the payments to investors should be subject to this type of tax or if they should be treated as operating revenue and thus handled differently.
The lack of clear guidance on the tax treatment of these payments can create confusion. If the revenue share payments are not classified correctly, companies may be at risk of paying higher taxes or facing penalties for non-compliance.
Tax Uncertainty
The absence of clear guidelines in Egypt’s tax system regarding the treatment of “Revenue Share” agreements results in significant uncertainty for investors and startups. Without clear legal frameworks or regulations addressing this type of arrangement, both parties face risks related to how the payments are taxed. If companies are unable to prove that the payments are operating revenues, and not dividend distributions, they may face fines, additional taxes, or legal disputes with the tax authority.
Additionally, companies might encounter issues if they fail to comply with the appropriate tax codes or if their contracts are not properly documented. This uncertainty could lead to financial and legal challenges down the road, as businesses might be required to pay back taxes or penalties.
Need for Updated Tax Legislation
As the “Revenue Share” model has become increasingly popular, particularly in the startup ecosystem, it is essential that the Egyptian tax system be updated to account for such financing models. The government should issue clear regulations outlining how to treat the revenue shared with investors, including whether these payments are taxable income or operating expenses.
An update to the tax system would allow startups and investors to avoid misunderstandings and legal complications arising from the lack of specific tax guidance. This update could include the establishment of clear rules for withholding taxes on payments made to investors and provide certainty about whether these payments should be considered “income” or “expenses” for tax purposes.
Conclusion
While the “Revenue Share” model provides startups with a flexible way to raise capital, the tax treatment of this model in Egypt remains unclear and complex. The absence of clear legislation and regulations means that companies and investors face significant challenges in determining how to comply with tax requirements. To ensure a sustainable and transparent investment environment, it is crucial for Egypt’s tax system to be updated to address modern financing models like “Revenue Share,” providing clarity on tax treatment and protecting the interests of all parties involved.
Frequently Asked Questions
What is a revenue share agreement for startups in Egypt?
+
A revenue share agreement is a financing model where investors receive a fixed percentage of a startup’s operating revenues instead of equity or profit distributions. In Egypt, this structure is increasingly used by early-stage startups but lacks a specific legal or tax framework.
How are revenue share payments taxed in Egypt?
+
Egyptian tax law does not clearly define the tax treatment of revenue share payments. Depending on interpretation, the tax authority may treat them as taxable income, non-deductible expenses, or potentially reclassify them as dividends.
Are revenue share payments deductible for startups?
+
Startups may attempt to deduct revenue share payments as operating expenses when calculating corporate income tax. However, the Egyptian Tax Authority may challenge this treatment if it considers the payments closer to profit distribution rather than business costs.
Can revenue share payments be treated as dividends?
+
Yes. If the agreement resembles profit sharing or investment returns, the tax authority may reclassify revenue share payments as dividends, which could trigger withholding tax obligations and potential penalties.
Is withholding tax applicable to revenue share payments?
+
There is no clear guidance on whether withholding tax applies to revenue share payments. If reclassified as dividends or investment income, withholding tax of up to 10 percent may apply. Otherwise, it may not be required.
What tax risks do startups face using revenue share models?
+
Key risks include reclassification of payments, denial of expense deductions, additional corporate income tax, withholding tax exposure, fines, and disputes with tax authorities due to unclear documentation and lack of specific regulation.
To find out more, please fill out the form or email us at: info@eg.Andersen.com
Contact Us
