Author: Thomas Vanhee

Ramadan Generosity Generates Tax Revenue

Post author By Thomas Vanhee
Post date July 4, 2024

Ramadan Generosity Generates Tax Revenue

The Holy Month of Ramadan is the ninth month of the Islamic calendar Muslims worldwide observe it as a month of fasting, prayer, self-reflection, and enhanced community spirit. The annual observance of Ramadan is one of the five pillars of Islam.

Ramadan is regarded as a time of piety, charity, and blessings. Charities and foundations are noticeably more active during the Holy Month, providing assistance to those in need. In a spirit of generosity, meals are provided at mosques, malls, and other public places.

Businesses see the Holy Month of Ramadan as an opportunity to enable generosity by organizing sales and offering promotions, deals, discounts, gifts and benefits of all kinds. For example, companies may offer “buy one, get one free” or “two for the price of one” promotions, or other combined offers where certain products are offered for free or at a reduced price when bought together with another product (e.g., receiving one year of car insurance free of charge when purchasing a new car).

Traditionally, businesses also celebrate the Holy month by hosting Iftar parties, handing out Iftar snack boxes, or giving gifts in cash or in kind during Eid al Fitr, the religious feast marking the end of Ramadan.

This article discusses how to deal with UAE value-added tax (VAT) and Corporate Taxation (CIT) while maintaining the spirit of generosity embedded in the Holy Month of Ramadan.

Is There No Such Thing as a Free Lunch, Really?

Arguably, VAT does not like free items. It taxes so-called deemed supplies, where businesses give things away for free for which it previously deducted input VAT. However, not all free supplies are necessarily deemed supplies. Even though both look similar, i.e. a third party seemingly receives something without paying for it, only free supplies that are also deemed supplies carry VAT consequences.

As part of strategy to increase its sales and market share, a business may offer a customer a free item. For example, a supermarket could offer a “buy one, get one” formula for shampoo bottles. Although it provides the second bottle for free, the customer actually pays a lower price for two bottles. Therefore, this situation is not a deemed supply but rather a joint offer. In this case, the consideration paid by the consumer for (allegedly) one item only (i.e., the first bottle of shampoo) constitutes the taxable amount for the overall bundle supply (i.e., the two bottles of shampoo).

The same reasoning, also in terms of taxable amount determination, holds for promotional discounts, such as businesses slashing their prices by 50% during Ramadan. In this case, as in the previous situation, a business is not offering half of the product for free but rather a price discount. The discounted price reduces the taxable amount of the overall bundle supply.

A business might also consider giving a different item in addition to the item bought. For instance, upon purchase of an electric toothbrush, the seller can offer two free tubes of toothpaste. Although the item is given for free, such a “free supply” is still not a deemed supply. This is because the free item is given with the objective of increasing sales of the main item and should be considered ancillary to it. Similarly, such promotional offers and discounts can be claimed as deductible expenditures from a CIT perspective, given that such expenses are incurred wholly and exclusively for business purposes to promote products or services.

It is very different when a grocery store decides to donate food supplies to a shelter or to allow all employees to pick an item from its stock for Ramadan. Those constitute deemed supplies, and they are liable to VAT needs. This means that VAT on these deemed supplies constitutes a cost for the business since it is giving the items for free.

On the other hand, if employers know upon purchase that they are purchasing items not intended for taxable supplies, they cannot recover the input VAT (and the subject of the deemed supplies is not even on the table).

The business making the deemed supplies needs to issue a tax invoice for the deemed supply and, ideally, deliver it to the recipient. The VAT on the tax invoice is not deductible in the recipient’s hands.

In the UAE, the taxable value of deemed supplies is its cost. This constitutes the taxable basis on which VAT should be accounted for.

However, even though a supply may constitute a deemed supply, two thresholds apply. If a business stays below the thresholds, it can continue to recover the input VAT and does not have to account for VAT on the deemed supply.

There are two thresholds which apply alternatively:

The output tax chargeable on all deemed supplies should not exceed AED 2,000 in a 12-month period (i.e., AED 40,000 of costs VAT exclusive), and;
The value per person does not exceed AED 500 in a 12-month period (i.e., AED 10,000 of costs VAT exclusive), and it concerns samples or commercial gifts.

Fulfillment of one of these two thresholds allow businesses to occasionally provide small benefits or gifts to their employees and third parties without incurring VAT liabilities.

Given that these thresholds are very low, a business will easily exceed them. Considering the substantial administrative burden of monitoring the thresholds and implementing a process, a business could find it more practical to ignore the thresholds and always account for output VAT on the deemed supplies. That is also what most informed businesses seem to do.

While UAE VAT generates tax revenue from gifting by creating a deeming fiction, from a CIT perspective, expenses incurred on account of donations, grants, or gifts are not allowed as deductible expenditures when paid to a person who is not a Qualified Public Benefit Entity (“QPBE”). Where they are disallowed, they are added back and subject to UAE CIT.

UAE CIT legislation allows tax deductions for employment remuneration and any perquisites attached to the employment contract. Nevertheless, gifts given to employees that relate wholly or exclusively to the business but are not in accordance with the employment contract are not allowed.

Presently, the UAE CT Law and other domestic guidances released by the Federal Tax Authority do not clarify the deductibility of expenses for festive gifting to employees. Nonetheless, on the combined reading of the deductibility and non-deductibility rules, we are of the view that such expenses are unlikely to relate to the business fully. According to the UAE CT Law (Article 28, 2, d), the Federal Cabinet would further issue a decision to specifically list types of expenditure which are not deductible. We would additionally expect the FTA to issue guidance on the matter.

On the other hand, donations shall be allowed as a deductible expenditure when made to a QPBE. This is to encourage social and public welfare activities that are subject to regulatory oversight in the UAE. The clear distinction between the recipients of the donations, grants, or gifts makes it easier for tax authorities to administer the deductibility of expenses, incentivizing payments to specifically listed charities. We do, however, expect regular sponsorships to be deductible even when made to non-QPBE.

Entertainment and Personal Expenses Incurred during Ramadan

VAT is only recoverable when it is paid for goods and services bought to make taxable supplies. However, even though a business may exclusively make taxable supplies, there may still be expenses which are non-recoverable.

When an employer buys items and gives them to its employees for no charge and for their personal benefit, the employer cannot recover the input VAT. For example, if the employer decides to purchase chocolate dates for Ramadan to give to its employees, the input VAT paid is irrecoverable.

The same holds for so-called “entertainment expenses”. Entertainment services are “hospitality of any kind”. This includes hotel stays, food and drinks, tickets for shows and events and trips for entertainment. Therefore, if a business organizes an Iftar for its employees and for third parties, the input VAT is not deductible. Even though the event is held with the objective of improving social cohesion amongst the team and general ambience, indirectly increasing sales, and, therefore, having a clear business purpose, it is considered an entertainment expense.

However, a Public Clarification published by the Federal Tax Authority confirmed that VAT on certain entertainment costs is recoverable when used for a genuine business purpose, or when incidental to a business purpose. Notably, VAT on food and drinks provided during a business meeting, is recoverable, if:

The hospitality is provided at the same venue as the meeting;
When the meeting is interrupted, it is only by a short break for the provision of hospitality and then resumes as normal (e.g., a lunch break);
The cost per head of providing hospitality does not exceed any internal policy the business has established;
The food and beverages provided are not accompanied by any form of entertainment (e.g., a motivational speaker, a live band, etc.).

On the other hand, where the hospitality provided becomes an end in itself and is the reason for attending an event, it will be considered entertainment costs, and, thus, input VAT paid is not recoverable. In other words, if the staff comes for the party or the TED talk, the business will not be able to recover the input VAT. If the gathering is serious business, the input VAT will be recoverable.

Similar to UAE VAT Law, entertainment from a CIT perspective includes meals, accommodation, transportation, admission fees, facilities and equipment used for entertainment, and expenses for amusement.

From a CIT perspective, entertainment expenses incurred for a taxable person’s customers, shareholders, suppliers or other business partners are restricted to 50%. Given that entertainment expenses have a private element attached to them, which may be difficult to estimate and apportion, the UAE CIT legislation straightway disallows 50% of such costs.

While the current guidelines explain the policy objective of limiting the deductibility of expenses, citing personal consumption, it also states that staff entertainment expenses are fully deductible if incurred for “business purposes”.

There may also be instances where personal non-business expenses form part of the entertainment expenses. Should this be the case, it is important to identify entertainment expenses that relate to the business activity and only allow 50% of such identified portion.

For example, a family-owned company owns a box at the football stadium that is used for a client’s entertainment. Thus, any expenses incurred for client entertainment shall be allowed to the extent of 50% of such expenditure. Conversely, if the shareholder’s family uses such a box, the entire expenditure will be disallowed since it is personal in nature.

Charities

Although charities mostly carry out transactions that are outside the scope of VAT, given that, for the most part, they do not charge any consideration, they may still occasionally render taxable supplies and, therefore, incur certain VAT liabilities, starting from the obligation to register for VAT purposes.

Charities mainly receive their income from subsidies or donations, which are outside the scope of VAT. Occasionally, they may provide sponsoring opportunities to businesses, which are subject to VAT.

Under normal VAT recovery rules, input tax is only recoverable to the extent it relates to taxable supplies. In most cases, charities will be required to allocate and apportion VAT recovery between taxable activities (recoverable) and non-taxable activities or exempt activities (non-recoverable). Therefore, the input VAT recovery may prove to be quite complex.

A special refund scheme applies to so-called Designated Charities which meet the criteria set by the UAE Federal Tax Authority (FTA).

Similar to UAE VAT legislation, charitable organizations carrying out social, cultural, religious, or other public benefit activities without the motive for profit distribution will be exempt from CIT subject to certain conditions. Additionally, to achieve the exemption status, such organizations should apply to the local or Federal Government entity with which they are registered for it to be listed in the UAE Cabinet Decision.

Accordingly, such organizations shall be exempt from CIT from the beginning of the tax period in which it is included in the relevant Decision. The UAE CIT legislation uses the term “Qualifying Public Benefit Entity” (QPBE) for such organizations.

The conditions to be fulfilled by a QPBE to be exempt from CIT include:

It is established and operated for any of the following:
- Exclusively for religious, charitable, scientific, artistic, cultural, athletic, educational, healthcare, environmental, humanitarian, animal protection, or other similar purposes.
- As a professional entity, a chamber of commerce, or a similar entity operated exclusively for the promotion of social welfare or public benefit.
It does not conduct a Business or Business Activity, except for such activities that directly relate to or are aimed at fulfilling the purpose for which the entity was established.
Its income or assets are used exclusively in the furtherance of the purpose for which it was established, or for the payment of any associated necessary and reasonable expenditure incurred.
No part of its income or assets is payable to, or otherwise available, for the personal benefit of any shareholder, member, trustee, founder, or settlor that is not itself a Qualifying Public Benefit Entity, Government Entity, or Government Controlled Entity.
Any other conditions as may be prescribed in a decision issued by the Cabinet at the suggestion of the Minister.

As such, a QPBE should not conduct business or business activity unless the same is aimed at the purpose for which it is established. That is, it may carry out commercial activities as long as the objectives of the organization are met and any additional surplus is not distributed as dividends or any other benefit. For instance, the following shall not be construed as commercial activities:

Organizing events such as gala dinners to raise funds.
The sale of admission tickets by a museum.
Or the sale of refreshments in the canteen of a sports club.

As stated above, on meeting the above conditions, a Qualifying Public Benefit Entity will be an exempt person and thus will not be subject to corporate tax in the UAE, and any payments made to such organizations will be available for tax deduction for the payor.

Conclusions

The Holy Month of Ramadan triggers several tax consequences for businesses.

First, businesses making sales promotions are required to examine the tax consequences of these sales promotions.

Businesses may also not be allowed to recover input VAT on certain purchases or will be liable for VAT on a deemed supply when providing employees with entertainment or gifts.

Similarly, for CIT purposes, it is pertinent to segregate business expenses, entertainment expenses, and non-business-related expenses to assess the amount of tax deductible.

Charitable organizations should evaluate whether they qualify as exempt persons from the perspective of CIT and evaluate the VAT implications in a time-bound manner.

Given the very strict penalty framework, it is important to be aware of the VAT/CIT consequences of these activities and take action in this regard to avoid any claims or penalties.

Public Consultation

Aurifer’s reply to the Public Consultation initiated by the UAE Ministry of Finance (MoF)

Post author By Thomas Vanhee
Post date May 18, 2024

Aurifer’s reply to the Public Consultation initiated by the UAE Ministry of Finance (MoF)

This is Aurifer’s reply to the Public Consultation initiated by the UAE Ministry of Finance (MoF) regarding the implementation of potential measures favoring Research and Development (“R&D”) embedded in the UAE Corporate Income Tax framework.
The input we have shared is meant to assist the Ministry in considering certain positions, as well as best practices abroad.

Several of the questions in this public consultation are aimed at collecting information from businesses regarding their existing R&D activities and we are therefore ill suited to respond in our capacity as a tax consulting firm. As such, we have chosen to address some of the queries separately.

The United Arab Emirates (UAE) government is currently exploring the implementation of R&D tax incentives to promote innovation and further diversify the national economy. The proposed tax incentive under the UAE CIT law is considered an indirect instrument to support R&D to be developed in the UAE. The initiative fits into the wider policy of the UAE’s Ministry of Industry and Advanced Technology which has made strengthening the UAE’s R&D ecosystem a crucial part of its strategic objectives to fortify the UAE’s position as a global leader in industries of the future.

A guidance paper was provided offering a comprehensive definition of R&D, which builds upon available OECD standards, specifically referencing the “Frascati Manual.” Notably, the guidance paper categorizes R&D into three primary types:

• Basic Research: This includes theoretical and practical investigations aimed at broadening knowledge about phenomena without immediate commercial applications.
• Application-Oriented Research: This includes research that focuses on specific, practical aims to develop new products or services.
• Experimental Research: This involves the systematic exploration of past research and experiences to discover new knowledge that can lead to the creation or enhancement of products and processes.

From an economic perspective, the proposed tax incentives intend to encourage private sector investment in innovation, a key component for ensuring the UAE’s long-term economic resilience while enhancing its competitive stance on the global stage.

To this end, the guidance paper delineates a clear framework for eligibility. The eligibility seems to be suggested based on OECD standards. It would allow easier tracking of the development and investment in R&D, and easier reporting.

However, certain activities are not included. For example, routine engineering and quality control activities are not eligible, which may restrict the incentive’s applicability to some sectors, such as manufacturing. Certain scientific activities are also excluded.

MoF is considering basing its policy principles on this guidance. In this regard, while the Frascati Manual provides useful guidelines for the classification of R&D activities, the measurement of R&D expenditure etc, it is primarily aimed at the collection of statistics and does not provide clear guidance in the context of R&D tax incentives.

R&D Tax Credits are applicable in many other jurisdictions, and are a tool often used by governments to encourage investment in research. The OECD is currently tracking 43 R&D Tax Credit Regimes.

Some regimes and their description include:

– Ireland: 30% credit on R&D expenditures; Up to 32% credit of qualifying expenditure relating to digital game development.
– Belgium: part of the withholding required for Personal Income Tax purposes for specific profiles such as researchers is not required to be paid to the tax authority, and effectively results in a grant to the business employing the staff. This is referred to as the payroll withholding tax credit, although technically speaking it is not a credit.
– Australia has a tiered R&D tax credit, granting a higher tax credit for SMEs which can go up to 43.5%.
– France has amongst others accelerated depreciation for R&D Capital Assets (as do many other countries).

The successful implementation of R&D tax incentives will depend greatly on the simplicity of the application process and the efficiency of its administration. A cumbersome process could deter businesses from applying, undermining its effectiveness. We would recommend that the auditing process is not different from other aspects of the CIT law, however some aspects may require specialized input.

In relation to outsourcing arrangements, it is important to be conscious that R&D activities in practice often involve collaborations with other institutions or bodies. This can be done with the aim of benefitting from synergies and to avail of certain resources which might not be immediately available to all companies (particularly in the SME space). For example, start-ups may collaborate with universities that have better facilities, greater access to funding from the State etc.

As such, although the preference should always be for R&D activities to be conducted internally by the relevant applicant company or within the UAE, it is important to be cognizant of the realities of such arrangements and activities for certain organizations.

In this regard, the Irish R&D tax credit regime has a limitation on relief in scenarios where companies engage in outsourcing activities. The relief will be restricted to 15% of the expenditure incurred by the company itself on R&D activities or €100,000, whichever is the greater. This is subject to the company incurring at least the same level of expenditure on qualifying activity which it carries out itself. It is also worth noting that outsourcing is not permitted to connected persons i.e. related parties.

We would consider this to be a reasonable approach. However, it may be worth to consider the introduction of a slightly less restrictive provision in relation to outsourcing to ensure that there is sufficient uptake of the new R&D tax incentive. Following a period of assessment, the FTA can then assess whether the relevant thresholds or restriction percentages need to be modified accordingly.

In general, indirect costs would not be considered qualifying R&D expenditure unless they directly relate to the activity being undertaken. For example, any rent incurred on a lab facility being used to conduct R&D activities or the energy consumption required to perform the relevant activities. An advantage of allowing a certain allocation of indirect costs would be that it may offer a greater tax incentive for companies to establish their operations in the UAE. However, the allocation of indirect costs can often be an imprecise exercise which will depend on the relevant allocation key and could lead to manipulation by taxpayers in order to inflate the amount of qualifying expenditure.

If R&D tax incentives are implemented, we would recommend MoF and the FTA to develop guidelines around how to address cost sharing agreements with public and private authorities in the UAE. Such agreements are important in the UAE as much of the R&D activities in the UAE are initially driven by governmental initiatives.

The UAE may consider that its tax regime is already very attractive. At 9%, with multiple exemptions, it is already one of the most beneficial tax regimes in the world. Moreover, for Free Zone entities, the QFZP regime also has provided that income derived from the ownership or exploitation of intellectual property (potentially produced as a result of R&D) constitutes a qualifying activity, even granting an up-lift of 30% on qualifying expenditures.

The application of R&D tax incentives with respect to qualifying income from intellectual property would not lead to a reduction of the tax liability, but may be relevant, depending on the design for the non-qualifying income. The combination of a low rate and income from qualifying intellectual property being able to benefit from a more favorable regime in the free zones, already makes the UAE very attractive.

In the framework of Pillar Two, it is advisable that if R&D tax incentives are implemented, that they are structured as so-called Qualifying Refundable Tax Credits (“QRTC”), and that they are structured in such a way to have a positive effect on the Substance Based Income Exclusion (“SBIE”). For them to be considered “refundable”, according to the OECD’s Model Rules on Pillar 2, the refundable tax credit needs to be designed in a way such that it must be paid as cash or available as cash equivalents within four years from when a Constituent Entity satisfies the conditions for receiving the credit under the laws of the jurisdiction granting the credit.

The result of a tax credit being considered a QRTC is that it does not reduce the Covered Tax for the purposes of calculating the ETR of an in-scope Constituent Entity of an MNE under Pillar Two, contrary to a traditional tax credit. Rather, it will increase the denominator when calculating the ETR. It is therefore generally speaking more favorable. When a QRTC is granted for expenses which would increase the SBIE, which is a deduction from the excess profits subject to the topup tax based on a percentage granted on the value of qualifying tangible assets and payroll expenses, this would be seen as an additional advantage to taxpayers.

One of the few benefits in place under the GloBE rules is the application of the SBIE. The SBIE, when combined with QRTC’s which aim to reinforce the SBIE, is a recommended approach. While the availability of tax benefits impacting the tax liability as a regular tax credit is severely restricted, expenditure-based tax incentives that target payroll or tangible assets may be less affected than income-based tax incentives.

Although the above considerations need to be considered from an MNE perspective, it is also important to bear in mind that there is a rich ecosystem of start-ups engaging in R&D activities. As such, it may be worth allowing an option for taxpayers to elect either for their eligible R&D tax credit to be repaid in cash or cash equivalents (i.e. as a QRTC) or to request for it to be offset their tax liabilities (i.e. in a more traditional tax credit). This would allow greater flexibility and potential benefits for both categories of taxpayers.

Prepared by Thomas Vanhee (thomas@aurifer.tax) and Liam Purcell (liam@aurifer.tax), on behalf of Aurifer.

UAE Corporate Income Tax

Family Foundations and UAE Corporate Income Tax

Post author By Thomas Vanhee
Post date May 2, 2024

The business people working together at table. The meeting or summit concept

Family Foundations and UAE Corporate Income Tax

In the evolving landscape of UAE Corporate Income Taxation (“UAE CIT”), the intricacies surrounding family foundations stand out as an area of significant interest as well as complexity.

Family foundations encounter a unique set of challenges and opportunities under the new UAE CIT regime. The introduction of CIT in the UAE highlighted the importance of not just succession planning but also tax planning and compliance management.

Effective tax planning and compliance, grounded in a deep understanding of the UAE CIT Law (“Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses”), is crucial for these entities to optimize their tax positions, avoid penalties and contribute to their long-term sustainability and growth.

This requires a strategic review of financial structures, operational practices, and investment strategies to align with the UAE CIT framework while achieving business objectives.

This article aims to delve into the nuances of family foundations as outlined in the UAE CIT Law and provide a thorough understanding of their tax treatment.

Family Foundations under UAE CIT Law

Family foundations hold a unique position in the UAE legal landscape, with specific provisions of UAE CIT Law applying to them. Understanding these provisions is key to navigating the wealth of tax obligations and benefits you can access using this type of structure.

Under the different UAE laws, multiple types of foundations and trusts exist. A foundation, generally a civil law concept, is, in principle, a type of structure with a legal personality. Being endowed with legal personality, it would be subject to UAE CIT if not for the special regime applicable to it under the UAE CIT Law.

Trusts are generally a common law concept and, in the UAE, also have legal personality when established under the UAE Trust Law (see Article (3) of that Law). The same holds for endowments under the UAE Endowments Law No (5) of 2018 (see Article (10)1 of that law), but not for trusts established in the Financial Free Zones.

Foundations have gained a lot of popularity in recent years. Indeed, in the UAE, these vehicles are mainly used for succession planning and asset protection.

Tax Transparency of Family Foundations

Article 1 of the UAE CIT Law defines a family foundation as a foundation, trust, or similar entity. In other words, the family foundation as a concept under the UAE CIT law refers to a broader context than just foundations per se.

These entities are established with the primary aim of benefiting identifiable natural persons or public benefit entities. The beneficiaries need to be identified or identifiable (e.g., distant relatives, friends, or future offspring). Their core activities consist of managing assets or funds related to savings or investments.

The key provision is Article 17 of UAE CIT Law, which allows family foundations to be treated as unincorporated partnerships and, hence, not be subject to UAE CIT. Following the application of these provisions, family foundations are, therefore, transparent for tax purposes. This means that any potential taxation shifts a level, in this case, to the family foundation’s beneficiaries.

Several conditions need to be met for a family foundation to be treated as a fiscally transparent entity. From an administrative point of view, an application to that effect must be filed with the UAE Federal Tax Authority (“UAE FTA”).

A family foundation seeking to be treated as fiscally transparent is not permitted to undertake activities that would have constituted a business activity within the meaning of the UAE CIT Law if the activity had been undertaken or the assets held by the founder, settlor or any of the beneficiaries of the structure. In this regard, in general, the constitutional documents of the family foundation outline the objectives of the vehicle. Those would normally not include commercial objectives.

This means that if the income was directly earned by natural persons, or the assets directly held by one of the above natural persons, the income would not fall inside the scope of UAE Corporate Income Tax. By reference to Article 11, 6 of the UAE CIT Law, Cabinet Decision No. 49 of 2023 states that employment income, real estate income and personal investment income earned (directly) by a natural person are not within the scope of UAE CIT and do not constitute business income. Real estate income and personal investment income are relevant for family foundations, employment income is not, as a legal person cannot have an employment contract.

The ensuing fiscal transparency also ensures a better alignment of UAE CIT with the neutrality of legal forms. Indeed, the possibility of family foundations being treated as fiscally transparent entities reflects the reality that individuals use those entities to manage their personal wealth and investments for a number of legitimate aims, such as asset protection, succession, and other reasons. The income from those assets would otherwise also not be liable under UAE CIT had it been earned directly by those individuals. The foundation, or the trust, comes with the added benefit of asset protection and succession planning.

Any potential capital gains realized by the family foundation, e.g. through the sale of shares or real estate assets, would also likely not be considered taxable at the family foundation level. This point is, however, unclear, and no guidance exists to confirm it. Equally, in regard to the accumulation of assets, guidance is lacking, but it is assumed by the authors it also benefits from the transparency regime.

Another requirement is that the family foundation must not be set up for the main or principal purpose of avoiding UAE CIT. Given the tax neutrality achieved by a family foundation under the UAE CIT Law, the structure is treated as a pass-through, so there would not necessarily be any possibility for the avoidance of taxes.

Common Family Foundation Structures

A UAE resident individual wishes to preserve their assets for succession planning and contributes his Dubai real estate assets to the family foundation, as well as the shares held in the top holding company of a large, diversified group. The individual has fallen out with certain kids. He instead wants to favor other kids in terms of succession while avoiding inheritance disputes. Therefore, the individual contributes the shares held in the Holding Co and settles a concessionary rate to the Dubai Land Department for the transfer of the real estate assets into the Foundation. This situation is depicted below.

Payments to Beneficiaries

While not explicitly stated in the UAE legislation, payments made to beneficiaries fall under the general rules. Given that the family foundation is fiscally transparent, the tax regime needs to be analyzed at the beneficiaries’ level.

While not made explicit, we would expect that given the income earned is outside of the scope of UAE CIT, based on the exclusion under the abovementioned Cabinet Decision No. 49 of 2023, there would be no UAE CIT applicable.

If the beneficiaries are not UAE tax residents, however, the tax regime applicable to the payments made to the beneficiaries will depend on the tax regime applicable in the country where the beneficiaries are tax residents.

Disqualified Family Foundations

Disqualified family foundations, because they conduct commercial activities, would not benefit from tax transparency for family foundations. Foundations are legal entities and therefore when disqualified they would be taxed as normal legal persons. As to trusts, this would depend on their legal status, as they may not have legal personality.

UAE VAT Obligations of Family Foundations

VAT and UAE CIT operate under different definitions. Therefore, it is perfectly foreseeable for a family foundation to have no corporate tax liabilities but encounter VAT liabilities.

For example, if it owns rented commercial real estate and its turnover exceeds the Mandatory Registration Threshold of AED 375,000, the family foundation is required to register for VAT purposes.

Substance for Family Foundations

Under the UAE’s Economic Substance Regulations (“ESR”), licensees earning relevant income are subject to substance requirements, which may entail the obligation for these entities to file a notification and report.

According to the UAE MoF’s FAQs, however, a “trust” or a “foundation” would generally not be considered a licensee. Some foundations may, however, be considered a “Holding Company Business” given that they hold shares and earn passive income. As such, they are subject to substance requirements, which may be limited, as substance requirements for holding companies are reduced.

According to the UAE MoF, the ESR regime may soon be changed or repealed.

Family Foundations and International Tax

In this regard, MOF FAQ No. 107 states: “Further information on the transition from the existing Economic Substance Regulations after the UAE Corporate Tax regime comes into effect and any substance related reporting and compliance obligations for Qualifying Free Zone Persons will be provided in due course.”

Complications arise when assets are held internationally, i.e., if a UAE family foundation keeps assets outside of the UAE territory.

When it comes to real estate assets abroad, they are traditionally agreed to be taxable in the country of situs or source, i.e., where the real estate asset is located. If the income from the real estate is taxable in the country of source, and there is a provision to avoid double taxation under UAE CIT Law or the relevant treaty, the taxes would not be creditable at the level of the family foundation, given that the family foundation is not liable to tax. The tax in the country of source would, therefore, constitute an unrelieved business cost. The beneficiaries also should not be in scope and, thus, would not be able to claim foreign tax credits.

The same situation applies to withholding taxes, which may constitute a pure deadweight cost for the family foundation.

Tax treaty entitlement of tax-transparent entities, such as foundations, is also not guaranteed. Only in 2017 was an additional provision added to Article 1 in both the OECD and UN Model (i.e., under Article 1,2) to confirm that tax-transparent entities can claim treaty benefits, subject to various conditions.

Public Consultation

Aurifer’s views on Pillar Two for the UAE

Post author By Thomas Vanhee
Post date April 22, 2024

the-uae-pillar-two-public-consultation-document

Aurifer’s views on Pillar Two for the UAE

The UAE Pillar Two Public Consultation document was initially issued by the UAE Ministry of Finance as part of their groundwork for Pillar Two implementation. Aurifer has integrated its responses within the document and our firm views do not necessarily reflect the views of our clients, nor of the individuals employed by the firm. Access the document by clicking the “Subscribe and Download PDF.”

Tax Updates UAE Corporate Income Tax UAE Tax

Business Visitor VAT Refunds

Post author By Thomas Vanhee
Post date March 22, 2024

Income Tax Return Deduction Refund Concept

Business Visitor VAT Refunds

Check your business eligibility for foreign business refund via the Business Visitor Refund Scheme in the EU and GCC. Download our latest brochure here.

UAE Corporate Income Tax

Tax Groups under UAE Corporate Income Tax: What You Need to Know

Post author By Thomas Vanhee
Post date February 23, 2024

Tax Groups under UAE Corporate Income Tax: What You Need to Know

The UAE Corporate Income Tax in Articles 40-42 of the UAE Corporate Income Tax Law (Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses) contains provisions on “Tax Groups”, i.e., the situation where two or more taxable persons are allowed to form a tax group and, therefore, be treated as a single taxable person for UAE CIT purposes.

Forming a tax group may benefit taxable persons from various perspectives, such as the possibility to offset income and losses between its members, tax neutralization of inter-group operations, or administrative advantages such as the ability to file a single tax return.

The UAE Federal Tax Authority (FTA) has further commented on the tax group provisions under UAE CIT in the Corporate Tax (CIT) Guide on Tax Groups (CTGTGR1), issued on 8 January 2024. The FTA’s Guide is a valuable resource for taxable persons who are considering forming or entering into a tax group.

We analyze tax group provisions under UAE CIT, also in light of the latest indications contained in the FTA’s Guide, more in-depth below.

Eligibility Criteria

In order to form a tax group, the parent company must file an application before the FTA, where it needs to demonstrate that all of the following conditions are satisfied:

1. Members of the tax group are juridical persons

For a company to form or be part of a tax group, it must be a juridical person, i.e., an entity with a legal identity separate from its founders, like joint stock or limited liability companies. Accordingly, sole establishments run by individuals do not qualify due to the absence of legal personality. The FTA’s Guide clarifies that unincorporated partnerships, due to their lack of separate legal identity, are ineligible for tax grouping in the UAE, in contrast to incorporated partnerships.

The FTA’s Guide leaves the eligibility of foreign-incorporated partnerships managed in the UAE somewhat open to interpretation. Analyzing the relevant provisions of UAE CIT Law and the FTA’s interpretation of those criteria, it seems plausible that these foreign entities, if managed in the UAE and meeting specific legal entity criteria, might qualify for inclusion in a tax group.

On the other hand, it is settled that a juridical person within a fiscally transparent unincorporated partnership is eligible to join a tax group as a member (see our previous reports discussing UAE legal structures and partnerships here).

There is no limit to the number of members of a tax group. However, a juridical person can only be a member of one tax group at any given time. It is also not possible for a parent company to form or enter into multiple tax groups with different subsidiaries.

2. Members of the tax group are UAE residents

The condition of being resident in the UAE includes both entities incorporated in the UAE and foreign entities if effectively managed within the UAE.

However, residency eligibility extends only to entities recognized as UAE tax residents under applicable Double Taxation Agreements (DTAs). Consequently, a juridical person taxed as a resident in another country under such agreements is outright excluded from tax group membership.

DTAs typically set forth their own criteria determining tax residency and may have tie-breaker rules, or, usually, as a last resource to break the “tie”, MAP to determine in which jurisdiction a company is a resident. Tax residency under the relevant DTA is, therefore, critical for defining a company’s ultimate eligibility for inclusion in a tax group. A foreign company not classified as a UAE resident person is ineligible for tax group membership.

Last but not least, having a permanent establishment (PE) in the UAE does not, by itself, suffice for a foreign legal entity to qualify as a UAE resident since the residence criteria under Article 11(3) of UAE CIT Law are not met by a PE.

Embedded in this requirement is that for the purposes of forming a tax group, a UAE resident parent is required. In other words, a group which a foreign holding company holds cannot qualify (unless the foreign holding company is a tax resident in the UAE).

Illustrative example: resident subsidiaries of a foreign parent forming a tax group

Source: Corporate Tax (CIT) Guide on Tax Groups (CTGTGR1), p. 22

Description

Company F (incorporated in and tax resident of a foreign country) holds 100% of the share capital of Company E, which in turn holds 100% of the share capital of Company A, Company B, and Company C. Company A, Company B, Company C and Company E are all incorporated and resident in the UAE for CIT purposes.

Assuming all other conditions to form a tax group are met, Company E, as a parent company, can apply to the FTA together with Company A, Company B, and Company C to form a tax group for UAE CIT purposes.

3. Parent company owns (in)directly at least 95% of the share capital of members of the tax group

Establishing a tax group in the UAE requires the parent company to own, directly or indirectly, at least 95% of the share capital in each subsidiary.

This threshold is key for including companies with minority shareholders, which might be essential due to legal requirements in company formation (e.g. a company type requires two shareholders and the company is incorporated with 99% of the shares held by the parent and 1% by another group company).

Share capital, defined as the nominal issued and paid-up capital, is crucial in determining shareholders’ rights like voting, profit distribution, and capital return.

The FTA’s Guide further elaborates on different types of share or capital and their impact on the formation and maintenance of a tax group according to UAE CIT Law. An important element to note in this regard is that the term “shares or capital” must be interpreted consistently with other provisions under UAE CIT Law and UAE Ministry of Finance (MoF)’s Implementing Decisions (in particular, Ministerial Decision No. 116 of 2023 on the Participation Exemption for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses).

This would suggest an approach favouring a holistic interpretation of the UAE CIT provisions, opening up to cross-references to fill in possible legislative gaps under UAE CIT Law and implementing regulations.

Illustrative example: shares with a different nominal value

Company A (incorporated in and tax resident of the UAE) has issued two classes of shares to its shareholders:

Source: Corporate Tax (CIT) Guide on Tax Groups (CTGTGR1), p. 26

Description

Company B holds 100% of Class 1 shares of Company A. Applying the formula above to Class 1 shares leads to the following result: 1,000 ÷ 2,000 × 100% = 50%.

As the number of shares held in Company A is weighted by reference to their nominal value, the share capital ownership condition is not met by Company B even though Company B has 100% of the Class 1 shares and 99% of the total number of shares.

As rights relating to the shares (such as voting rights and profit rights) are usually determined by reference to the nominal value, this provides a more realistic picture of the ownership stake in Company A.

4. Parent company owns (in)directly at least 95% of the voting rights of members of the tax group

To establish a tax group, the parent company needs to control a minimum of 95% of the voting rights in each subsidiary, counting both direct and indirect holdings. This voting rights condition is separate from share capital ownership and focuses on shareholder-approved matters.

While typically aligned with share capital, voting rights might differ due to share classes, restrictions or unique share types. Accordingly, the assessment of such a condition can produce different results than the share capital condition if restrictions on voting rights apply or if voting rights are not aligned with share capital ownership.

This occurs in the case of shares without voting rights or, on the contrary, carrying extraordinary voting rights. On the other hand, we note that eligibility under the voting rights condition is unaffected in case of vote agreements existing between shareholders or arrangements for a proxy vote.

5. Parent company is (in)directly entitled to at least 95% of each subsidiary’s profits and net assets

Establishing a tax group necessitates the parent company’s entitlement to at least 95% of a subsidiary’s profits and net assets, independently verified from share capital ownership.

This dual condition involves complex assessments, especially when diverse share classes or contractual arrangements exist that might skew the alignment between ownership percentages and economic entitlements.

To this end, the focus is on effective entitlement to profits and net assets. As such, the analysis of both conditions requires a nuanced understanding of legal and financial structures within the company, ensuring that even in the presence of varied share classes, shareholder agreements, nominee agreements or other types of agreements, the parent company maintains the requisite level of control over profits and net assets.

6. No member is an exempt person or QFZP

Tax grouping under UAE CIT specifies that exempt persons or Qualifying Free Zone Persons (QFZPs) are prevented from forming or joining a tax group.

This aligns with the principle of grouping entities having aligned tax obligations (see our previous reports discussing the UAE Free Zone Regime here). In other words, the UAE legislator metaphorically does not want to mix apples and oranges. This is common in other jurisdictions too. Doing otherwise, i.e., allowing tax grouping between members subject to a different tax regime would trigger considerable complexity.

However, a Free Zone Person who is not a QFZP can be part of a tax group if all the other conditions for forming or joining a tax group are met. A Free Zone Person may be a disqualified QFZP or may have opted out of the QFZP regime.

Therefore, being a legal entity established in one of the over 40 UAE Free Zones is not preclusive to tax group eligibility. It also follows that if a tax group member becomes an exempt person or non-electing QFZP, it must exit the tax group from the start of that tax period. Worth noting is that government entities, as exempt persons, cannot form or join tax groups, but their taxable subsidiaries can, under specific conditions. Furthermore, small business relief under Article 21 of UAE CIT Law applies to the tax group’s consolidated revenue, thus possibly affecting individual members’ eligibility for this relief.

7. Members of the tax group must have the same financial year

The financial year condition for tax groups in the UAE emphasizes uniformity in tax filing periods among all tax group members, aimed at simplifying tax administration and reducing the complexity of apportioning results.

This requirement implies that all members must align their financial year with the parent company, including newly incorporated entities wishing to join. Each legal entity can do this by making an application before the FTA before joining a tax group.

Moreover, should there be a need to change the financial year for any member, it must be coordinated across the entire tax group to maintain compliance. This underscores the importance of synchronization in financial reporting within tax groups, ensuring streamlined tax processes and adherence to regulatory requirements.

8. Members of the tax group must prepare their financial statements using the same accounting standards

The accounting standards condition for tax grouping in the UAE mandates not only uniformity in financial years but also in financial reporting. In this regard, it is a requirement that all tax group members use the same standards, typically International Financing Report Standards (IFRS) or IFRS for SMEs if revenue is below AED 50 million.

Financial alignment is meant to facilitate the preparation of consolidated financial statements for the entire tax group, which is crucial for determining taxable income.

In cases where individual members use different standards (e.g., AAOIFI accounting standards for Islamic Financial Institutions), they must align their practices before forming or joining a tax group. The emphasis on consistent accounting practices across the group enhances transparency and accuracy in financial reporting for tax purposes.

As the discussion above shows, establishing a tax group in the UAE is a multifaceted process that necessitates adherence to a series of detailed but also open-to-interpretation criteria.

Modifications to Tax Groups

The FTA’s Guide outlines various scenarios that can occur within a tax group, including formation, joining, leaving, changing the parent company, as well as cessation. The timing of these events is also dictated by the UAE CIT Law. We summarize these events relevant to the lifetime of a tax group under UAE CIT Law below.
The first relevant event relates to entering into a tax group. Joining a tax group involves a subsidiary applying with the parent company to the FTA, provided all the relevant conditions are met. The application submission also determines the tax period for joining. For newly incorporated entities, joining is possible from their incorporation date, either as a new subsidiary or a new parent company.
On the opposite side of the spectrum, there is exiting a tax group. Leaving a tax group occurs when a subsidiary either applies with the parent company for departure, no longer meets membership conditions, or ceases to exist due to business transfer. In cases of business transfer, tax implications of asset and liability transfers are considered, with exceptions for business restructuring relief or qualifying group relief.
Changing the parent company for tax group purposes requires an application to the FTA, ensuring the new parent meets all necessary conditions. This change can happen either through meeting the tax group conditions or as a universal legal successor following a merger or transfer.
We note that the compliance implications of all the changes above are significant. Notably, if a subsidiary does not continuously meet tax group conditions, it must file taxes separately and is liable for its own UAE CIT. Importantly, incorrect tax returns due to unrecognized changes in the tax group can lead to administrative penalties for both the departing entity and the remaining members of the tax group. These complexities highlight the importance of accurate and timely management of tax group status changes to avoid compliance issues and financial penalties.

Deregistration and Cessation of a Tax Group

In essence, the formation or inclusion in a tax group does not necessitate the deregistration of its members, and these members are exempted from filing individual tax returns. A taxable person must apply for tax deregistration if they discontinue their business or business activity.

However, in a tax grouping setting, the cessation is evaluated based on the tax group’s overall activity. This means that if an individual member ceases its business, it does not mandate the deregistration of the entire tax group unless the group as a whole ceases its business activities.

When all members of a tax group cease their business activities, the parent company should request the dissolution of the tax group by applying before the FTA. This application should confirm that all outstanding CT liabilities and administrative penalties have been paid and that the tax group has filed all tax returns. Upon approval of this application, the FTA will deregister the Tax group for CIT purposes from the cessation date or another date set by the FTA.

Subsequently, each member of the dissolved tax group must individually apply for tax deregistration. The FTA’s Guide provides further details as regards the conditions for tax deregistration, including the dissolution of the tax group, a change in the parent company, or the cessation of a subsidiary within the tax group.

When a tax group applies for cessation through the parent company, this application also includes a request for the tax group’s deregistration for UAE CIT purposes. This does not necessarily trigger any consequences for VAT purposes, since tax grouping under UAE CIT is distinct from tax grouping under UAE VAT.

On the other hand, the tax group must confirm in this application that all corporate taxes and administrative penalties are cleared and all tax returns are filed for the FTA to proceed with deregistration. If a tax group ends because it no longer meets the necessary conditions, it must inform the FTA within 20 business days. This notification is also considered the same as a deregistration request. The tax group must state whether all taxes, penalties, and returns are addressed for the FTA to process deregistration.

Finally, in cases where a tax group has only two members, and one transfers its business to the other, resulting in its cessation, the tax group ends as of the transfer date. The remaining entity must notify the FTA within 20 business days of the effectuated transfer, and this notice is taken as a deregistration application. Similarly to other deregistration procedures, the tax group must confirm the payment of all taxes and penalties and the filing of returns for the FTA to proceed with deregistration. No separate application for business restructuring relief is needed in this scenario.

Conclusion and grouping as a planning tool

In conclusion, the ultimate decision to form or join a tax group under UAE CIT Law involves a balanced evaluation of envisaged tax advantages and disadvantages. It is crucial for MNEs operating in the UAE to ensure that all relevant factors are properly considered and that the decision on tax grouping aligns with the MNE’s overall strategic objectives.

Notably, tax grouping serves its best purpose when certain members of the group are loss-making entities. This is because, in a tax group setting, the losses of loss-making members of the tax group are offset immediately and in full against the profits of the profit-making members.

On a standalone basis, instead, losses can be carried forward and offset against 75% of future taxable income. On a standalone basis, losses can also be transferred between members of the same qualifying group (not tax group), which would require that members are 75% commonly held. A downside of forming a tax group is that the nil bracket up to AED 375,000 only applies once at the tax group level instead of multiple times at the individual member’s level.

Moreover, where administrative simplification may be touted for a group’s tax filing, it is not necessarily much simpler, given that a consolidation first needs to take place from an accounting and tax point of view. The filing itself (i.e. filing the numbers on the portal) is not in itself a very burdensome exercise.

Tax Updates UAE Corporate Income Tax UAE Tax

Key Developments in GCC International Tax Treaties – A 2023 Recap

Post author By Thomas Vanhee
Post date January 5, 2024

Key Developments in GCC International Tax Treaties – A 2023 Recap

UAE

January:

UAE and Chile – Income Tax Treaty between Chile and the United Arab Emirates was effective on 1 January 2023.

UAE and Zambia – The UAE and Zambia tax treaty entered into force on 13 January 2023 and has been retrospectively effective since 1 January 2023. The withholding tax rates are 5% on Dividends, Interests, Royalties, and Technical Services.

UAE and Democratic Republic of Congo – As per the latest information provided in the August 2023 update by the UAE MoF, the Income Tax Treaty (2021) between Congo and the UAE became effective on 24 January 2023. This treaty will be applicable from 1 January 2024 for withholding and other taxes.

February:

UAE and Gabon – The UAE and Gabon tax treaty entered into force on 16 February 2023 and was retrospectively effective from 1 January 2019. The withholding tax rates are 10% on Dividends and Royalties, 7% on Interests, and 7.5% on Technical and other Services.

May:

UAE and Czech Republic – The Czech Republic and the UAE signed the Czech Republic – UAE Income Tax Treaty (2023). The signing was held in Prague on 24 May, marking a significant milestone in bilateral cooperation between the two nations.

UAE and Swiss Federal Council (Bundesrat) – The Swiss Federal Council (Bundesrat) approved the Protocol to the Switzerland – UAE Income Tax Treaty (2011) on 17 May 2023.

August:

UAE and Cambodia – The third round of negotiations regarding a tax treaty between Cambodia and the United Arab Emirates took place on 21 August 2023. During this meeting, the representatives of both nations addressed all outstanding matters that were carried over from the previous round, which was held earlier on 11 April 2023, leading to an agreement on 30 of the 31 articles under discussion for the Tax Treaty

October:

UAE and Ukraine – As of 19 October 2023, the amending Protocol of Ukraine – United Arab Emirates Income and Capital Tax Treaty (2003) has come into effect. The amending Protocol was signed on 14 February 2021 and will be applicable from 1 January 2024 for withholding and other taxes.

UAE and Tanzania – On 9 October 2023, the UAE Cabinet approved the income tax treaty with Tanzania, which was initially signed on 27 September 2022.

November:

UAE and Ivory Coast – The tax treaty between the UAE and the Republic of Ivory Coast was originally signed on 25 November 2021. The UAE Cabinet granted its formal approval to this bilateral agreement on 4 September 2023.

UAE and Swiss National Assembly (Nationalrat) – The Swiss National Assembly (Nationalrat) has granted its approval to the amending Protocol signed on 5 November 2022, which pertains to the Switzerland and UAE Income Tax Treaty (2011). This Protocol, after endorsement by the Council of States (Ständerat), will proceed further in the legislative process.

UAE and Cuba – Cuba and the United Arab Emirates signed an Income Tax Treaty on 29 November 2023.

QATAR

January:

Qatar and Czech Republic – Czech Republic and Qatar signed an Income Tax Treaty on 21 June 2022, which became effective on 1 January 2023

March:

Qatar and Guernsey – The Protocol to the Double Tax Treaty between Qatar and Guernsey entered into force as of 8 March 2023. The DTT was signed by the two countries back in 2013.

June:

Qatar and Uzbekistan – Uzbekistan and Qatar signed an Income Tax Treaty on 6 June 2023.

Qatar and Ukraine – On 11 June 2023, the amending Protocol, which was signed on 2 September 2021 and pertains to the Qatar – Ukraine Income Tax Treaty (2018), became effective. The provisions of the Protocol concerning withholding and other taxes are typically applicable from 1 January 2024. Importantly, the Protocol has been integrated into the primary text of the Treaty.

October:

Qatar and Saudi Arabia – On 31 October 2023, according to information published by the Saudi Arabian government, the Saudi Arabian Council of Ministers authorized the negotiation and signing of an Income Tax Treaty with Qatar. The Tax Treaty to be negotiated, signed, and ratified by both contracting parties will be the first agreement of this kind between Saudi Arabia and Qatar.

Qatar and Egypt – On 19 October 2023, the President of Egypt signed Decree No. 254 of 2023, ratifying the Income Tax Treaty concluded with Qatar on 27 February 2023. The Decree was published in Egypt’s Official Gazette No. 42 on 19 October 2023. The DTT is not yet in force, pending ratification by Qatar.

SAUDI ARABIA

January:

Saudi Arabia and Morocco – The Income Tax Treaty between Morocco and Saudi Arabia was effective on 1 January 2023.

Saudi Arabia and Sri Lanka – Sri Lanka and Saudi Arabia signed an Income Tax Treaty on 26 January 2023.

November:

Saudi Arabia and Slovakia – Saudi Arabia and the Slovak Republic formally signed an income tax treaty on 13 November 2023. The signing took place in Bratislava, Slovakia.

Saudi Arabia and Gambia – The Gambia and Saudi Arabia entered into a tax treaty on 9 November 2023 as part of the Saudi-Arab- African Economic Conference held in Riyadh on the same day.

Saudi Arabia and Egypt – Saudi Arabia and Egypt are in the process of negotiating a revision to their DTT.

OMAN

January:

Oman and Qatar – The Income and Tax Capital Treaty between Oman and Qatar became effective on 1 January 2023.

May:

Oman and Egypt – Egypt and Oman signed an Income Tax Treaty on 22 May 2023 and a Memorandum of Understanding on cooperation in areas related to financial policies and developments on the sidelines of the Egyptian-Omani Business Forum in Cairo.

July:

Oman and Cyprus – Oman signed a DTT with Cyprus. Official approval was granted for an agreement to combat double taxation and address tax evasion pertaining to income taxes on 19 July 2023.

November:

Oman and Russia – On 29 November 2023, the Russian government announced the approval of the Oman-Russia Income Tax Treaty (2023) by the Russian State Duma, the lower chamber of the Russian parliament. The treaty outlines specific tax rates.

Oman and Kazakhstan – On 10 November 2023, the Kazakhstan government granted authorization through Decree No. 994 for the Minister of Finance to sign an income and capital tax treaty with Oman. An official version of the income and capital tax treaty has yet to be published.

KUWAIT

March:

Kuwait and San Marino ‘initiated’ a DTT on 23 March.

July:

Kuwait and Ecuador – Substantial progress was revealed in the ongoing negotiations for a DTT between Ecuador and Kuwait. The discussions, now at an advanced stage, indicate a promising advancement in the bilateral tax relations between both countries.

Customs & Trade Int'l Tax & Transfer Pricing Tax Updates UAE VAT

Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors

Post author By Thomas Vanhee
Post date December 29, 2023
No Comments on Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors

Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors

Explore the complexities of real estate investment taxation in the UAE with the article “Immovable Property Income in the UAE: Tax Implications for Domestic and Foreign Investors.”

This piece, authored by our very own Thomas Vanhee, Priyanka Naik, and Giorgio Beretta, and featured in Tax Notes International on December 18, 2023, offers a detailed look at the new corporate tax landscape effective June 1, 2023.

It provides valuable insights for both local and international investors navigating the UAE’s real estate market.

Click to read the full article and stay informed about these essential tax developments.

GCC Tax Int'l Tax & Transfer Pricing

Overview Draft KSA Income Tax Law and Draft Tax Procedures Law

Post author By Thomas Vanhee
Post date November 3, 2023

Overview Draft KSA Income Tax Law and Draft Tax Procedures Law

On 25 October 2023, the Zakat, Tax and Customs Authority (“ZATCA”) in the Kingdom of Saudi Arabia (“KSA”) published the Income Tax Law Draft (“proposed Law” or “new ITL”) in the Istitlaa Portal, which aims to update the KSA’s income tax system, currently governed by the Income Tax Law (Royal Decree No. M/1 dated 1/15/1425 AH) (“current Law”). At the same time, ZATCA also published a draft of the Zakat and Tax Procedural Law on the same platform (“draft Procedural Law”).

ZATCA proposes replacing the existing Income Tax Law with a new draft that aligns with the KSA’s evolving tax landscape, embraces global best practices to stimulate investment, and streamlines compliance and transparency. In addition, it implements defensive measures against transactions with tax havens. We summarise below the main changes to the application of corporate income tax in KSA if the proposed Law comes into force.

Tax haven blacklist

The proposed Law provides several provisions aimed at tackling profit shifting and tax avoidance. The proposed Law introduces the concept of a preferential tax regime, which is not present in the current Law. According to the proposed Article 10(2), any transaction involving a resident or permanent establishment in a jurisdiction that employs a preferential tax regime will have special provisions applicable, which are less favourable than the normal regime. These special provisions pertain to how expenses, depreciation, WHT rates, and TP regulations are applied.

A tax regime qualifies as preferential if it meets one of the conditions outlined in the proposed Article 10(3). Likely, the most prominent situation is the one where a country applies a statutory income tax rate of less than 15%. Further, a country will also be considered to have a Preferential Tax Regime if it has no information exchange agreement or if it does not have substance requirements applicable in its jurisdiction.

The jurisdictions that fall under this preferential tax regime will be determined through a decision made jointly by the ZATCA Board and the Ministry of Foreign Affairs. In other words, they will draw up a blacklist. In the region, these provisions will impact UAE, Bahrain, Qatar and Kuwait, all countries that either tax below 15% or exempt GCC-held businesses. KSA may essentially be blacklisting those countries, and policy responses will be expected from those countries.

The WHT rate for payments to such preferential regimes will always be 20%, irrespective of the type of payment. Where there is no Double Tax Treaty (“DTT”) available with the residency country, this impact is profound. In the GCC, KSA currently only has a DTT with the UAE, although negotiations for a DTT with Qatar are underway.

Other consequences include that the participation exemption may not apply when the investee is in a jurisdiction regarded as a preferential tax regime. Further, the deductibility of expenses for payments made to preferential tax regimes may be impaired, and depreciation may not be available for the purchases of assets from preferential tax regimes.

Withholding taxes

The proposed Law makes a clearer division for the application of withholding taxes. Withholding taxes will be applicable for the following payments:

Dividends, rental payments, and interest payments: 5%
Payments for Services: 10%
Royalties: 15%

Currently, a more detailed analysis of the nature of the services is required to identify the applicable WHT rate. The amendment is a surprise given that a recent reform has already taken place. Since 12 September 2023, the WHT rate for technical and consultancy services between related parties was reduced to 5% from 15%. The draft Law would now bring all services to 10%. This is not a positive evolution, given the expansion of the economy and current interactions with non-resident suppliers. Companies in jurisdictions that have DTTs with KSA may seek shelter under those treaties unless they have a Permanent Establishment in KSA.

Special incentives

Article 33 of the proposed Law foresees that special tax regulations may apply. This prefaces different tax regulations related to the SEZs in KSA, the ILBZ and potentially for the RHQ in accordance with the Regional Head Quarter Regime and other potential regimes.

In the same vein, there will be deductions for R&D and incentives for Green Investments. The design of those deductions and incentives may be in line with a Qualifying Refundable Tax Credit under the Pillar Two rules. Further, the creation of an investment reserve will encourage investment in assets.

Updated Residency rules and Service Permanent Establishment

In comparison to the current Law, the residency Article in the proposed Law (Article 2) gives extended details to the residence criteria of the natural person and sets rules to count the days in this regard. According to the Article, less time is required for natural persons to meet the residency criteria. Most crucial is that a natural person will be a tax resident for Income Tax purposes where they conduct business-related activities, and their length of stay exceeds 90 days during a tax year and 270 days over the course of three years.

In relation to the concept of Permanent Establishment (“PE”), the current Law provides two forms of PE: the Fixed PE and Agency PE. However, since the KSA, in practice, has also been enforcing a Services PE based on its sourcing rules, the proposed Law explicitly adds the Service PE in Article 6(3) with a threshold period of 30 days in any 12 months. This is a low threshold, which is likely easily to be crossed. The OECD’s Model Tax Convention has no Services PE, and the UN Model Tax Convention which puts the threshold at 183 days in any 12 months. Where KSA has DTT’s, the provisions of the DTT will prevail.

Binding nature of rulings and guide and Zakat penalties

Amongst others, the draft Procedural Law imposes penalties on non-compliant Zakat payers. It also would bind ZATCA to its own administrative guidance and rulings. This removes any ambiguity for all taxpayers as they are assured they can place reliance on the Law when in force.

Non-GCC national resident persons clarified to be in scope

These provisions have caused some concern amongst expats in KSA. It was already part of the law but has been clarified. It does not constitute Personal Income Tax but rather a business tax applicable to non-GCC nationals conducting a business in KSA.

Adoption BEPS standards

In the proposed Law, Article 19 includes interest deductibility limitations different from the current rules. As per these proposed rules, the net loan charges are tax-deductible only in the tax year they arise and are capped at a maximum of 30% of the adjusted earnings. This approach is considered best practice by the OECD, recommended under BEPS Action 4 and is in line with numerous other jurisdictions.

Further, the proposed Law tackles the issue of the hybrid mismatch of financial instruments between the KSA and other jurisdictions. It rejects any discounts or tax exemptions on the financial instrument if the tax is not appropriately imposed in the other country due to varying tax treatments between the KSA and that other country. Therefore, the application of such instruments will depend on the tax regime in the corresponding country. This provision is an implementation of the recommended norms under BEPS Action 2.

Further, KSA domestically also adopts a Principal Purpose Test, a norm prescribed under BEPS Action 6.

Consistency terms and clarifications

To ensure that the proposed Law is interpreted consistently and in a unified manner, the Law provides detailed definitions for existing terms in the current Law and consolidates them into one article rather than adding them to different articles in the proposed Law.

Furthermore, the proposed Law took a further step and included interpretation rules for undefined terms in the Law, where it has a hierarchy for different legal references starting with the meaning included in the Income Tax By-Laws through to the Accounting Standard adopted in the KSA that do not contradict to the proposed Law. There are a range of other provisions also included where their impact under the current Law is unclear.

Other provisions

The proposed Law treats the Partnership as fiscally non-transparent (opaque) for Tax purposes. In the current Law, the unlimited Partnership is treated as fiscally transparent.

The proposed Law explicitly states that expenses related to Real Estate Transactions Tax (“RETT”) and non-deductible VAT paid by the taxpayer will be deductible, provided these expenses are for the purpose of generating taxable income.

In this regard, it also states that any payments to a Related Person that is not at arm’s length will exclude the excess payment from being permitted as a deduction for the purpose of the proposed Law.

The statute of limitation for audits and refunds would further become five years instead of the currently applicable three years. Exit taxes apply for removing assets from KSA.

Pillar Two and entry into force

Currently, there are no Pillar 2 rules on the Global Minimum Tax detailed in the Draft ITL, even though many large GCC-held businesses may have an ETR below 15%, considering the application of Zakat. When they have constituent entities in other jurisdictions that implement Pillar 2, these businesses may be impacted as of 1 January 2024.

The Entry into force is foreseen for 90 days after publication in the Official Gazette. The Regulations are aimed to be issued by the ZATCA Board 180 days after issuance of the Law and would immediately enter into force after publication. Given the timelines on the public consultation, this means that the Law will likely not enter into force and be applicable before Q2 2024.

UAE Corporate Income Tax UAE Tax

UAE’s Corporate Tax Framework: Understanding Participation Exemption

Post author By Thomas Vanhee
Post date November 3, 2023

UAE’s Corporate Tax Framework: Understanding Participation Exemption

The UAE Ministry of Finance recently issued Ministerial Decision no. 116 of 2023, which provides new clarity, especially regarding the Participation Exemption in the UAE Corporate Tax (CT) landscape.

We dissected the recent Ministerial Decision and highlighted key application conditions for the UAE CIT Participation Exemption, the ‘equivalence requirement’, and ‘subject-to-tax requirement.’

MD 116 of 2023 also provides further details as regards Islamic financial instruments, debt instruments and exchanges of Participating Interests.

Check below to learn more.