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Does the newly issued UAE economic substance guidance answer all questions?

Does the newly issued UAE economic substance guidance answer all questions?
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Does the newly issued UAE economic substance guidance answer all questions?

Does the newly issued UAE economic substance guidance answer all questions?

Earlier this year, the United Arab Emirates (“UAE”) issued Cabinet Decision No. 31 concerning economic substance requirements (“Economic Substance Regulations” or “ESR”). UAE onshore and free zone entities (“Licensees”) that carry out one or more Relevant Activities as defined under the ESR, are required to meet the Economic Substance Test in respect of the Relevant Activities carried out in the UAE. However, many businesses were left wondering how to meet certain criteria set out by the ESR. We previously wrote on the issue. To see our previous article, click here.

On 11 September 2019, the Ministry of Finance published Ministerial Decision No. 215 for the year 2019 on the issuance of directives for the implementation of the provisions of the Cabinet Decision No. 31 concerning economic substance requirements (“The Ministerial Decision”). The Ministerial Decision contains guidance on how the Economic Substance Test may be met by Licensees in order to comply with the ESR. The guidance is intended to serve as a guide to entities carrying out one or more Relevant Activities captured by the ESR. In addition, the Ministerial Decision sets out various guidelines on how Regulatory Authorities shall comply with the various functions imposed on them by the ESR and which powers are granted to them to ensure effective execution of the ESR provisions.

Licensees

Every Licensee that carries on a Relevant Activity and derives an income therefrom in the UAE, including a Free Zone or a Financial Free Zone, must meet the Economic Substance Test (article 3.1. and 4.1 of The Ministerial Decision). It seems that licensees carrying on a relevant activity, without deriving any income from that activity, are not in scope of the ESR. The practical implications of this requirement seem rather limited, as most of the Relevant Activities as defined in the ESR (perhaps with the exception of holding activities) are usually carried out for consideration.

The ESR stipulate that its provisions do not apply to entities that are directly or indirectly owned by the Federal Government, or the Government of any Emirate of the UAE or the governmental authority or body of any of them (article 3 (2) of the ESR). The Ministerial Decision now clarifies that the government’s shareholding interest must be at least 51% for the entity to fall outside the scope of the Economic Substance Regulations (article 3.2. and 4.2 of The Ministerial Decision).

Relevant activities

With respect to the Relevant Activities, carried out by Licensees, the Ministerial Decision reiterates that:

  • Licensees that carry out more that one Relevant Activity are required to satisfy the Economic Substance Test for each Relevant Activity (article 6 (1) of the ESR); 
  • There are reduced substance requirements for holding companies that do not carry out any other Relevant Activity (in short, Holding Companies are not required to carry out any Core Income Generating Activities in the UAE); and
  • Higher reporting requirements and standards apply for Licensees that derive income from a High Risk IP Business. Such Licensee shall be presumed by the Regulatory Authority to not meet the Economic Substance Test (see below). This assumption must be rebutted by the Licensee (article 5.3 of The Ministerial Decision). Furthermore, the Regulatory Authority is required to submit all information obtained in relation to such Licensee to the the Ministry of Finance, irrespective whether the Regulatory Authority has made a determination as to whether such Licensee has met the Economic Substance Test or not (see below).

The Economic Substance Test

Reporting requirements

Under the ESR, Licensees are required to submit an information notification to the Regulatory Authority, indicating (i) whether or not it is carrying on a Relevant Activity, (ii) whether or not all or any part of the Licensee’s gross income in relation to the Relevant Activity is subject to tax in a jurisdiction outside of the UAE, and (iii) the date of the end of its Financial Year. The Ministerial Decision stipulates that the notification must be made with effect from 1 January 2020.

In addition, a Licensee that is carrying on a Relevant Activity and is required to satisfy the Economic Substance Test, must prepare and submit a report to the Regulatory Authority, no later than twelve (12) months after the last day of the end of the financial year of the Licensee. The Ministerial Decision clarifies that this requirement applies in respect of financial years commencing on or after 1 January 2019.

Each Regulatory Authority shall set out the form of reports to be filed and mechanisms for submitting such forms to the Regulatory Authority.

Meeting the Economic Substance Test

In general, the Economic Substance requirements will be met:

  • If Core Income Generating Activities (“CIGA”) are conducted in the UAE;
  • If the activities are directed and managed in the UAE;
  • If there is an adequate level of qualified full-time employees in the UAE, 
  • If there is an adequate amount of operating expenditure in the UAE,
  • If there are adequate physical assets in the UAE.

The Ministerial Decision clarifies that the list of CIGA not exhaustive. This means that other activities outside the ones listed in the ESR, which could be considered as (one of) the most important activities of a Licensee, may qualify as CIGA and should therefore be carried out in the UAE. This may also be an indication that a Licensee is not required to carry out all CIGA listed in article 5 of the ESR in relation to a Relevant Activity.

A Licensee’s activity is directed and managed if there are an adequate number of board meetings held and attended in the UAE in relation to that activity. The term adequate is dependent on the level of Relevant Activity carried out by the Licensee. Meetings must be recorded in written minutes which are kept in the UAE and signed by attendees. Quorum for such meetings must be met and attendees must be physically present in the UAE. Directors must have the necessary knowledge and expertise in relation to the Relevant Activity, which entails that their activity is not merely limited to giving effect to decisions being taken outside the UAE. In the event that a Licensee is managed by an individual (e.g. single managing director), the Ministerial Decision states that these requirements will apply to such individual.

The meaning of the term “adequate” in terms of the level of qualified full-time employees, the amount of operating expenditure and physical assets will be dependent on the nature and level of Relevant Activity being carried out by the Licensee in question. A licensee must maintain sufficient records to demonstrate the adequacy in relation to these requirements. Employees must be suitably qualified to carry out the Relevant Activity. Premises may be owned or leased by the Licensee, however, the Licensee must be able to submit the necessary documentation evidencing the right to use the premises.

With respect to outsourcing, the Ministerial Decision clarifies that timesheets can be used to demonstrate the level of employees which are being outsourced in relation to a certain Relevant Activity. Furthermore, outsourcing may not be used with the objective of circumventing the Economic Substance Test.

Retention of information and Records

The ESR do not prescribe a set period for the retention of information and records by Licensees. Taking into account the six-year limitation period for the Regulatory Authority to determine whether a Licensee has met the Economic Substance Test, it is advisable that a Licensee retains any relevant information evidencing compliance with the ESR for a period of six years. 

Any records required to be kept and submitted to the Regulatory Authority must be provided in English. In the event that such records are kept in a language other than English, the Licensee shall provide an English translation thereof.

Regulatory Authority functions

The Ministerial Decision provides further detail on how Regulatory Authorities shall comply with the various functions imposed on them by the ESR and which powers are granted to them to ensure effective execution of the ESR provisions.

The Regulatory Authority shall obtain all documentation, records and information from any Licensee which they are required to submit to the Regulatory Authority within the timeframe stipulated in the ESR. The Regulatory Authority shall follow-up promptly with any Licensee in the event of any delay of failure in the submission of required documentation, records and information or in case the latter would prove to be incorrect or incomplete. 

In this respect, the Regulatory Authority may:

  • Serve a notice on a Licensee requiring further documentation or information; and/or
  • Enter a Licensee’s premises in order to obtain necessary documentation or information; and/or 
  • Impose on a Licensee an administrative penalty not exceeding AED 50,000.

The Ministerial Decision further provides guidance to Regulatory Authorities on how to determine whether a Licensee has met the Economic Substance Test (e.g. timesheets may be used as a means to verify adequate” employee criterion). In general, the Ministerial Decision states that the Regulatory Authority should adopt a strict yet pragmatic approach to determine whether a Licensee meets the Economic Substance Test.

In case a Licensee fails to meet the Economic Substance Test, the Regulatory Authority shall issue a notice, stating the reasons for that determinations, containing details of any administrative penalty, directing any action to be taken to satisfy the Economic substance Test and advising the Licensee of its right to appeal.

The Regulatory Authority will notify the Competent Authority of each Licensee that fails to satisfy the Economic Substance Test in relation to any activity. The Competent Authority shall provide the submitted information to the Foreign Competent Authority in the event that (i) the Licensee fails to meet the requirements under the ESR for a certain Financial Year, or (ii) the Licensee carries out a High Risk IP Business.

Conclusion

The Ministerial Decision provides some clarification with respect to a number of elements touched upon in the ESR (e.g. which companies are outside of scope of the ESR, the deadlines for the submission of the notification and reports to the regulatory authority, guidance on how to meet the Economic Substance Test). For the most part, however, the guidance merely reiterates the provisions of the ESR. We therefore expect that a large number of companies in the UAE will still have many questions in terms of how to comply with the ESR.

As expected, the Ministerial Decision does not contain one-size-fits-all criteria on how to meet the Economic Substance Test (i.e. in the sense that the Ministry of Finance does not prescribe a specific number in terms of what is considered an adequate number of employees, operating expenditure and physical assets). What qualifies as adequate, will instead depend on the nature and level of the Relevant Activity carried out by the Licensee and it will be up to the latter to provide evidence thereof to the Regulatory Authority.

Another thing worth noting is that the Ministry of Finance has given ample freedom to the Regulatory Authorities to ensure the effective implementation of and compliance with the ESR. Given the fact that every Regulatory Authority has been given the opportunity to determine its own forms and mechanisms for submitting the economic substance reports, in combination with the fact there seems to be some leniency in terms of determining whether a business has met the economic substance test (after all, one Regulatory Authority’s interpretation of what is adequate may differ from another), from a practical point, businesses can expect some level of divergence in terms of how the ESR will be implemented between the different Regulatory Authorities in the UAE.

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Customs & Trade Int'l Tax & Transfer Pricing

10 things to know about the UAE’s Country by Country Reporting

10 things to know about the UAE’s Country by Country Reporting
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10 things to know about the UAE’s Country by Country Reporting

10 things to know about the UAE’s Country by Country Reporting

The UAE is a popular destination for foreign entities to set up their businesses in the Middle East region, amongst others because there is no corporate income tax on the federal level. 

In line with international developments around tax transparency, the UAE decided to align its legislative framework with international tax practices by adopting Country by Country Reporting (“CbCR”). The adoption of BEPS Action 13 (introduction of CbCR legislation) is a strong recommendation from the OECD and is part of the wider OECD BEPS action plan and the Inclusive Framework.

Below we list the top 10 things to know for UAE businesses in relation to the new CbCR.

     1. What is a Country by Country Report?
The CbCR is a high level report through which multinational groups report relevant financial and tax information, for each tax jurisdiction in which they do business.

      2. Who does it apply to?
The reporting is compulsory for multinational groups which are present in at least two tax jurisdictions and which meet the consolidated revenue threshold of AED 3.15 billion (approx. USD 878 million) in one financial year. The subsidiaries of the group need to be linked through common ownership or control.

     3. Which entity files the CbCR?
Multinational groups have to establish which entity must submit this report, the i.e. the ultimate parent entity (“UPE”) or a surrogate parent entity (“SPE”). If the tax jurisdiction of the UPE does not have CbCR legislation or does not (automatically) exchange the reports, the tax jurisdiction of the SPE needs to file the CbCR.

The jurisdiction where the CbCR is filed will automatically exchange the information shared in the CbCR with the other tax jurisdictions in which the group is active.

    4. If the UAE entity does not file the CbCR, does it have any other obligation?
If the UAE entity is part of a multinational group, it needs to notify the UAE Ministry of Finance of the name of the entity submitting the CbCR and the tax residence of this entity before the last day of the financial reporting year (31 December 2019 for the first year). There is no formal process in place yet for notifying MoF of this.

    5. When do we submit the CbCR?
The CbCR regulations came into effect as of 1 January 2019, this means that for the financial year ending 31 December 2019, the CbCR must be submitted at the latest by 31 December 2020, and annually thereafter.

    6. What information should we provide?
The CbCR needs to include the amount of revenues, profits (losses) before income tax, income tax paid, income tax payable, declared capital, accrued profits, number of employees, and non-cash or cash-equivalent assets for each country. 

     7. What will the CbCR be used for?
The CbCR allows tax authorities around the world to automatically exchange information on taxable profits in different tax jurisdictions. The information allows the tax authorities to make a first assessment before highlighting risk jurisdictions in which too little tax is being paid.

Given the current absence of Federal Corporate Income Tax, the UAE authorities will not have a particular interest in the CbCR. Other States however will be interested in what the UAE subsidiary of the international group is reporting.

     8. How long do we keep the information?
The relevant records need to be maintained until 5 years after submitting the CbCR. The records can be kept electronically and in English.

     9. Is there a format for submitting the CbCR?
The report should be in the same format as per the OECD guidelines. Click here for Appendix C of OECD’s guide for reference.

    10. Are there any penalties for non-compliance?
(See above table)
Except for the additional daily penalty, the total fines imposed may not exceed AED 1,000,000 in one financial year.

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Customs & Trade Int'l Tax & Transfer Pricing

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?
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Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

Just how spectacular are the new UAE Economic Substance Regulations for the UAE?

At a glance

On 30 April 2019, the United Arab Emirates (“UAE”) issued Cabinet Decision No. 31 concerning economic substance requirements (“Economic Substance Regulations”). UAE onshore and free zone entities that carry on specific activities mentioned in the regulations will need to examine whether they meet the economic substance requirements. Failing to meet those will trigger penalties. But why is this at first glance inane looking piece of legislation so important for the UAE?

Background

The introduction of a legal framework regulating the economic substance criterion in the UAE is a direct consequence of the Organisation for Economic Co-operation and Development’s (“OECD”) ongoing efforts to combat harmful tax practices under Action 5 of the Base Erosion and Profit Shifting (“BEPS”) project. 

It also follows the increased focus by the European Union (EU) Code of Conduct Group (“COCG”) on companies established in jurisdictions with a low or no income tax regime, resulting in the publication of the first EU list of non-cooperative jurisdictions, which currently includes the UAE (“EU Blacklist”). In response to the EU COCG initiatives, the governments of the Bahamas, Bermuda, British Virgin Islands (BVI), Cayman Islands, Guernsey, Isle of Man, Jersey, Mauritius and Seychelles introduced economic substance rules with effect from 1 January 2019.

There has also been growing interest and scrutiny from the public opinion as to whether entities established in such jurisdictions should be required to have sufficient economic substance before being able to benefit from beneficial tax regimes. 

The purpose of the Economic Substance Regulations is to curb international tax planning of certain business activities, which are typically characterised by the fact that they do not require extensive fixed infrastructure in terms of human and technical capital, in a way which allows profits to be shifted to no or nominal tax jurisdictions, as opposed to taxing profits where the company has actually created economic value. 

One of the reasons why the UAE has attracted so many businesses is because there is currently no income tax regime at a federal level. The economic substance legislation is specifically targeted at businesses that do not have genuine commercial operations and management in the UAE.

The main reason why the UAE has decided to introduce economic substance legislation lies in the country’s aim to further align its legislative framework with international tax practice and the standards set out in the OECD BEPS action plan.

What is economic substance?

Economic substance is a concept introduced to ensure that companies operating in a low or no corporate tax jurisdiction have a substantial purpose other than tax reduction and have an economic outcome that is aligned with value creation. In other words, economic substance requirements are used to analyze whether a company’s presence has a purpose besides the mere reduction of a tax liability. 

Which entities are in scope?

The Economic Substance Regulations apply to UAE onshore and free zone entities that carry out one or more of the following activities:

  • Banking
  • Insurance
  • Fund management
  • Lease-finance
  • Headquarters
  • Shipping
  • Holding company
  • Intellectual property (IP)
  • Distribution and service centre

Entities that are directly or indirectly owned by the UAE government fall outside the scope of the Economic Substance Regulations.

Economic Substance Test

Entities are required to meet the Economic Substance Test when they conduct any of the above activities.

For each Activity, the regulations have defined the so-called Core Income Generating Activities (“CIGA”). This is a list of activities that must be conducted in order to meet the Economic Substance Test. For example, for intellectual property the CIGA would consist of research and development.

In general, the Economic Substance requirements will be met:

  • If CIGA are conducted in the UAE;
  • If the activities are directed and managed in the UAE;
  • If there is an adequate level of qualified full-time employees in the UAE, 
  • If there is an adequate amount of operating expenditure in the UAE,
  • If there are adequate physical assets in the UAE.

In case the CIGA are carried out by another entity, these need to be controlled and monitored.

In accordance with EU recommendations, the regulations provide for less stringent requirements for Holding Company Businesses (“Holding Companies”).

Outsourcing

The CIGA may be outsourced, if there is adequate supervision and the outsourced activity is conducted in the UAE. Economic substance requirements will not be met if multiple Licensees outsource the same activity to the same service provider. There is no possibility for double counting the same service provider.

Reporting and compliance 

Licensees will need to prepare and submit an annual report to their Regulatory Authority (Free Zone Authority or DED), within a period of twelve months after the end of each financial year. The Regulatory Authority will then submit the report to the Ministry of Finance (“Competent Authority”).

Since the Economic Substance Regulations came into effect per 30 April 2019, for existing entities, the first report will have to be submitted in 2020. 

Administrative penalties and sanctions

– Failure to meet the economic substance test

AED 10,000 to AED 50,000 (First Financial Period)

AED 50,000 to AED 300,000 (Consecutive Financial Periods)

– Failure to provide information

AED 10,000 to AED 50,000

In case of continuous non-compliance, Regulatory Authorities may suspend, revoke or deny renewal of an entity’s license.

Exchange of information

If a Licensee fails to meet the Economic Substance Test for a financial year, the Regulatory Authority will inform the Minister of Finance for the financial year in question. 

The Minister of Finance will then inform the foreign competent authority where the parent company, ultimate parent company or ultimate beneficial owner is established of the non compliance. This may lead in these countries to denying treaty benefits. This requires that the UAE has entered into a Treaty or similar arrangement with that country.

Takeaway – much ado about?

UAE entities involved in banking, insurance, fund management, investment holding, financing and leasing, distribution and service center, headquarter companies and intellectual property (IP) activities should asses whether their current presence and activity level meets the newly introduced Economic Substance requirements. 

Where required, they make the necessary adjustments to ensure that their business is compliant with the UAE regulations which entered into force on 30 April 2019, in order to avoid  administrative penalties, and potentially deregistration.

Moving away from the dusty provisions of the law, what consequences does the Economic Substance law now really trigger?

Operational companies should be little worried. They will not be impacted. The very small companies should be slightly worried. The businesses that were attracted by 50 year tax holidays and other promises and failed to develop any substantial activity in the UAE should be more worried.

How much the UAE will be effectively policing this legislation remains to be seen. Merely taking the example of Switzerland, that country had signed up to multiple exchange of information obligations but dragged its feet for the longest time. 

For now though, the UAE has an argument towards the EU and, more importantly, individual countries, to get the UAE off their blacklists. This is important, since some UAE headquarters are currently being denied double tax treaty benefits in a number of countries, because of its failure to comply with international norms.

The legislation may potentially become obsolete though, if the UAE introduces Corporate Income Tax at a rate considered high enough to no longer be considered as a low tax jurisdiction.

Read our previous article on the introduction of Economic Substance Requirements in the UAE here. 

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Customs & Trade Int'l Tax & Transfer Pricing

UAE economic substance requirements to be implemented

Disclosing the UBO in the UAE
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Disclosing the UBO in the UAE

UAE economic substance requirements to be implemented

With the impending publication of the drafting of an economic substance law in the UAE, it is important to anticipate the consequences of the introduction of such a law on the UAE and offshore structures in the UAE. The UAE currently has no such substance requirements but has been strongly encouraged by the European Union to implement them. The impact on offshore structures will be substantial.

Current lack of substance requirements

The UAE is a federation of seven emirates. There is currently no direct tax legislation on a federal level in the UAE. However, some Emirates (e.g. Abu Dhabi, Dubai, Sharjah,…) have introduced income tax regimes for oil and gas companies and foreign banks. These decrees only apply to companies which are established in one of the aforementioned Emirates. The Income Tax Decrees do not contain any substance criteria.

Partly as a result of the current lack of substance requirements in the UAE, it has become increasingly important for international companies established or operating in the UAE to prove that the entity or structure has not been set up solely for tax purposes. 

Tax residency certificate

Corporations established in the UAE can apply for a ‘tax residency certificate’ (‘TRC’) with the Ministry of Finance of the UAE. A tax residence certificate (‘TRC’) is a certificate issued by the UAE government to eligible government entities, companies and individuals to benefit from Double Tax Treaties signed by the UAE.

The following documents are generally required in order to apply for the tax residency certificate:

  • Valid Trade License.
  • Certified Articles or Memorandum of association.
  • Copy of identity card for the Company Owners or partners or directors.
  • Copy of passport for the Company Owners or partners or directors.
  • Copy of Residence Visa for the Company Owners, partners or directors.
  • Certified Audited Report.
  • Certified Bank Statement for at least 6 months during the required year.
  • Certified Tenancy Contract or Title Deed.

Please note that although the requirements do not expressly mention that the certificate can only be granted to local companies, the Ministry of Finance does not issue tax residence certificates to offshore companies (not to be confused with free zone companies). 

Although the TRC may be helpful to obtain benefits under double tax treaties, in itself it cannot be considered as proof of economic substance in the UAE.

Developments on substance requirements in the UAE

Background

On 1 December 1997, the EU adopted a resolution on a code of conduct for business taxation with the objective to curb harmful tax competition. Shortly thereafter, the Code of Conduct Group on Business Taxation (COCG) was set up to assess tax measures and regimes that may fall within the scope of the code of conduct for business taxation.

On 5 December 2017, the COCG published the (first) EU list of non-cooperative jurisdictions for tax purposes, in cooperation with the Economic and Financial Affairs Council (ECOFIN).

The EU applies three listing criteria, which are aligned with international standards and reflect the good governance standards that Member States comply with themselves:

  1. Transparency: Jurisdictions should comply with the international standards on exchange of information, automatic (1.1) and on request (1.2). In addition, jurisdictions should sign the OECD’s multilateral convention or signed bilateral agreements with all EU Member States to facilitate such exchange (1.3).
  2. Fair Tax Competition: Jurisdictions should not have harmful tax regimes (2.1) nor facilitate offshore structures which attract profits without real economic activity (2.2).
  3. BEPS Implementation: Jurisdictions should commit to implement the OECD’s Base Erosion and Profit Shifting (BEPS) minimum standards, starting with Country-by-Country Reporting.

The UAE was initially placed on the EU Black list. However, following commitments to take appropriate measures against the above criteria, the EU transferred the UAE to the EU Grey list. 

However, due to non-compliance with criterion 2.2, the UAE was subsequently put back on the Black list at the start of this year. Criterion 2.2 requires that a jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction. 

Therefore, in order to fulfill its commitments to the EU, it is reasonable to expect that the substance requirements are likely to be introduced in the UAE in the foreseeable future. 

In accordance with the scoping paper on criterion 2.2 published by the COCG on 22 June 2018 and the associated work of the OECD’s Forum on Harmful Tax Practices (FHTP), the below describes how businesses may be impacted and what substance requirements could potentially be introduced in the UAE in the future.

Expected substance Law requirements

The scoping paper suggest to implement the substantial activities requirement in three key steps: 

(1) identify the relevant activities in their jurisdiction; 

(2) impose substance requirements; 

(3) ensure there are enforcement provisions in place. 

According to the Scoping Paper, the economic substance test would be met if:

a) Taking into account the features of each specific industry or sector, the concerned jurisdiction introduces requirements concerning an adequate level of (qualified) employees, adequate level of annual expenditure to be incurred, physical offices and premises, investments or relevant types of activities to be undertaken.

b) The concerned jurisdiction ensures that the activities are actually directed and managed in the jurisdiction. Any UAE substance requirements are likely to further specify when this condition would be met e.g., depending on frequency of board of director meetings, directors physically present, minutes recording strategic decisions and the knowledge and expertise of the directors.

c) The core income generating activities are performed in the jurisdiction. These substance requirements should mirror the requirements used in the FHTP in the context of specified preferential regimes. As per the scoping paper, the core income generating activities for banking could be: raising funds; managing risk including credit, currency and interest risk; taking hedging positions; providing loans, credit or other financial services to customers; managing regulatory capital; and preparing regulatory reports and returns.

Comparison with the other low tax jurisdictions which introduced the substance requirements

Following the EU blacklist of non-cooperative jurisdictions, many other low and nil tax jurisdictions have introduced economic substance requirements. Jurisdictions where substance compliance is required from 2019 include Bermuda, the British Virgin Islands (BVI), the Cayman Islands, Guernsey, and Jersey.

The Economic substance Law of BVI and Cayman Island are inspired by the core requirements in the scoping paper of the COCG and the FHTP requirements. The UAE is expected to follow the same path.

Conclusion

Currently, there are no substance requirements in the UAE. Corporations established in the UAE may apply for a ‘tax residency certificate’ with the Ministry of Finance of the UAE, when they qualify. Obtaining such a ‘TRC’ does not necessarily entail that a company has economic substance in the UAE.

Considering the efforts made by the UAE with respect to compliance with the fair tax competition criteria of EU, we anticipate that the UAE will issue economic substance requirements in the very foreseeable future, similar to the ones published recently by other low tax jurisdictions. 

The specific substance requirements in the UAE will likely depend on the type of activities conducted by the relevant business (e.g., banking, shipping and headquarter services would each require different substance requirements).

Businesses in the UAE should already assess their operations against the substance requirements in the light of the COCG and FHTP guidelines. 

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Customs & Trade Int'l Tax & Transfer Pricing

KSA publishes long awaited DTT with UAE

KSA publishes long awaited DTT with UAE
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KSA publishes long awaited DTT with UAE

KSA publishes long awaited DTT with UAE

The Double Tax Treaty (“DTT”) between the UAE and the KSA provides a significant tax incentive for businesses operating in the two contracting states. A positive impact on investment and trade between the two contracting States is expected in the aftermath of its entry into force. 

This is the first DTT signed between two GCC countries. KSA is a member of the G20 and a key player in the GCC economy and on the global oil markets. It is keen to reinforce its promising investment environment. On the UAE side, the signing of this DTT reinforces its status as a regional hub for foreign investments and shows its commitment to its continued attractiveness and excellence. 

Both contracting countries are members of the BEPS inclusive framework and signed the Multilateral Instrument (“MLI”). Signing such a bilateral DTT is a new step towards compliance with BEPS minimum standards – notably regarding transparency and tax avoidance. It goes hand in hand with the extensive TP legislation recently published in KSA. 

This article highlights the key features of the DTT and analyses its tax implications for businesses operating in the two contracting states.

1. About the Treaty

Due to lengthy negotiations, the treaty is based on the 2014 OECD Model Tax Convention, even though the model was updated in 2017. 

However, the KSA has already included this DTT in the list of its Covered Tax Agreements (“CTA”) in the MLI. It is yet to be included by the UAE, since the UAE signed the MLI shortly after the treaty.

The treaty will enter into force on the second month of the official notification between the two contracting countries. It is expected that the treaty will apply as of 1 January 2020.

2. Key Features 

Persons covered

Only the “residents” of the contracting states shall benefit from this treaty. 

This residence principle is generally adopted by the KSA in most of its recent treaties, contrary to the UAE which has recently opted for a citizenship criterion, such as for its recent DTT with Brazil. 

Residence

As a primary definition for “resident”, the treaty uses the standard language of the OECD Model Tax Convention.

An additional interesting provision is that the DTT expressly qualifies as resident, any legal person established, existing and operating in accordance with the legislations of the contracting states and generally exempt from tax:

•     if this exemption is for religious, educational, charity, scientific or any other similar reason; or 

•     if this person aims at securing pensions or similar benefits for employees.

Although the treaty does not specify whether the residence concept is applicable to businesses established in the Free Zones (UAE) or the Special Economic Zones (KSA), the competent tax authorities are required to coordinate to determine the requirements and conditions to be satisfied to be entitled to any tax benefit granted by this treaty.

Permanent Establishment “PE” Clause

The PE clause is largely based on the OECD Model Tax Convention, but features two elements inspired by the UN Model. It notably qualifies:

•      As a PE: a building site, construction or installation project after 6 months (12 in the OECD Model)

•      As a service PE: providing services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose if their presence lasts for a period or periods aggregating more than 183 days in any 12-month period

Taxes covered, rates and double taxation elimination

The DTT covers income tax and Zakat in the KSA and income tax in the UAE, inspite of the absence of a federal income tax law in the UAE.

No withholding tax regime applies in the UAE. The table added to this article shows the impact on the withholding tax rates in the KSA and the consequences of the treaty.

The DTT will not apply for royalty payments in case the beneficiary has a PE in the source country (exceptions apply). Similarly, excessive interest payments made between related parties shall not benefit from the DTT exemption.

The treaty provides for source country taxation only on income from natural resources exploration and development. The elimination of double taxation is performed through the tax credit method.

Zakat and the Treaty

Zakat is covered by the treaty (for the KSA). An interesting provision, introduced in several DTTs concluded by Saudi Arabia (e.g. Georgia, Mexico and Kazakhstan), states that “In the case of the KSA, […] the methods for elimination of double taxation will not prejudice the provisions of the Zakat collection regime.” 

This provision may have an impact on Zakat for UAE businesses, considering the recent update of the Zakat implementing regulations. This notably impacts PE headquarters that might be subject to Zakat in the KSA, if specific criteria are met.

3. MAP and other provisions

The treaty provides for a Mutual Agreement Procedure (“MAP”) which can be requested to the competent authority in any of the contracting states within 3 years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention. 

Investments owned by Governments (e.g. investments of Central Banks, financial authorities and governmental bodies) shall be exempt from taxes in the other contracting state. The income from such investments (including the alienation of the investment) is also exempt. The exemption does not include immovable properties or income derived from such properties.

There is no provision in the treaty for non-discrimination, assistance in the collection of taxes or territorial extension.

The entitlement to the benefits of the treaty will not be granted in case the main purpose of the transactions or the arrangements at stake is proved to be the enjoyment of such a benefit. 

4. Conclusion

Even though this DTT between the KSA and the UAE is largely based on the OECD model 2014, the PE definitions it provides adopted from the UN model, broadens the scope of the activities taxable in the source countries, and will require specific attention.

The relief of withholding tax on royalties and interests, along with the MAP will reinforce the business relationships between these two countries. It is regretful that there is not a clear framework for Free Zone or Special Zone companies.

Finally, it is to be expected that the treaty will soon be notified by the UAE as a CTA under the MLI. In such case, businesses willing to benefit from this DTT will have to satisfy the Principal Purpose Test for the concerned transactions or other investment arrangements.

Categories
Customs & Trade UAE Tax

UAE increasingly uses Anti Dumping Measures

UAE increasingly uses Anti Dumping Measures
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UAE increasingly uses Anti Dumping Measures

UAE increasingly uses Anti Dumping Measures

Since the introduction of its Anti Dumping law in 2017, the UAE has recently imposed anti dumping duties again to tackle goods dumped on the UAE market. Even though many countries have had a legal framework in place to take such measures since a long time, the UAE only adopted Federal Law No. 1 on Anti-dumping, Countervailing and Safeguard Measures in 2017.

This law implemented the 2011 GCC Common Law on Anti-dumping, Countervailing and Safeguard Measures. The law only applies to trade practices by non-GCC countries and not between GCC States.

Dumping occurs when goods are exported to the UAE at substantially lower prices than the sales price in the country of export. The sellers can for example offer these lower prices because of subsidies or other financial support provided by the government of the exporting country. 

In a wider perspective, as illustrated by the US-China trade war, countries are increasingly looking at trade measures to tackle trade imbalances. In 2015, the US decided to impose a 500% antidumping duty on Chinese steel.

In January 2019, the UAE Cabinet decided to increase customs duties applicable to rebar and steel coils from 5% to 10% as a means to provide trade protection to iron producers in the UAE. This article discusses the provisions of the mechanics of such trade measures in the UAE.

Assessing dumping

Dumping measures are taken after a complaint by the UAE industry or the minister. The complaint demonstrates the link between imports and similar domestic products and the damage caused to the domestic industry.

If the complaint is accepted, an investigation will be started and notified in the Official Gazette and UAE’s top two newspapers.

An Advisory Committee will send questionnaires to interested parties to obtain essential data, notify the countries concerned, inspect the exporter’s facilities, hold public hearings and prepare a preliminary report before making a decision.

The investigation will be terminated in cases the complaint is withdrawn, the dumping margin is less than 2% of the export price, the volume of imports is less than 3% of the total imports or if there is insufficient evidence to support the dumping claim.

What is the damage?

The damage caused to the domestic industry may take the form of material damage (e.g. a drastic drop in sales volume), a threat of material damage or material retardation to the establishment of a domestic industry.

The damage can be demonstrated by an increase in the volume of imports which leads to a significant depressing or suppressing effect on domestic prices.

Determining the dumping margin

The dumping margin is the fair comparison between the normal value and the export price of these goods. This will be the base for levying anti-dumping duties or alternative measures.

The normal value is the comparable price at which the goods under complaint are sold, in the ordinary course of trade, in the domestic market of the exporting country. The export price is the price at which goods are exported to the UAE. It is generally the value at ex-factory level. 

Imposing anti-dumping measures

During the investigation, provisional measures can be taken for 4 months. Provisional measures can be for example imposing temporary duties or requesting a security deposit upon import.

The investigation will be suspended or terminated if the exporter is willing to increase prices or cease exports at dumped prices.

The final decision of the investigation will either include the termination of the provisional measures or the imposition of a definitive measure. A definitive measure will be in the form of a duty valid for a maximum of 5 years or until the damaging effects of dumping have been eliminated (or any other trade measure).

The anti-dumping duty on imports of car batteries from South Korea is a prime example of a definitive measure imposed by the UAE since the introduction of the law. The duty remains effective for 5 years starting from 25 June 2017 onwards. 

The Advisory Committee will review these measures to ensure that they have the desired effect on the domestic economy. A review will also take place on the need for imposing anti-dumping duties for new exporters of like goods from the same country.

Effect on customs valuation and VAT

In the GCC, anti-dumping duties are levied over and above the normal customs duties applicable on on imports of goods. Customs duties and VAT are intrinsically linked. VAT applies on top of these customs duties. Since in the EU VAT also applies on top of anti dumping duties, presumably VAT also applies on top of anti-dumping duties.

Categories
Customs & Trade Int'l Tax & Transfer Pricing

BEPS MLI enters into force today

BEPS MLI enters into force today
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BEPS MLI enters into force today

BEPS MLI enters into force today

Tax avoidance and profit shifting have resulted in an estimated annual loss of USD 100 to 240 billion of tax revenue worldwide, effectively 4-10% of global corporate tax revenue. 
 
The Base Erosion and Profit Shifting initiative was endorsed by the OECD and the G20 and aims to address and tackle the shortcomings of the international tax system.

In order to achieve more quickly the objectives of the BEPS project, in November 2016 the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (also known as “MLI”) was adopted by over 100 jurisdictions.
 
The MLI is aimed at bridging the gap between international tax rules and the anti-BEPS measures. It simplifies the previously cumbersome process of renegotiation and amending tax treaties by allowing the MLI to supersede any existing treaties.

Once a bilateral tax treaty has been listed under the MLI, it does not need to be renegotiated for the MLI to have effect, thus avoiding any need for bilateral negotiations. The MLI notably contains a general anti-avoidance principle and specific provisions tackling the circumvention of treaty limitations or treaty shopping.  
 
The MLI will have a worldwide tax impact as its signatories include jurisdictions from all continents. On 29 June 2018 82 jurisdictions had signed the MLI, with a further 6 expressing their intent to sign. The current signatories have listed over 2,500 treaties, already leading up to over 1,200 matched treaties.
 
The MLI has now achieved the minimum number of ratifications to enter into force. As of today 1 July 2018, the MLI has entered into force in the ratifying countries. As from today, any jurisdiction ratifying the MLI will see it applying as from the date chosen for its entry into force. This will notably be the case on 1 October 2018 in the United Kingdom which ratified the MLI on 29 June 2018.

Direct impact on the GCC
 
The BEPS Inclusive Framework (“IF”) obliges committed countries to ratify the MLI or to meet its objectives. Being a member of the IF, the UAE, KSA and Bahrain have been working on modifying their tax policies. No GCC State however has ratified the MLI but they are expected to do so in the short run.
 
With the date of ratification yet undetermined, the consequences for GCC companies might seem far from their concern. However, examining each tax treaty with ratifying and non-ratifying countries and planning for necessary changes to be made is necessary to avoid its adverse effects. 
 
Leading up to the ratification of the MLI, businesses need to estimate costs of compliance, consider possible restructuring in order to continue benefiting from the double tax treaties and assess impacts on future cash flow. 
 
Indirect impact on the GCC
 
The jurisdictions ratifying the MLI are more likely to scrutinize the treaties and their benefits to ensure there is no abuse, even if the treaty is not covered by the MLI. Therefore, even in absence of ratification of the MLI by any GCC state, the application of its tax treaties might be altered by countries with whom treaties are signed and have ratified the MLI. 
 
Companies within the GCC with subsidiaries or parents in jurisdictions ratifying the MLI should assess all transactions to and from these countries in the light of the tax treaties impacted by the MLI. 
Categories
Customs & Trade GCC Tax

The UAE and Bahrain part of the BEPS Inclusive Framework

The UAE and Bahrain part of the BEPS Inclusive Framework
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The UAE and Bahrain part of the BEPS Inclusive Framework

The UAE and Bahrain part of the BEPS Inclusive Framework

Confirming their role as pioneers in building a sophisticated and efficient tax network, the UAE and Bahrain took strong steps forward to join international efforts against base erosion and profit shifting practices (known as BEPS).
 
Indeed, both of these countries has joined the BEPS Inclusive Framework, on 11 May and 16 2018 respectively, becoming the 115th and 116th country part of this initiative. 

The BEPS programme, started in 2013, was developed by 44 countries including all OECD (34) and G20 Members. It has three main objectives: 
– Reinstating the coherence of corporate income taxation from an international perspective
– putting the substance of the economic activities at the core of international taxation, and
– ensure transparency in the global economy. 

It resulted in the publication of 15 action plans in October 2015, known as the BEPS package.
 
Out of the 15 action plans, in January 2016 the OECD has prioritised 4 key priority measures. These measures are known as the BEPS Minimum Standards. They constitute the BEPS Inclusive Framework. 

The Inclusive Framework Members have committed to implement these actions quickly, and agreed to be subject to peer review to guarantee their effective implementation.
 
Accordingly, it is now highly likely that the UAE and Bahrain will, in the coming months, strengthen their tax compliance legislation in order to reach rapidly these four requirements, which aim at: 
  • Fighting harmful tax practices (BEPS Action 5), 
  • Preventing tax treaty abuse, including treaty shopping (BEPS Action 6), 
  • Improving transparency with Country-by-Country Reporting (BEPS Action 13), 
  • Enhancing the effectiveness of dispute resolution (BEPS Action 14).
Therefore, UAE and Bahraini Companies have to anticipate the increasing amount of administrative and tax requirements implied by these new concepts and obligations in the region. They must be ready to disclose several financial and business sensitive information to the Tax Authorities, much like their counterparts in the countries which have already adopted the measures. It is expected that both the UAE and Bahrain will be adopting the necessary legislative measures in the coming few months.  
 
Get in touch for a discussion on the assessment of the impact of these measures in the UAE and Bahrain. 

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