Category: UAE Tax

Impact of UAE Corporate Tax on Law Firms and Professional Services Firms

Post author By Thomas Vanhee
Post date June 27, 2023

UAE Free Zones - How Tax Exempt Are They?

Impact of UAE Corporate Tax on Law Firms and Professional Services Firms

1. Application of CIT to revenue of law firms and professional services firms

Applying the new UAE Corporate Income Tax (CIT) to law and professional services firms can be complex. This is, mainly, because the underlying structures of legal and professional firms may also be complex. In this section, we will first discuss firms structured as a regular legal person, such as a Limited Liability Company (LLC). We will distinguish between UAE mainland LLCs and Free Zone (FZ) LLCs. Subsequently, we will discuss entities potentially treated as transparent under UAE CIT, together with UAE branches of foreign (non-UAE) companies.

a. Legal Structures

i. Firm structured as a regular mainland UAE LLC

This type of corporate structure will frequently be adopted by several UAE law firms. UAE law firms have rights of hearing, therefore, they are necessarily owned by UAE (or GCC) nationals. Generally, they have no legal reason to be established in a UAE FZ and can, therefore, mostly be found in UAE “mainland” (i.e., non-FZ).

If so, UAE LLCs will be subject to 9% CIT on their worldwide profits, adjusted for tax purposes according to the relevant CIT legislation. This will be the default position for any law firms which are organized through a Limited Liability Corporation (“LLC”) in the UAE mainland.

ii. Firm structured as a mainland UAE partnership

An alternative legal structure may be that of a partnership. To this end, the UAE CIT law distinguishes incorporated and unincorporated partnerships.

The FAQs published by the UAE Ministry of Finance (MoF) provide examples of incorporated partnerships. According to the MoF’s FAQs, incorporated partnerships include Limited Liability Partnerships (LLPs), partnerships limited by shares, and other types of partnerships where none of the partners has unlimited liability for the partnership’s obligations or other partners’ actions[1].

This reference suggests that, where there is unlimited liability for corporate law purposes, the entity must be treated as transparent for CIT purposes[2]. This UAE approach is in line with that followed by other jurisdictions. Seemingly, incorporated partnerships where no partners have unlimited liability are subject to UAE CIT at the standard rate.

Unincorporated partnerships are described under the UAE CIT law as “a relationship established by contract between two Persons or more, such as a partnership or trust or any other similar association of Persons”[3].

Unincorporated partnerships are not considered taxable persons in their own right. Instead, they are considered “transparent”. It follows from this that partners rather than unincorporated partnerships are liable to tax, so that those transparent vehicles generally cannot claim any benefits under double tax treaties (DTTs), given that they do not meet the liable-to-tax criterion under Articles 1(2) and 4 of the OECD Model Tax Convention (MTC)[4].

The UAE Commercial Companies (CC) law, which is applicable in the UAE mainland and in any Free Zone not regulating corporate law itself, refers to two types of partnerships, i.e., a Joint Liability Company (JLC) and a Limited Partnership Company (LPC)[5].

Under the UAE CC law, a JLC is a company consisting of two or more physical partners who are severally and jointly liable in all their personal assets for the entity’s obligations[6]. As such, JLC would likely be treated as a transparent entity for corporate law purposes. Joint partners of a JLC are considered traders, and they are deemed to be conducting commercial activities directly.

Under the UAE CC law, an LPC is defined as “(…) a Company which consists of one or more joint partners, having the capacity of traders, who shall be liable, severally and jointly, for the partnership’s obligations, and one or more silent partners who shall not be liable for the partnership’s obligations, except to the extent of their contribution to the partnership’s capital. Silent partners shall not have the capacity of trader.”[7]

Given the criterion of “unlimited liability”, which the UAE seems to apply to both types of partnerships, JLC and LPC are likely to be treated as transparent for UAE CIT purposes, despite both being endowed with legal personality. This means that the individual partners will be considered as directly conducting the business, therefore being taxable persons of their own right liable to UAE CIT[8].

If transparency is not a preferred option, the legal entity treated as a partnership can file an application (i.e., an election) to be considered non-transparent (i.e., “opaque”)[9]. Where the application is successful, the status is effective from the start of the tax period in which the application is submitted or since the beginning of a subsequent tax period[10].

The election by an unincorporated partnership for non-transparency treatment under UAE CIT law is irrevocable, unless exceptional circumstances occur and subject to approval by the Federal Tax Authority (FTA)[11]. The unincorporated partnership, presumably only when transparent (since, otherwise, if opaque, the partners are disregarded for UAE CIT purposes), is required to notify the FTA within 20 business days from any partner joining or leaving its organization[12].

The underlying rationale behind an application for an incorporated partnership to be treated as an opaque structure and, therefore, as a full-fledged taxable person under UAE CIT could be:

Relieving the partners from the tax compliance burden and achieving simplicity
Enabling the partnership itself to access any of the 137 DTTs concluded by the UAE

iii. Mainland UAE branch of a foreign LLC

Sometimes, foreign firms are organized by way of a branch in the UAE mainland. The carrying out of professional activities through a branch in the UAE does not just have regulatory advantages in terms of the setup of the branch, but, when taxed, may also have the advantage that the branch (i.e., permanent establishment) income may be exempt or excluded from the scope of corporate tax in the country of the head office’s residence (in particular, in case of countries using the exemption method to avoid international double taxation).

There are no specific rules applicable to UAE mainland branches of a foreign LLC. Their profits are, therefore, taxable at the standard UAE CIT rate of 9%.

Complications with UAE-established branches, however, may arise with the allocation of profits between head office and branches, which requires a careful transfer pricing analysis of the functions, assets, and risks, following the OECD’s recommended Separate Entity Approach[13].

The discussions around profit allocations to branches could lead to mismatches between the UAE and the other country concerned, potentially leading to international double or non-taxation of the same profits. It is, therefore, critical for legal and professional firms operating cross-border to seek confirmation with the tax authority on the taxation of their branches, as well as about the method to avoid double taxation in the country of residence (i.e., the country of the head office or first establishment).

iv. Mainland UAE branch of a foreign partnership

It is common that law (mostly) and professional services firms (less so) outside the UAE and GCC region are organized by way of a partnership or LLP. This is very common in some countries like the United Kingdom and the United States.

The partnership structure offers a number of benefits in terms of the flexibility of making partners entitled to profits, but also regulatory, administrative and legal ease of having partners enter and exit, as well as other elements such as profit share entitlement for partners. A partnership is usually treated as transparent for corporate tax purposes in the country of residence or first establishment. It follows that only partners are subject to tax, usually by levying a Personal Income Tax (PIT) on their profit share entitlement.

If available, these partnerships may prefer setting up branches abroad, in countries which consider the branches and their partnerships as tax-transparent. Tax transparency in a foreign country gives the partnership more leeway on concluding cross-border ventures, sweeping up all income and expenses into one pool, determining a bigger profit pool to then subsequently distribute profits to the partners based on their profits share entitlement.

The circumstance that a partnership operates abroad in a jurisdiction where the partnership is not treated as tax-transparent may potentially create what is called, in technical terms, a “source-residence conflict”[14]. Taxation in the country of source cannot be considered in the country of residence if the foreign partnership would not be liable to tax itself in its residence country in the first place.

Whether the country of residence would generally provide an exemption or a credit is irrelevant: in this instance, the taxes paid in the country of source can be regarded only as a business cost for the partnership. Some countries solve this international tax issue through a legal fiction, which consists of allowing the partners to claim the tax credit which would have accrued to the partnership, had it not been transparent.

For this reason, it is often beneficial to set up a full-fledged subsidiary in those countries where the local branch would not be considered tax-transparent and may have an alternative structure catering for the countries where partnerships are not tax-transparent.

The UAE has provided flexibility in the application of its CIT to UAE branches of foreign unincorporated partnerships. The treatment of foreign partnerships under UAE CIT aims to mirror the tax treatment in the country of residence of the unincorporated partnership. If the partnership in the country of residence is tax-transparent, then the UAE would allow the same tax-transparent treatment for the UAE branch of the foreign partnership.[15] This is also the most common approach followed by other jurisdictions[16].

If the foreign partnership is treated as tax opaque in the jurisdiction of first establishment, then the UAE will not consider the UAE branch as transparent and levy UAE CIT upon it accordingly. The UAE CIT treatment will then be the same as the one applicable to a foreign LLC which has a branch in the UAE.

The tax transparency of UAE branches comes with some conditions attached:

The foreign partnership is not subject to tax under the laws of the foreign jurisdiction, i.e., if it is subject to tax, it is not transparent[17].
Each partner is individually subject to tax with regard to their distributive shares of any income in the foreign partnership[18].
The foreign partnership submits an annual declaration to the FTA confirming it meets the above conditions[19].
Adequate arrangements exist for cooperation between the UAE and the jurisdiction under whose applicable laws the foreign partnership was established for the purpose of exchanging tax information on the partners in the foreign partnership[20].

We discuss each of these conditions further below.

– Foreign partnerships not subject to tax

The complication around the application of the conditions laid down above is not so much on the requirement relating to the tax transparency of the foreign partnership. This is a condition which should be met, for example, in the case of a UK and US LLP. For partnerships established in other locations, an analysis will need to be made of the actual tax treatment of a partnership there.

– Each partner is individually subject to tax

The second condition, in comparison with the former one, is less straightforward. Tax transparency assumes taxation is triggered at another level, i.e., at the partners’ level. In the case of a UK LLP, partners in the LLP pay PIT to the extent they receive the income as self-employed partners.

It should be noted that natural persons, when conducting a business, are also in the scope of UAE CIT[21], and, for UAE CIT purposes, “Business” is defined in the same way as it is in the VAT law[22].

As regards resident natural persons, earning wages cannot be considered as conducting a business, regardless of the wages earned[23]. A wage is defined as “The wage that is given to the employee in consideration of their services under the employment contract, whether in cash or in kind, payable annually, monthly, weekly, daily, hourly, or by piece-meal, and includes all allowances, and bonuses in addition to any other benefits provided for, in the employment contract or in accordance with the applicable legislation in the State” (emphasis added).

In the UAE, partners working in a local branch of a foreign LLP would generally have an employment contract. Without an employment contract, historically, foreign partners could not obtain residency in the UAE, given that they require a visa. Their employment contract dictates their remuneration, which generally consists of salaried income plus a (more rather than less) substantial bonus at the discretion of the law or professional services firm.

This implies that the requirement to be subject to tax for the partners in order to obtain transparency may conflict with their (non-tax) employment status. Therefore, the actual employment relations between the partners and the firm need to be thoroughly analyzed.

If the UAE resident partners are not to be treated as independent or self-employed, and therefore conducting a business for UAE CIT purposes, the UAE mainland branch would be considered taxable, thus creating a “source-residence conflict”, potentially leading to a higher tax burden for the partnership[24].

When it comes to UAE-resident partners who earn salaried income and are entitled to a profits share, the subject-to-tax condition may not be met. A remedy against it could be to provide equity partners with an employment contract with a nominal salary (e.g., “nummo uno” or AED 1), stating that this salary constitutes an advance on their profits share, and reclaim the nominal salary when their profits share is paid out.

When it comes to foreign (non-UAE resident) partners in the partnership, the partner is considered subject to tax if they would be subject to tax on their distributive share of any income from the partnership in his (i.e., that partner’s) country of residence[25].

– Submission of annual declaration

The form and manner for this compliance requirement are yet to be defined by the FTA.

– Tax information exchange agreement

It is unclear what the MoF is actually referring to with this condition. There is a wide variety of international agreements which countries enter into for the purposes of exchanging tax information.

If, with this condition, the MoF is referring to the equivalent of Article 26 of the OECD MTC, then the fact that the UAE does not have a DTT with all countries (the United States being a notable absentee in this regard) may prevent the application of tax transparency treatment of a foreign partnership.

However, other tax agreements may also regulate the exchange of financial information, which may eventually be used for UAE CIT purposes. This is the case of FATCA, which requires banks and other financial institutions in the UAE to exchange information on account holders with the United States[26].

v. Firm structured as a UAE FZ LLC or non-transparent entity

The first question which needs to be asked is whether the FZ-established firm is transparent for tax purposes. The Company Regulations for the specific FZ will need to be analyzed to understand whether any of the partners have unlimited liability. In those FZs, different regimes may apply. For example, the DIFC has a separate limited partnership regime[27], and so does the ADGM[28]. These regimes need to be analyzed on a case-by-case basis.

If none have unlimited liability, then the firm will be considered equivalent to an FZ LLC. Subsequently, the firm will need to analyze whether it earns qualifying income subject to 0%.

vi. Firm structured as a UAE FZ partnership

The first question which needs to be asked is whether the firm is transparent for tax purposes. The Company Regulations for the specific FZ will need to be analyzed to understand whether any of the partners have unlimited liability. In those FZs, different regimes may apply. For example, the DIFC has a separate limited partnership regime[29] , and so does the ADGM[30]. These regimes need to be analyzed on a case-by-case basis.

If the partners have unlimited liability, then the firm will be considered tax-transparent. The levying of UAE CIT then moves to the partners’ level. Presumably, the partners will not be able to claim the status as a QFZP, since this is reserved for legal entities only, and, therefore, will be subject to tax at the standard UAE CIT rate of 9%.

vii. Firm structured as a UAE FZ branch of a foreign firm

The first question which again needs to be asked is whether the firm is transparent for tax purposes. The same criteria apply as for UAE mainland branches of a foreign firm.

If the branch is not transparent, the same complications may arise as to the allocation of profits to the branch. Given that it is established in an FZ, when not transparent, it will need to ask itself as well whether its income constitutes qualifying income.

viii. Summary Table

b. Other Considerations

i. Tax Grouping

UAE companies are entitled to form a “fiscal unity” or Tax Group for UAE CIT purposes upon application before the FTA. The most important condition for a Tax Group to comply with is the (in)direct shareholding requirement of 95%. However, FZ entities whose qualifying income are subject to 0% cannot enter into a Tax Group. In addition, the parent (which can be intermediate) needs to be a UAE company. Under this arrangement, only one tax return needs to be filed[31]. These conditions also apply to partnerships or branches of foreign partnerships established in any of the UAE FZs.

The availability of Grouping would require that there are multiple legal entities in the UAE which are taxable persons under the same regime (i.e. the default regime where they are a taxable person)[32].

There are notable differences with VAT grouping, the most important of them likely being that the common shareholding percentage for VAT groups is 50% or more (whereas for tax groups it is 95% or more[33]), and for VAT groups Free Zone entities can be included, whereas Qualifying Free Zone Persons are excluded from entering a tax group[34].

Below is a comparative table comparing tax groups with VAT groups.

Comparison	CIT	VAT
Consequence	Consolidation of profits and losses	Disregarding transactions between members VAT group considered as one taxable person for supplies and purchases and for right to recover input VAT
Common ownership	95% share capital, voting rights and entitlement to profits	50% voting/market value interest/control or side agreement Common Economic, financial and regulatory practices
Inclusion FZ/Exempt taxable persons	No	Yes
Transfer losses	Yes	N/A
Intra-group transfers	At no gain/no loss with 2 year claw back	Out of scope
Administration and payment	Parent	Responsible member
Joint liability	Yes – can be ring fenced on approval	Yes
Application	By parent and subsidiaries	By Responsible person

2. Expenses of a law or professional services firm

a. Expenses of an LLC or a non-transparent partnership

There are no specific provisions applicable to the expenses incurred by a law or professional services firm. Therefore, expenses borne by both types of firms are subject to the general UAE CIT rules. However, certain matters are specific to UAE law firms and professional services firms, which may be relevant to consider. Those are:

– Deduction for UAE CIT purposes of paid remuneration

Employee’s remuneration, whether it is a base salary or other types of income allowances, constitutes a deductible expense for UAE CIT purposes. This holds true, irrespective of the nationality of the employee (i.e., UAE, GCC, non-UAE, and non-GCC). It might be assumed that pension and social security contributions, or GOSI contributions, for employees holding GCC nationality would also be deductible.

– End of Service Gratuity and Pension Contributions for Non-GCC nationals

Employees who do not hold GCC nationality and who are not employed by a DIFC company are subject to the EOS regime, where employers need to provision an amount which is a multiple of their base salaries.

Currently, the UAE legislation does not provide for any treatment of such EOS provisions or other provisions for that matter. In our view, however, provisions created for uncertain future payments, write-off of assets, etc. will most likely not be allowed a deduction under UAE CIT. However, provisions that are created for expenses that are actually crystallized/incurred may be allowed.

For contributions into Private Pension funds made by an employer on behalf of the employees, the total value of contributions is deductible[35]. However, the value of each Pension Plan Member cannot exceed 15% of the total Pension Plan Member’s remuneration, which gives entitlement to a deduction under UAE CIT[36]. We understand this provision to state that one single member cannot benefit from more than 15% of the benefits in the plan in order for the payments into the plan to be deductible[37].

We would normally expect DEWS, the DIFC Employee Workplace Savings Plan to qualify. However, if there are fewer than seven employees with equal contributions, the 15% condition will not be met , and therefore the amount of deductible contribution will be capped at 15%.

For employees of a Qualified Free Zone Person (QFZP), however, the tax deduction entitlement and limitation above may have no tax impact if the QFZP only has qualifying income, being that income taxed at a 0% rate. A tax impact would materialize if a QFZP also earns non-qualifying income.

– Bonuses

Bonuses are an important component of remuneration packages for fee earners and partners. Bonuses constitute the variable part of monthly or annual compensation, which depends on the monthly or annual financial performance of the law or professional services firm concerned. For fee earners and non-equity partners, those bonuses are usually granted as part of their remuneration package as employees. Bonuses are granted at the discretion of the management or constitute fixed bonuses (tiered or other), as referred to in the employment contract or in the employee manual.

For equity partners, several practices exist. In the UAE, so far, those practices have not been driven by any tax consideration. This explains why examples are known to us where equity partners in UAE firms received their profit share on a cash rather than accrual basis (e.g. 9 months after the end of the financial year to give sufficient time for clients to settle their bills).

Given that audit practices in the UAE were not always consistent, or even absent for some companies, there was less corporate governance, and practices have varied considerably.

Equity partners also often do not actually hold equity stakes. They are only referred to as equity partners in name but hold no shares in the company. They will often hold a right to profits or hold ghost equity. These are contractual rights to profits, rather than the legal right which a shareholder has to receive dividends distributed by a company in which he or she holds shares.

In other situations, partners may hold units, the value of which is, however, annually determined by the partnership’s management. Partners are awarded units, and once the profit pool is determined, the number of units held will determine the profits the partner is entitled.

Both in the cases of ghost equity and units, an important question will be whether this constitutes a deductible expense, or is equivalent to a dividend, and therefore is paid after tax (in which case the profits are higher and, therefore, the net tax liability of the company would be higher).

Given that these constitute rather a contractual right and not a right based on shares held in the entity, the revenues earned from these contractual rights would likely rather be a tax-deductible expense. Should this approach be correct, however, effective entitlement to a deduction under UAE CIT would require careful drafting of the partnership agreement upon a partner joining a partnership.

– Other employee-related expenses

Insurance such as the workmen’s compensation would likely be deductible. However, insurance paid by the employer on behalf of the employee, like the unemployment insurance scheme in place in the UAE, would likely not be deductible, as it is not an expense for which the employer is liable.

– The deduction for tax purposes of profits distribution for partners considered as “connected persons” and whether it is considered at a market rate

In order to be deductible for UAE CIT purposes, any payment or benefit granted to a “connected person” must correspond to the market value of what is provided by the connected person and is incurred wholly and exclusively for business purposes.

Connected persons are:

i. the owner of the taxable person,

The owner would be a natural person who directly or indirectly owns an ownership interest in the taxable person or controls the taxable person.

ii. a director or officer of the taxable person, or

iii. a related party of the first two categories.

UAE CIT further provides that partners in a transparent unincorporated partnership are considered connected persons, and so are any related parties of those partners[38].

To determine what is the applicable market value, UAE CIT legislation refers to transfer pricing principles. And yet, none of the transfer pricing methods referred to under the UAE CIT law lends itself to determining what a market rate remuneration for a partner’s salary is. Also, there is a considerable amount of variation between the more traditional courthouse lawyers on the one hand, and corporate or tax lawyers on the other.

For managing partners of a law firm who have a more ceremonial role, and actually do not feature on the trade license as managers, there should be no concern. Similarly, for managing partners who are managers on the license but have no different remuneration package as compared to their peers, there should be no impact.

Given also limited public information on partner remuneration, law and professional services firms may be confronted with complexities around defending partner remuneration for partners qualifying as connected persons.

– The deduction of entertainment expenses

UAE CIT law puts a 50% cap on any entertainment, amusement, or recreation expenditure incurred for the purposes of receiving and entertaining customers, shareholders, suppliers, or other business partners.

These expenditures include but are not limited to meals, accommodation, transportation, admission fees and facilities and equipment used in connection with entertainment. The MoF also has the possibility to determine other types of excluded expenditure.

Examples of this type of expenditure could be an iftar meal for clients, a reception for the opening of a new office in the presence of business partners, a shareholder meeting abroad in a tourist location, or a new year’s reception. In practice, the deductibility of such expenses may often be litigated and disputed by tax authorities[39].

Interestingly, the entertainment expenditure limitation does not seem to impact such expenses incurred for staff. We assume that this is subject to the general rule and therefore be limited by the requirement that this is a business expense.

– Expense reimbursements

Quite often, fee earners will incur expenses to be reimbursed (e.g., hotel, transportation, meals, translation fees, research in databases, etc.). In a professional services environment, those expenses are even more important. Also, these costs are often recharged to clients. When they are recharged, they constitute expenses for the firm, and revenue as well.

When expenses are incurred in the name and on behalf of the client (e.g., license fees, court fees, etc.), these costs do not run through the profit and loss account of the company but rather through the balance sheet. These costs are therefore not expenses nor revenues for the company. From a VAT point of view, these types of expenses will be disregarded from the taxable amount as well[40].

– The deductibility of interest payments

Law and professional services firms sometimes need to borrow money for a variety of reasons (e.g., expansion into new regions, fit out new office, etc.). An interest expense is a deductible expense for UAE CIT purposes.

However, UAE CIT legislation caps the deductibility of net interest expenditure at 30 % of EBITDA[41]. Net interest expenditure is the amount by which the interest expense (including interest expense rolled forward) exceeds the interest income.

By way of an example, if the revenues of a firm are AED 1,000 and its cost of sales and overhead expenses are AED 600, then its EBITDA is AED 400. Any interest expenses it may incur would only be deductible up to a value of AED 120 (i.e., 30% of AED 400).

The MoF has determined a safe harbour of AED 12 million, below which the 30% EBITDA cap does not apply[42]. When the net interest expense is capped, the balance between the cap and the actual net expense can be carried forward for a maximum of 10 years[43].

Any interest expense which would be disallowed under other provisions of UAE CIT law (e.g., because it relates to exempt dividends) is excluded from the net interest calculation[44].

Certain taxable persons are excluded from the 30% EBITDA cap, such as:

Banks
Insurance providers
Natural Persons conducting a business, and
Any other Person as determined by the MoF

Finally, a group cap may be available for consolidated businesses[45].

Specific financial assistance rules apply as well, disallowing interest expenses entirely in certain situations[46]. This is the case where a loan is obtained, directly or indirectly, from a related party, and it is obtained for specific purposes, which are:

A divided or profit distribution to a related party
A redemption, repurchase, reduction or return of share capital to a related party
A capital contribution to a related party
The acquisition of an ownership interest in a person who is or becomes a related party following the acquisition

The deduction is allowed nonetheless when it can be demonstrated that the main purpose of obtaining the loan is not to gain an advantage under UAE CT[47]. It is considered that there is no UAE CT advantage where the related party is subject to UAE CT (or a tax of a similar character) in the foreign jurisdiction on the interest at a rate not less than the standard rate of 9% under UAE CT.

– Donations to charitable organisations

Donations, gifts, and grants provided to Qualifying Public Benefit Entities in the UAE constitute a deductible expense[48].

Accordingly, taxable persons will be eligible to deduct an equivalent amount of such contributions for the purpose of calculating the corporate tax liability due for the period.

It should be noted that Qualifying Public Benefit Entities are exempt from UAE CIT, provided they meet the conditions laid down under Article 9 of the UAE CIT law[49].

Amongst others, the activity would need to be:

Exclusively for religious, charitable, scientific, artistic, cultural, athletic, educational, healthcare, environmental, humanitarian, animal protection or other similar purposes.
As a professional entity, chamber of commerce, or a similar entity operated exclusively for the promotion of social welfare or public benefit.

Such Qualifying Public Benefit Entities may have an ancillary business activity, which may push those entities in the scope of VAT but allow them to be exempt from UAE CIT, nonetheless.

Any donations, gifts and grants provided to non-Qualifying Public Benefit Entities will not be deductible. That looks to be the case also when this happens in favor of a foreign entity[50].

The UAE’s Federal Cabinet has listed Qualifying Public Benefit Entities, including entities like universities, chambers of commerce, foundations, and charities, as well as professional, sport and cultural associations.[51].

b. Expenses of a transparent partnership or a transparent branch of a foreign partnership

Due to its transparency, the UAE transparent partnership or the transparent branch of a foreign partnership will have no tax liability themselves. Therefore, there are no meaningful considerations around tax-deductible expenses for those transparent entities.

For the avoidance of doubt as well, the provisions of UAE CIT law state that amounts which are withdrawn from a transparent unincorporated partnership by a natural person who is a taxable person are not deductible[52]. This likely is a reference to the transparent nature of such partnerships[53].

[END NOTES]

[1] FAQ #48, UAE Ministry of Finance Corporate Tax FAQs, https://mof.gov.ae/corporate-tax-faq/, consulted on 30 June 2023.

[2] UAE MoF’s Explanatory Guide on Federal Decree-law No. 47 of 2022 on the Taxation of Corporations and Business, pp. 7 and 46, https://mof.gov.ae/wp-content/uploads/2023/05/Explanatory-Guide-on-Federal-Decree-Law-No.47-of-2022-on-the-Taxation-of-Corporations-and-Businesses-2.pdf, consulted on 30 June 2023.

[3] Article 1 UAE CIT law.

[4] See Paragraph 8.3. of the OECD Commentary to the OECD MTC on Article 4, which states the following: “Where a State disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not liable to tax and may not, therefore, be considered to be a resident of that State”. This reflects the idea of when a person is covered and is entitled to the benefit of a DTT as specified in Article 1(2) of the OEC MTC (as updated in 2017) as regards wholly or partly transparent entities. Some treaties will, however, specifically note that a partnership is a resident. See Article 4(1)(b) of the DTT between the United States and Luxembourg or Article 4(1) of the DTT between Belgium and Luxembourg

[5] Title 2 of Law No. 32 of 2021 (hereinafter, the UAE CC law).

[6] Article 39 of the UAE CC law.

[7] Article 62 of the UAE CC law.

[8] See MoF’s Explanatory Guide, p. 47, which reads as follows: “…for Corporate Tax purposes, the Unincorporated Partnership is treated as an aggregation of Persons whereby each Person (partner) is treated as carrying on, and being a part owner of, the Business and the assets and liabilities of the partnership in accordance with the contract underlying the Unincorporated Partnership”.

[9] Article 16, Clause 1 of the UAE CIT law.

[10] Article 16, Clause 10 of the UAE CIT law.

[11] Article 3, Clause 1 of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[12] Article 3, Clause 2 of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law. Presumably, this applies only to equity rather than also salaried partners.

[13] OECD report on the attribution of profits to permanent establishments, 17 July 2008, https://www.oecd.org/tax/transfer-pricing/41031455.pdf, consulted on 30 June 2023.

[14] International tax implications for partnership are described at length in the OECD’s Partnership report, OECD (1999), The Application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, No. 6, OECD Publishing, Paris, https://doi.org/10.1787/9789264173316-en, consulted on 30 June 2023, and also in OECD/G20 Base Erosion and Profit Shifting Project Neutralising the Effects of Hybrid Mismatch Arrangements Action 2: 2015 Final Report, https://www.oecd-ilibrary.org/docserver/9789264241138-en.pdf?expires=1687676531&id=id&accname=guest&checksum=1A4EEFD494D5FA739D2503603BC67A97, pp. 139 – 143, consulted on 30 June 2023.

[15] See MoF’s Explanatory Guide, p. 47, which, in this regard, explains that “[t]he UAE applying a different tax treatment to a Foreign Partnerships that is treated as fiscally transparent in the relevant jurisdiction(s) could result in unintended and unwanted tax consequences, not only for the UAE resident partners in the Foreign Partnership, but also for any non-resident partners whose UAE tax position can be impacted as a result”.

[16] In this regard, see J. Jones, i.a., “Characterisation of Other States’ Partnerships for Income Tax”, Bulletin – Tax Treaty Monitor, Section 3.2, p. 306,

[17] Article 16, Clause 7(a) of the UAE CIT law.

[18] Article 16, Clause 7(b) of the UAE CIT law.

[19] Article 16, Clause 7(c) of the UAE CIT law and 4, Clause 1(a) of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[20] Article 16, Clause 7(c) of the UAE CIT law and Article 4, Clause 1(b) of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[21] Article 11, Clause 3(c) of the UAE CIT law.

[22] Comparing Article 1 of the UAE CIT law and Article 1 of the GCC VAT Agreement, the two definitions concerned match.

[23] Article 2, Clause 1(a) of Cabinet Decision No. 49 of 2023.

[24] Ultimately, the outcome will much depend on the approach of the country of residence/formation of the partnership towards CIT paid in the UAE as the country of source of the income, and how potentially international double taxation between the two countries may be avoided.

[25] Article 4, Clause 2 of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[26] Agreement between the Government of the United Arab Emirates and the Government of the United States of America to improve International Tax Compliance and to Implement FATCA of 17 June 2015, https://home.treasury.gov/system/files/131/FATCA-Agreement-UAE-6-17-2015.pdf, consulted on 30 June 2023.

[27] See the DIFC’s Limited Partnership Law No 4 of 2006, https://www.difc.ae/business/laws-regulations/legal-database/limited-partnership-law-difc-law-no-4-2006/, consulted on 30 June 2023.

[28] See the ADGM’s Limited Liability Partnership’s Regulations, https://en.adgm.thomsonreuters.com/rulebook/limited-liability-partnerships-regulations, consulted on 30 June 2023.

[29] See the DIFC’s Limited Partnership Law No 4 of 2006, https://www.difc.ae/business/laws-regulations/legal-database/limited-partnership-law-difc-law-no-4-2006/.

[30] See the ADGM’s Limited Liability Partnership’s Regulations, https://en.adgm.thomsonreuters.com/rulebook/limited-liability-partnerships-regulations.

[31] Article 40 of the UAE CIT law states on Tax Groups the following:

A Resident Person, which for the purposes of this Decree-Law shall be referred to as a “Parent Company”, can make an application to the Authority to form a Tax Group with one or more other Resident Persons, each referred to as a “Subsidiary” for the purposes of this Chapter, where all of the following conditions are met:
a) The Resident Persons are juridical persons.
b) The Parent Company owns at least 95% (ninety-five percent) of the share capital of the Subsidiary, either directly or indirectly through one or more Subsidiaries.
c) The Parent Company holds at least 95% (ninety-five percent) of the voting rights in the Subsidiary, either directly or indirectly through one or more Subsidiaries.
d) The Parent Company is entitled to at least 95% (ninety-five percent) of the Subsidiary’s profits and net assets, either directly or indirectly through one or more Subsidiaries.
e) Neither the Parent Company nor the Subsidiary is an Exempt Person.
f) Neither the Parent Company nor the Subsidiary is a Qualifying Free Zone Person.
g) The Parent Company and the Subsidiary have the same Financial Year.
h) Both the Parent Company and the Subsidiary prepare their financial statements using the same accounting standards.

[32] Article 40 of the UAE CIT Law.

[33] Article 40, 1, b of the UAE CIT Law.

[34] Article 40, 1, f of the UAE CIT Law.

[35] Article 5, Clause 1 of Ministerial Decision No. 115 of 2023 on Private Pension Funds and Private Social Security Funds for Corporate Tax Purposes

[36] Article 5, Clause 3 of Ministerial Decision No. 115 of 2023 on Private Pension Funds and Private Social Security Funds for Corporate Tax Purposes

[37] The 15% contribution cap likely is meant to avoid opportunistic behaviors by employers which might try to inflate some employees’ (perhaps those with managing positions) pension plan contributions.

[38] Article 36, Clause 4 of the UAE CIT law.

[39] The same applies for UAE VAT purposes. See, in particular, the Taxable Person Guide for Value Added Tax (June 2018), pp. 39-40, which states the following: “A business is generally prohibited from recovering input tax on expenses incurred in respect of the provision of entertainment to anyone not employed by the business, including customers, potential customers, officials, shareholders, owners, and investors in the business. The type of entertainment expenses which are covered by the restriction include hospitality (e.g..accommodation, food and drinks) which are not provided in the normal course of a meeting, access to shows or events, or trips provided for the purposes of pleasure or entertainment. This means that where a business incurs any such expenses, the business will not be able to recover VAT incurred on the expenses”.

[40] See Article 26, Clause 6(c) of the GCC VAT Agreement, which excludes from the VAT taxable amount “c) amounts paid by the Taxable Supplier in the name of and to the account of the Customer. In this case, the Taxable Supplier may not deduct Tax paid on these expenses”.

[41] EBITDA stands for “Earnings Before Interest Tax Depreciation and Amortization”.

[42] Article 30, Clause 3 of the UAE CIT law and article 8 of Ministerial Decision No. 126 of 2023 on the General Interest Deduction Limitation Rule for the UAE CIT law.

[43] Article 30, Clause 4 of the UAE CIT law.

[44] Article 30, Clause 5 of the UAE CIT law.

[45] Article 30, Clause 7 of the UAE CIT law.

[46] Article 31, Clause 1 of the UAE CIT law.

[47] Article 31, Clause 2 of the UAE CIT law.

[48] A contrario, Article 33, Clause 1 of the UAE CIT law.

[49] These are further detailed in Cabinet Decision No. 37 of 2023.

[50] This may fall foul of the non-discrimination provisions in the GCC Economic Agreement of 2001, more specifically Article 3, Clause 1.

[51] Cabinet Decision No. 37 of 2023 Regarding the Qualifying Public Benefit Entities for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses.

[52] Article 33, Clause 5 of the UAE CIT law.

[53] A contrario, a combination of non-deductibility of the expenses in the hands of the non-transparent unincorporated partnership and taxation in the hands of the natural person receiving the income would lead to double taxation.

Free Zones UAE Tax

The New CIT Cabinet And Ministerial Decisions: Insights On The Free Zone Corporate Tax Regime

Post author By Thomas Vanhee
Post date June 26, 2023

The New CIT Cabinet And Ministerial Decisions: Insights On The Free Zone Corporate Tax Regime

In January 2022, the UAE announced a new federal Corporate Tax (CT) applicable to business profits for financial years starting on or after 1 June 2023. This marked a significant shift in the UAE’s tax landscape, particularly impacting businesses operating within the nation’s Free Zone Regime.

The UAE Free Zone CT Regime provides a system of economic zones established in the UAE that offer favourable conditions for doing business in and outside the UAE. It provides various benefits, including 100% foreign ownership, certain tax incentives (such as a 0% CT rate), and simplified administrative procedures.

The Federal Decree-Law No. 47 of 2022, known as the “CT Law,” published on 9 December 2022, left some key elements undefined, notably the criteria for a Free Zone (FZ) Person to qualify as a Qualifying Free Zone Person (QFZP), a status enabling access to the FZ’s embedded 0% CT rate. Of the five conditions, two were critical for achieving QFZP status: the requirement to derive “Qualifying Income” and the requirement to maintain “adequate substance”. Yet, definitions of both these terms under the UAE CT law were ambiguous, awaiting further clarification by the UAE Ministry of Finance (MoF).

To address these critical aspects, the UAE MoF issued two landmark decisions on 1 June 2023: Cabinet Decision No. 55 of 2023 on Determining Qualifying Income and Ministerial Decision No. 139 of 2023 regarding Qualifying Activities and Excluded Activities. These decisions – effective immediately upon publication – provide essential guidance for businesses operating in one of the more than 40 multidisciplinary UAE’s FZ. We discuss those elements in further detail below.

1. Determining Qualifying Income for Free Zone (FZ) Persons

The cornerstone of Cabinet Decision No. 55 of 2023 is the definition of “Qualifying Income”. This term encompasses two key areas – transactions with FZ Persons and transactions with non-FZ Persons.

To fully grasp the nuances of this Cabinet Decision, it is essential to comprehend certain key terms. The term “Beneficial Recipient”, for instance, typically denotes the individual or entity that is the actual recipient of the income and has the power to utilize and enjoy the benefits accruing from it (reminiscent of the requirement for passive income under double tax treaties to be the beneficial owner). On the other hand, the term “Good” in the context of this Cabinet Decision refers, amongst others, to any tangible product or commodity that is involved in transactions within any of the UAE FZs.

Also it is crucial to understand what constitutes “Qualifying Income” for entities operating within the UAE’s Free Zones, as it directly impacts their tax obligations under the new UAE CT law.

Qualifying Income by a QFZP includes the following:

– Income derived from transactions with other FZ Persons, except for income derived from Excluded Activities
– Income derived from transactions with a Non-FZ Person, only in respect of Qualifying Activities and not Excluded Activities
– Any other income provided that the QFZP satisfies the so-called “De Minimis Requirements”

Transactions with FZ Persons are relatively straightforward, encompassing all income that a QFZP derives from activities and transactions carried out within the jurisdiction of a QFZP with another FZ Person.

In the context of the new UAE CT Law, Qualifying Income refers to the types of income that are subject to the 0% CT rate. Determining which income is a “Qualifying Income” involves carefully reviewing the types of income, amounts, parties, and transactions involved, as detailed in the charts below.

From the above flowchart, the starting point is analyzing the source of income earned by a QFZP, which can arise from the following 4 categories:

1. Income from Non-FZ Person

2.Income from FZ Person

3.Income from Real Estate
– Immovable Property located in a UAE FZ
– Immovable Property Located in UAE Mainland

4. Income from Permanent Establishment
– UAE Permanent Establishment
– Non-UAE Permanent Establishment.

This article will provide a breakdown of each category of the above flowchart and guide you through the flow to determine whether the source of income will ultimately be subject to 9% or 0%.

Non-FZ Person

Transactions with Non-FZ Persons refer to income generated from dealings with entities not registered or incorporated within a UAE FZ. The specific conditions and considerations for such transactions need to be thoroughly evaluated.

For income earned by a QFZP from a Non-FZ Person, a distinction to be made is between Qualifying Activities, Excluded Activities and Non-Qualifying (or Non-Excluded) Activities, the latter being a term which is not defined.

– If the source of income arises from a Qualifying Activity of an FZ Person, the income will be considered as Qualifying Income and is subject to 0%.

– If the source of income arises from an Excluded Activity of an FZ Person, the income will be considered Taxable Income and is subject to 9%. However, this is subject to the so-called “De Minimis Requirements” rule, which will be explained further below.

– If the source of income arises from a Non-Qualifying Activity of an FZ Person, the income will be considered as “Taxable Income” and is subject to 9%, which is also subject to the conditions outlined in the “De Minimis Requirements” rule.

So, what is Qualifying Activity? As per Ministerial Decision No. 139 of 2023, Qualifying Activities include a wide range of business activities and services provided to entities located outside of a UAE FZ, including:

Manufacturing of goods or materials;
Processing of goods or materials;
Holding of shares and other securities;
Ownership, management and operation of ships;
Reinsurance services;
Fund management services subject to UAE regulatory oversight;
Wealth and investment management services subject to UAE regulatory oversight;
Headquarter services to related parties;
Treasury and financing services to related parties;
Financing and leasing of aircraft, including engines and rotatable components;
Distribution in or from a Designated Zone that meets relevant conditions;
Logistics services;
Any activities ancillary (qualified as such if it has no independent function but is necessary to perform the main Qualifying Activity) to the above activities.

Excluded Activities, on the other hand, are those that are not considered Qualifying Activities and, therefore, cannot benefit from a 0% tax rate, including:

Banking activities subject to UAE regulatory oversight;
Insurance activities subject to UAE regulatory oversight;
Finance and leasing activities subject to UAE regulatory oversight;
Ownership and exploitation of immovable property (other than Commercial Property located in an FZ);
Ownership and exploitation of intellectual property assets;
Any transactions with a natural person, except certain transactions in relation to Qualifying Activities;
Any activities ancillary (qualified as such if it has no independent function but is necessary to perform the main Excluded Activity) to the above activities.

Any activity which does not fall under Qualifying Activity and Non-Qualifying Activity is referred to as Non-Qualifying Activity.

If the source of the income is from a Qualifying Activity, it will result in 0% tax on the Qualifying Income derived from the Qualifying Activity. However, if the source of income is from an Excluded Activity or Non-Qualifying Activity (together considered as Non-Qualifying Revenue), the taxable income will be subject to 9%, but it may be possible for the taxable income to be considered Qualifying Income if it fulfils the so-called “De Minimis Requirements” rule.

“De Minimis Requirements” are fulfilled where Non-Qualifying Revenue derived by a QFZP are:

Max 5% of total revenue earned in a tax period by the QFZP;
Max AED 5 million of revenue earned in a tax period by the QFZP;

whichever is lower.

If the Excluded Activity or Non-Qualifying Activity income level is above the “De Minimis Requirements” threshold, then the FZ Person would not be eligible to be treated as a QFZP, and all of its income would be subject to tax at the standard 9% CT rate in the relevant tax period. Such a business would also be excluded from seeking to be treated as a QFZP for the following four tax periods.

Free Zone (FZ) Person

For income earned by a QFZP from an FZ Person, the only distinction to be made is between Excluded Activities and Non-Excluded Activities. Excluded Activities are described above.

If the source of income arises from a Non-Excluded Activity of an FZ Person, the income will be considered as “Qualifying Income” and is subject to 0%.

If the source of income arises from an Excluded Activity of an FZ Person, the income will not be considered as Qualifying Income and is subject to 9%.

1.3 Income from Real Estate

Cabinet Decision No. 55 of 2023 also provides a special tax regime for income attributable to immovable property located in the Free Zone, which we have shown in the chart below:

1.3.1 Immovable property located in a Free Zone

The source of income for an immovable property can be derived from immovable property located in a UAE Free Zone or Mainland and will have different tax treatments.

If the immovable property is located in a Free Zone, there is a demarcation between a Commercial Property and a Non-Commercial Property.

If the transaction of the Commercial Property is with a Non-FZ Person, the income derived from the transaction will be taxable at 9%.

If the transaction of the Commercial Property is with an FZ Person, the income derived from the transaction will be subject to a 0% tax rate.

On the other hand, any transaction or dealing with Non-Commercial Property by any other person will result in the income being taxed at 9%.

This regime may benefit some of the FZ authorities which are also landlords.

1.4 Income from Permanent Establishments

Decision No. 55 of 2023 also addresses revenue from UAE and non-UAE permanent establishments (PEs). This element plays a vital role in shaping the tax landscape for FZ entities, and a thorough understanding is essential for effective tax planning and compliance in UAE Free Zone Corporate Tax Regime.

A PE refers to a place of business or other form of presence as laid down in Article 14 of UAE CT law through which the business of an FZ Person is wholly or partly conducted. The income generated through a UAE or non-UAE PE should be evaluated under specific conditions.

If the source of income is derived from a UAE PE, the income is taxed at 9%.

If the income is derived from a non-UAE PE, the income is also taxable at 9%. However, foreign tax credit may be available.

It is also possible for an FZ Person to elect for having its non-UAE PE income exempt or disregarded for UAE CIT purposes. In such an event, however, no foreign tax credit will be available.

2. Adequate Substance in Free Zones and Outsourcing

For an FZ Person to qualify as a QFZP, it must derive Qualifying Income and maintain adequate substance. The latter requires the QFZP to undertake core income-generating activities within an FZ. Activities that generate the QFZP’s income must be conducted in a UAE FZ, not just managed from there.

The concept of “adequate substance” ties into the UAE’s Economic Substance Regulations, which aim to ensure that businesses genuinely carry out the substantial activity within the UAE rather than being “shell” or “letterbox” companies. The two legislations operate however independently, and there are subtle differences between them.

A QFZP is allowed to outsource activities to a third party or related party in an FZ, provided it maintains adequate supervision. This means that while the QFZP can outsource some of its activities, it must still have sufficient control and oversight over those outsourced activities. This ensures that the QFZP is still considered to be performing the core income-generating activities within an FZ.

Furthermore, to maintain adequate substance, the QFZP must demonstrate the adequacy of the following commensurate to the activities carried out by the FZ Person:

Adequate assets;
An adequate number of qualified employees;
An adequate amount of operating expenditures.

Contrary to the Economic Substance Regulations, there is no directed and managed criterion for the substance requirements.

3. Practical Examples

3.1 Example 1

FZCo1 is a limited liability company that is incorporated, controlled, and managed in the Dubai International Financial Centre (DIFC), a UAE Free Zone. FZCo1 is a holding company of the FZCo1 Group, which includes many companies conducting different types of businesses in and outside the UAE. The company employs a few persons in its headquarters in DIFC, mainly accounting personnel. The company also has different bank accounts and active credit lines with financial institutions in the DIFC. FZCo1 has established a branch in the UAE mainland and another branch in the UAE’s Free Zone of Abu Dhabi Global Market (ADGM).

Result:

FZCo1 is likely to meet the condition of maintaining adequate substance in the UAE to qualify as a (QFZP). It can therefore benefit from 0% UAE Corporate Tax (CT) on the relevant “Qualifying Income” (i.e., “holding of shares and other securities”). The company conducts its core income-generating activities in a UAE’s FZ (i.e., DIFC). It has adequate assets (i.e., headquarters premises), employees (i.e., accounting personnel), and operating expenditures (i.e., as demonstrated through the bank accounts and active credit lines, and other expenses) therein, considering the nature and level of activities performed. Provided that all the other relevant conditions are met, FZCo1’s branch in the UAE’s Free Zone of Abu Dhabi Global Market (ADGM) can also benefit from 0% UAE CT in respect of income attributable to it. FZCo1’s branch established in the UAE mainland is instead subject to 9% UAE CT in respect of income attributable to it.

3.2 Example 2

FZCo2 is a limited liability company that is incorporated, controlled, and managed in the Jebel Ali Free Zone Authority (JAFZA) of the UAE. FZCo2 conducts multiple activities across different business lines. One of its business activities consists of licensing patents and trademarks of pharmaceutical products to other companies in that industry. FZCo2 also owns several commercial properties in JAFZA, which it leases out to FZ and non-FZ persons to conduct business in that UAE’s FZ. Moreover, FZCo2 owns several commercial properties in the UAE mainland, which are rented to FZ and non-FZ Persons to conduct business therein.

Result:

Even if provided that FZCo2 meets all the relevant conditions to be treated as a QFZP, income from the licensing of patents and trademarks of pharmaceutical products is regarded as income from an “Excluded Activity” (i.e., “ownership or exploitation of intellectual property assets”). Therefore, income from such an Excluded Activity cannot benefit from 0% UAE CT but is subject to the standard 9% UAE CT rate, despite the activity being conducted in a UAE’s FZ (i.e., JAFZA).

As regards income from the lease of immovable property, a distinction must be drawn depending on the type, location and other party involved in the relevant transaction. Only income from the lease of commercial property by FZCo2 in an FZ (i.e., JAFZA), where the other party is also an FZ Person, can benefit from a 0% UAE CT rate. In all other instances, the standard 9% UAE CT rate applies.

4. Other Considerations for a Qualifying Free Zone

Other key considerations associated with qualifying for a FZ person and their implications for businesses are as follows:

Elective taxation at 9%;
Elective taxation at 9% effective from the commencement of the tax period in which election is made; (or)
Commencement tax period following the tax period in which the election was made;
Cannot be a member of Tax Group;
Cannot transfer/offset losses to/from taxable (related) persons;
Participation Exemption applies in relation to income from QFZP (subject to conditions);
Must file a tax return;
May be required to file disclosure form along with tax return (to be notified by Authority);
Must prepare and maintain audited financial statements;

5. Our Take

The newly issued Cabinet Decision No. 55 of 2023 and Ministerial Decision No. 139 of 2023 have provided much-needed clarity to the UAE Corporate Tax framework, particularly for FZ Persons. These decisions have brought forth specific definitions for Qualifying Income, Qualifying Activities, and Excluded Activities, thereby setting clear parameters for tax obligations for businesses operating within one of the more than 40 multidisciplinary UAE FZs. It is also worth mentioning that the guidelines concerning the so-called De Minimis Requirements for maintaining adequate substance have been detailed.

The scope of the 0% UAE CT rate appears to be narrower than initially anticipated, potentially reducing the UAE’s attractiveness as a tax-friendly business jurisdiction. Moreover, the Qualifying Activities do not seem to encompass all the activities businesses may undertake with third countries, potentially limiting the scope of the 0% rate. Financial services, which are traditionally exempt from tax in many FZ jurisdictions when “exported”, are also included in the list of “Excluded Activities”. This could have substantial implications for the financial sector and potentially discourage financial institutions from operating in UAE FZs.

The rationale behind excluding certain activities from the Qualifying Activities list is unclear and could benefit from further clarification. The original purpose of establishing FZ’s was to facilitate export-related income; however, it is important to note that not all activities conducted with third countries fall under this category. Certain services, such as professional consultancy, legal, tax, administrative, along with software development and leasing of non-aircraft assets, are notably excluded from the scope of Free Zone activities focused on export.

Furthermore, businesses and stakeholders must keep an eye on future developments and changes to these laws and regulations as the UAE government continues refining its corporate tax framework. It will be crucial for businesses to monitor these changes closely to ensure that they remain compliant and can effectively manage their tax obligations in the UAE. It is likely that the Ministry of Finance and the FTA’s position on some of the matters might evolve or be clarified.

If you wish to understand the UAE Corporate Tax on Qualifying Free Zone Persons easily, we have simplified the essential information under this topic through this informative animated video.

UAE Tax

CIT in the UAE: The PE Clause for Individuals

Post author By Thomas Vanhee
Post date May 11, 2023

CIT in the UAE: The PE Clause for Individuals

Introduction

The United Arab Emirates (UAE) announced the introduction of a Corporate Taxation (CT) regime on 31 January 2022. On 9 December 2022, the Ministry of Finance (MoF) of the UAE published Federal Decree-Law No. 47 of 2022 (UAE CT Law), issued on 3 October 2022, after a public consultation process initiated on 28 April 2022. UAE CT Law applies only to business profits – i.e., no personal income tax is levied on other types of income such as proceedings from real estate, employment or private investment and savings earned in a personal capacity.

The UAE CT Law has been effective since 25 October 2022, and a UAE CT liability applies for financial years starting on or after 1 June 2023. The UAE CT Law is also complemented by several implementing decisions to be adopted by the UAE Cabinet, the UAE Ministry of Finance (MoF) and the UAE Federal Tax Authority (FTA). Only a minor part of this detailed legislation has been issued at the time of writing.

Some of the main objectives for implementing the UAE CT regime are:

Cementing the UAE’s position as a world-leading hub for business and investment.
Meeting international standards for tax transparency and preventing harmful tax practices.
Accelerating the UAE’s development and transformation to achieve its strategic objectives.

Overall, the UAE CT Law is designed relatively straightforwardly and aims to be as business friendly as possible. It applies a relatively moderate headline rate of 9% on business profits above AED 375,000 (i.e., USD 100,000). There is also a separate rate of 0% on ‘Qualifying Income’ earned by ‘Qualifying Free Zone Persons’, which applies to Free Zone companies. Details on what constitutes ‘Qualifying Income’ are expected to be released through a UAE Cabinet Decision soon.

Further, the UAE CT Law has incorporated, where possible, recommendations and best practices from the 2013-15 BEPS project (e.g., the 30% EBITDA interest deduction limitation from BEPS Action 5 and the Principal Purpose Test (PPT) under BEPS Action 6).

Remarkably, there is no direct reference under UAE CT Law itself to the OECD/G20-Inclusive Framework BEPS Project, which involves the implementation of a Global Minimum Tax, otherwise known as ‘Pillar Two’. The only indication towards adopting Pillar Two can be read in the UAE MoF FAQs, where the UAE reiterated its commitment to the Inclusive Framework to adopt the proposal in due course.

Overall, the UAE CT implements a worldwide taxation system for entities with tax residency in the UAE. For non-resident entities, the UAE CT has sourcing rules and definitions of what constitutes a Permanent Establishment (PE). Those sourcing rules give the UAE the right to tax certain transactions which have a link with the UAE. Those transactions would usually be taxed by way of a withholding tax. However, Article 45 of UAE CT Law has provided it will only apply a 0% withholding tax with no reporting obligations.

PE Definition under UAE CT Law

When a business activity of a non-UAE resident enterprise amounts to a certain threshold of presence or activity in the UAE, the PE definition becomes crucial. Non-UAE resident businesses with a PE in the UAE are subject to 9% UAE CT on the profits allocated to that PE.

In the previous article, the authors discussed the PE concept under UAE CT Law and contrasted this definition with international tax principles. This article deals with the PE concept applied to individuals operating as solo entrepreneurs or freelancers (including investment managers) in the UAE territory. In particular, the authors discuss when an individual physical presence and/or a home office in the UAE may qualify as a PE under UAE CT Law.

Article 14(7) of UAE CT Law

Besides establishing when a fixed place of business or a non-independent agent acting on behalf of a non-resident enterprise qualify as a PE in the UAE, the PE definition in Article 14 of UAE CT Law considers, under Clause 7, whether and when the physical presence of an individual in the UAE territory may lead to a foreign enterprise having a PE therein.

Notably, Clause 7 of Article 14 of UAE CT Law stipulates that ‘[f]or the purposes of Clause 3 of this Article [i.e., Article 14 of UAE CT Law], the Minister may prescribe the conditions under which the mere presence of a natural person in the State does not create a Permanent Establishment for a Non-Resident Person …’.

The provision in Article 14(7) of UAE CT Law is neither part of any ‘standard’ PE definition under national CT laws nor included in Article 5 of the OECD Model Convention (OECD MC) or the UN Model Convention (UN MC). The exact scope of this provision is somewhat vague, also given that its actual coverage is explicitly made subject to a future determination by a UAE MoF’s Cabinet Decision. A systematic interpretation of Clause 7 of Article 14 of UAE CT Law (in light of other Clauses within Article 14 of UAE CT Law) would suggest reading it in parallel with Point c) of Clause 1 of Article 14 of UAE CT Law. From this perspective, Clause 7 of Article 14 of UAE CT Law might be read as designating when the mere presence of an individual does not amount to ‘any other form of nexus’ in the UAE, as stipulated under Point c) of Clause 1 of Article 14 as a third type of PE under UAE CT Law.

There are, however, a few elements of Clause 7 of Article 14 of UAE CT Law which already appear sufficiently explained:

Clause 7 applies only to natural persons, i.e., individuals. It follows that companies or other legal entities are not affected by this provision. On the other hand, one may wonder whether unincorporated partnerships may somehow fall within the scope of this provision since, under Articles 16 of UAE CT Law, these legal entities may not be considered taxable persons of their own rights, but instead their partners assume UAE CT liability on their behalf.
Clause 7 explicitly refers and, therefore, must be read jointly with Clause 3 of Article 14 of UAE CT Law concerning the list of specific activities whose carrying on through a fixed place of business is insufficient to constitute a PE. The rationale behind excluding any relevance of such activities for PE purposes is likely to be found in the OECD MC Commentary, which, in paragraph 58, stipulates that the analogous exclusionary list under Article 5(4) of the OECD MC relates to activities which only contribute marginally to the profits of the enterprise, i.e., ‘are so remote from the actual realisation of profits that is difficult to allocate any profit to the fixed place of business in question’.
Clause 7 establishes no link to Clause 5 of Article 14 of UAE CT Law concerning the personal PE. Therefore, it can be assumed that a person habitually concluding or negotiating contracts on behalf of a Non-Resident Person always constitutes a PE, without any possibility for such an activity to be excluded under Clause 7 of Article 14 of UAE CT Law. Clause 7 of Article 14 might be of concern also to an investment manager in case anyof the conditions to be considered an ‘independent agent’ under Clause 6 of Article 14 of UAE CT Law, as detailed explicitly in Article 15 of UAE CT Law, are not fulfilled. This is because, in case any of the conditions for the ‘Investment Manager Exemption’ (IME) to apply, according to Article 15 of UAE CT Law, are not fulfilled, whether the investment manager triggers a PE for a foreign investment fund is to be checked against all the clauses of Article 14 of UAE CT Law and, in particular, Clause 7 of that Article, concerning the ‘mere presence of a natural person’.
Applying Article 14(7) of UAE CT Law to the Case of an Individual Physically Present in the UAE

Since Clause 7 of Article 14 of UAE CT Law refers to ‘any of the following instances’, the cases under which the mere presence of an individual in the UAE does not constitute a PE as detailed in Points a) and b) appear to be alternative (contrary to the subparagraphs 1) and 2) under Point b), which instead refer to ‘all of the following conditions’). Therefore, the PE exclusion applies even if only one of the requirements specified in any of the two subparagraphs of Clause 7 is fulfilled.

Point a) of Clause 7 of Article 14 of UAE CT Law sets forth a PE exclusion in the case of the mere presence of a natural person being ‘a consequence of a temporary and exceptional situation’. Arguably, this exclusion only applies in limited circumstances, such as the one that occurred during the outbreak of COVID-19 in 2020-21, where many employees were stranded in locations other than where they used to live and/or work. The authors also note that the expression used under Point a) of Clause 7 of Article 14 of UAE CT Law is somewhat comparable to that of ‘exceptional circumstances’ used for counting the days of physical presence leading to the tax residence of a natural person in the UAE.

Point b) of Clause 7 of Article 14 of UAE CT Law is only applicable to an individual who is employed by a foreign enterprise. However, how the concept of ‘employee’ should be interpreted is not (yet) specified. In this connection, one may wonder whether only a formal relationship of employment is acknowledged or, instead, this provision might also apply in cases of international hiring-out-of-labour (IHOL), where, following a substance-over-form approach, the ‘real’ employer might differ from the ‘formal’ employer. The authors also note that a definition of ‘employment’ for tax residency purposes is provided by a decision issued by the UAE FTA on 1 March 2023. And yet, the definition contained in that decision does not refer to the concept of ‘employment’ under Article 14 of UAE CT Law, so the interpretive value of that expression for PE purposes cannot simply be assumed.

Subparagraph 1 of Point b) of Clause 7 of Article 14 of the UAE CT Law refers to ‘core income-generating activities of the Non-Resident Person or its Related Parties’. This expression, as well as Clause 7 in general, is not included in either the OECD MC or the UN MC. Reference to ‘core income-generating activities’ suggests the need to determine whether business activities conducted in the UAE territory have a preparatory or auxiliary character. In this regard, the OECD MC Commentary provides that, in order ‘to distinguish between activities which have a preparatory or auxiliary character and those which have not’, ‘[t]he decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole’. The authors also note that the UAE MoF’s Economic Substance Requirements (ESRs) resolution contains an identically worded expression. One may therefore wonder whether such an identical wording implies that the carrying out of any of the activities within the scope of ESRs always triggers a PE in the UAE.

Applying Article 14(7) of UAE CT Law to the Case of a ‘Home Office PE’ in the UAE

The actual business operations carried out in the UAE vis-a-vis the overall business activity of a foreign enterprise might also be critical to determine the existence of a PE in the UAE in the form of a ‘home office’. This occurs when the employee physically present in the UAE uses a home therein in lieu of an office so that such a private dwelling in the UAE can be considered at the disposal of the foreign employer of the individual who lives there. Actual relocations in the UAE might eventually be facilitated by applications for a special residence visa by foreign employees moving to the UAE territory or the city of Dubai while retaining employment in their respective foreign countries.

Regarding the case of a ‘home office PE’ in the UAE, the authors would advise that the clarifications to be released by the UAE MoF under Clause 7 of Article 14 of UAE CT Law for ‘core income-generating activities’ help determine when activities carried out at a private dwelling of an employee (e.g., a hotel room) amounts to a PE, such activities not being instead ‘merely auxiliary’. In this connection, the authors are of the view that no home office PE should be triggered when an employee’s activities performed in the UAE are not aimed at the UAE market or customers. On the other hand, it must be recalled that the circumstance that business activities performed by an individual through his/her presence in the UAE are not part of the ‘income-generating activities’ of a foreign enterprise is, by itself, insufficient to exclude the existence of a PE in the UAE. This is because of the operation of the anti-fragmentation rule in Clause 4 of Article 14 of UAE CT Law in the case of business activities by two or more parties which are linked to one another.

Subparagraph 2 of Point b) of Clause 7 of Article 14 of UAE CT Law also requires that ‘[t]he Non-Resident Person does not derive State Sourced Income’. This condition might prove difficult to escape from a foreign enterprise considering the broad scope attributed to ‘State Sourced Income’ under Article 13 of UAE CT Law. Notably, this provision sourced in the UAE not only services performed but even services ‘benefitted’ in the UAE territory. Moreover, Clause 2 of Article 13 includes a broad list of ‘State Sourced Income’, some of which, arguably, have only a weak nexus with the UAE, such as ‘income from a contract insofar as it has been wholly or partly performed or benefitted from in the State’ or ‘income from the use or right to use in the State, or the grant of permission to use in the State, any intellectual or intangible property’. In this connection, it is also unclear whether a natural person might constitute a PE for a foreign enterprise even if the State Source Income derived by the foreign enterprise is unrelated to the specific activities the employee performs in the UAE.

Conclusions

UAE CT Law and the PE clause contained in Article 14 therein have been designed to adopt international tax best practices. In this regard, the PE clause in UAE CT Law generally follows the corresponding provisions in Article 5 of OECD and UN MCs and explanations provided in the related Commentaries. However, applying and interpreting the concepts and definitions contained in Article 14 of UAE CT Law is not always straightforward. This article has focused on the implications of the PE clause for individual entrepreneurs and freelancers (including investment managers). It has shown that, in certain instances, based on Article 14(7) of UAE CT Law, individuals may trigger a PE in the UAE if they are physically present or have a home office therein. Individual entrepreneurs and freelancers (including investment managers) should therefore examine attentively whether and when their activities and/or presence may trigger the UAE PE clause and, consequently, a UAE CT liability.

For Thomas Vanhee and Varun Chablani: The views expressed in this article are sole of the authors and do not necessarily reflect the position of the employers or the parties with which the authors are affiliated.

For Giorgio Beretta: This work has been developed within the framework of the Amsterdam Centre for Tax Law (ACTL) research project “Designing the tax system for a cashless, platform-based and technology-driven society” (CPT project). The CPT project is financed with university funding and funds provided by external stakeholders (i.e., businesses and governments) interested in supporting academic research to design fair, efficient and fraud-proof tax systems. For more information about the CPT project and its partners, please visit its website https://actl.uva.nl/cpt-project/cpt-project.html. The usual disclaimers apply.

UAE Tax

CIT in the UAE: The PE Clause for Companies

Post author By Thomas Vanhee
Post date May 10, 2023

CIT in the UAE: The PE Clause for Companies

1. Introduction

The United Arab Emirates (UAE) announced the introduction of a Corporate Taxation (CT) regime on 31 January 2022. On 9 December 2022, the Ministry of Finance (MoF) of the UAE published Federal Decree-Law No. 47 of 2022 (UAE CT Law), issued on 3 October 2022, after a public consultation process initiated on 28 April 2022. The UAE CT Law applies only to business profits – i.e., no personal income tax is levied on other types of income such as proceedings from real estate, employment or private investment and savings earned in a personal capacity.

The UAE CT Law has been effective since 25 October 2022, and the CT liability applies for financial years starting on or after 1 June 2023. The UAE CT Law is also complemented by several implementing decisions to be adopted by the UAE Cabinet, the UAE Ministry of Finance (MoF) and the UAE Federal Tax Authority (FTA). Only a minor part of this detailed legislation has been issued at the time of writing.

Some of the main objectives for implementing the UAE CT regime are:

Cementing the UAE’s position as a world-leading hub for business and investment.
Meeting international standards for tax transparency and preventing harmful tax practices.
Accelerating the UAE’s development and transformation to achieve its strategic objectives.

2. PE Definition under UAE CT Law

This article discusses the PE concept under UAE CT Law and contrasts this definition with international tax principles. In the article, the authors analyse the UAE’s PE policy and approach with a few practical examples, focusing on applying the PE clause to companies and other legal entities. The operation of the so-called ‘Separate Entity Approach’ for allocating profits between the head office (HO) and the PE is not addressed.

3. Article 14 of UAE CT Law

UAE CT Law provides a definition of PE under Article 14. The PE definition under UAE CT Law shows similarities and differences with the related concepts in the OECD Model Tax Convention on Income and Capital 2017 (OECD MC) and the United Nations Model Double Taxation Convention between Developed and Developing Countries 2017 (UN MC). Notably, UAE CT Law develops a preference for the PE definition under the OECD MC, with some deviations.

Article 14(1) of UAE CT Law sets forth the instances where a non-resident is considered to have a PE in the UAE, i.e., where, alternatively:

A non-resident person has a fixed or permanent place in the UAE through which the business of the non-resident or any part thereof is conducted (commonly known as ‘Fixed Place PE’, also including the so-called ‘Construction PE’).
A Person has and habitually exercises an authority to conduct a business or a business activity in the UAE on behalf of the non-resident person (commonly known as ‘Agency PE’).
Where a non-resident person has any other form of nexus in the UAE (to be specified in a UAE MoF’s Cabinet Decision).

4. Comparing the PE Definition under UAE CT Law with the OECD and UN MCs Approaches

Article 14(1)(a) and (2) of UAE CT Law delineates the so-called ‘Fixed PE’, while Article 14(1)(b) and (5) of UAE CT Law lay down the so-called ‘Agency PE’. Both types of PEs closely follow the corresponding definitions under Article 5 of the OECD MC. Nevertheless, some different nuances between the PE definitions under UAE CT Law and the OECD MC can be noted.

4.1. Fixed PE under UAE CT Law and the OECD MC

Article 14(2) of the UAE CT Law contains eight instances of fixed PEs. In general, Article 14(2) of UAE CT Law mirrors Article 5(2) of the OECD MC, except in the situations below:

The term ‘place of management’ under UAE CT Law also covers the following words, ‘where management and commercial decisions that are necessary for the conduct of the Business are, in substance, made’. The authors submit that this wording under UAE CT Law – in particular, a reference not only to ‘management’ but also to ‘commercial’ decision – might suggest that not the place of ‘management and control’ but that of ‘effective management’ of the business should be considered, i.e., the place where the day-to-day management decisions of the business are routinely taken.
UAE CT Law includes the expression ‘land, buildings and other real property’. This expression is not found in either the OECD or the UN MCs. However, it is unclear whether the expression ‘land, buildings or other real property’ marks an effective departure from the corresponding provision under the OECD and UN MCs or is merely clarificatory.
The so-called ‘Construction PE’, while separately listed in Article (14)(2)(i) of UAE CT Law as one of the instances of a fixed PE, deserves some attention, given that it includes a duration of 6 months, unlike the other types of fixed PEs. This duration is shorter than the Construction PE under the OECD MC, which prescribes a 12-month period. Instead, the 6-month threshold is used under the UN MC.

4.2. Exceptions to a ‘Fixed Place PE’ under UAE CT Law and the OECD MC

Article 14(3) of UAE CT Law contains a list of activities which, taken in isolation, do not amount to a PE, similarly to the exclusionary provision under Article 5(4) of the OECD MC. The scope of this exclusionary provision involves situations, where, notably, certain activities are conducted in isolation and are of a ‘preparatory’ or ‘auxiliary’ nature.

In detail, the coverage of Article 14(3) of UAE CT Law mirrors that of Article 5(4) of the OECD MC, except in the situations below:

UAE CT Law does not have a provision equivalent to ‘[m]aintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery’, as laid down in Article 5(4)(b) of the OECD MC.
OECD MC uses the term ‘[m]aintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity’, while Article 14(3)(d) of UAE CT Law has a slightly broader wording, i.e., ‘conducting any other activity of a preparatory or auxiliary nature for the non-resident person’.
OECD MC covers the term as ‘[m]aintenance of a fixed place of business solely for any combination of activities above provided that the overall activity is of a preparatory or auxiliary nature’, while Article 14(3)(e) of UAE CT Law has a slightly broader wording, i.e., ‘[c]onducting any combination of activities mentioned in paragraphs (a), (b), (c) and (d) of Clause 3 of this Article, provided that the overall activity is of a preparatory or auxiliary nature’.

Overall, the scope of the exclusionary provision under the PE definition of Article 14(3) of UAE CT Law seems slightly broader than that of Article 5(4) of the OECD MC. Therefore, a non-resident person may benefit from the PE exclusionary clause in more situations than based on the corresponding provision under the OECD MC.

4.3. Comparing the Anti-Fragmentation Rule under Article 14(4) of UAE CT Law and Article 5(4.1) of OECD MC

Article 14(4) of UAE CT Law provides an exception to Article 14(3) of UAE CT Law (effectively, an exclusion to the exception to the UAE general rule for PE).

The core of the provision is that the exception under Article 14(3) of UAE CT Law does not apply, so a PE exists in the UAE, if all of the following four requirements are fulfilled:

A fixed or permanent place in the UAE is used or maintained by a non-resident.
The same non-resident or its Related Party carries on a Business or a Business Activity at the same place or another place in the UAE.
The same place or the other place constitutes a PE for either the non-resident or its Related Party.
The ‘overall activity’ resulting from the combination of the activities carried out by the non-resident and its related party at the same place or at the two places is not of a preparatory or auxiliary nature. Such overall activity would form a ‘cohesive business operation’, had the activities not been fragmented.

The mirror provision in the OECD MC is laid down in Article 5(4.1.), which refers to the term ‘or’ (i.e., disjunctive) when delineating the requirements under (iii) and (iv) above. On the other hand, UAE CT Law uses the term ‘where all of the following conditions are met’ (i.e., conjunctive, equivalent to ‘and’). This might suggest that, for the exclusion of the PE exception to apply under UAE CT Law, both the conditions under (iii) and (iv) above must be jointly fulfilled.

The difference is material. Take the situation of a company, Alpha, based in the United States, with which the UAE does not have a tax treaty. It has a closely related enterprise in the United States, Beta. Both companies are part of ‘AB Group’. Alpha maintains a place of business ‘A’ in the UAE. Beta also maintains a place of business ‘B’ in the UAE. In A, the sole activity of invoicing is performed. In B, the sole activity of account reconciliation is performed. Both A and B individually do not constitute a PE of the respective non-resident companies, their activities being merely ‘preparatory’ and ‘auxiliary’ within the meaning of Article 14(3) of UAE CT Law. When viewed together, the activities of A and B form a ‘cohesive business operation’, since the combined finance function of invoicing and account reconciliation can no longer be holistically considered ‘preparatory’ or ‘auxiliary’. And yet, the anti-fragmentation rule under Clause 4 of Article 14 of UAE CT Law cannot apply since none of the two fixed places is of ‘a preparatory of auxiliary nature’ as prescribed under point b) of that Article.

4.4. Comparing the ‘Agency PE’ and ‘Independent Agent’ Concepts under Article 14(5) of UAE CT Law and Article 5(5) of OECD MC

As explained above, Article 14(1)(b) delineates the ‘Agency PE’ concept along with Article 14(5) of UAE CT Law. These two provisions fundamentally reflect Article 5(5) of the OECD MC.

Essentially, Article 14(5) of UAE CT Law provides that the so-called ‘Agency PE’ is triggered if either of the conditions is met:

The Person habitually concludes contracts on behalf of the non-resident.
The Person habitually negotiates contracts that are concluded by the non-resident, without the need for material modification by the non-resident.

Article 5(5) of the OECD MC also provides these two alternative conditions. The only meaningful difference between the two systems is that UAE CT Law does not refer to the type of contracts, as covered under both the OECD and UN MCs. Also, UAE CT Law does not include the additional clause under Article 5(5)(b) of the UN MC, i.e., ‘habitual maintenance of stock of goods from which the person regularly delivers goods or merchandise on behalf of the enterprise’.

An exception to the PE rule is the ‘Independent Agent’ concept covered under Article 14(6) of UAE CT Law. Under this provision, a PE is not triggered when the agent resident in the UAE performs certain activities for the non-resident in the ‘ordinary course’ of its own Business or Business Activity. This is because such an agent’s activities represent a separate and independent enterprise.

Article 14(6) of UAE CT Law also significantly mirrors Article 5(6) of the OECD MC. The only meaningful difference is that the OECD MC also refers to ‘closely related’ enterprises. The distinction is nuanced. The OECD MC excludes from the scope of the ‘independent agent’ provision the case in which the person acting (almost) exclusively on behalf of ‘one or more enterprises that are closely related’. This exclusion of ‘closely related’ enterprises is missing in UAE CT Law.

Importantly, Clause 6 of Article 14 of UAE CT Law also becomes relevant in relation to Article 15 of UAE CT Law, which lays down the so-called ‘Investment Manager Exemption’ (IME). This clause – which is not contained in the OECD or UN MCs but only under the PE definition of some countries – provides a series of conditions based on which, if all are fulfilled, ‘an Investment Manager shall be considered an independent agent when acting on behalf of a Non-Resident Person’.

4.5. Article 14(1)(c) of UAE CT Law: A Nexus or Service PE?

Based on Article 14(1)(c) of UAE CT Law, a PE can also be established on a non-resident person having ‘any other form of nexus’ in the UAE. A UAE MoF’s Cabinet Decision is expected to provide additional details on the scope of this provision. Even though it is not expressly stated so far, the open-ended nature of this provision may allude to a possible expansion to other types of PEs, such as a Service PE (inspired by Article 5(3)(b) of the UN MC) or an Insurance PE (inspired by Article 5(6) of the UN MC) both types of PEs laid down in the UN MC. The expression ‘any other form of nexus’ could also be linked with Clause 7 of Article 14 of UAE CT Law, detailing the ‘conditions under which the mere presence of a natural person in the State does not create a permanent establishment for a Non-Resident Person’. A forthcoming blog from the authors of this blog will discuss the scope and issues relating to Clause 7 of Article 14 CT Law.

5. Conclusion

This article has shown how the PE policy under UAE CT Law must still be fully ‘decodified’. The authors believe that implementing decisions to be adopted by the UAE Cabinet, the UAE MoF, and the UAE FTA will help shed some light on (still) unclear elements of the PE policy under UAE CT Law. Meanwhile, businesses operating in the UAE should rely on qualified interpretation by tax experts to fill in other (non-)intended legislative blind spots. Also, other than the PE Clause under UAE CT, businesses should include the examination of tax treaty provisions applicable to their individual situation in their PE analysis.

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Working remotely tax free – not that simple

Post author By Thomas Vanhee
Post date May 9, 2023

Working remotely tax free – not that simple

The Government of Dubai launched a virtual working program for overseas employees wishing to relocate to Dubai whilst retaining employment in their respective countries. This program aims to enable individuals to utilize the economical and tax advantages associated with residing in Dubai, despite being employed in their countries.

While seemingly very attractive, unfortunately it is not that easy for these employees to ensure that their salary will be tax free. In addition, every case may be different. Of course the UAE does not impose Personal Income Tax, but that does not mean that the other jurisdiction will let go that easily.

One can broadly distinguish the following scenarios:

Scenario 1: No Double Taxation Treaty in place between UAE and country of employment

Nothing shall prevent the application of the Personal Income Tax Law of the country of employment. That country shall retain the right to tax the person on his employment income (but may choose not to tax the employment income).

E.g.: Jim is a US Citizen and and is employed by USCO. He decides to work from Dubai. The US tax authority still has the right to tax Jim.

Scenario 2: Double Tax Treaty in place between UAE and country of employment or tax residency and person does not qualify as tax resident in UAE

A non-resident in the UAE which is employed by a non UAE entity would still be taxed on his income in the state of his residence. Under the treaty, the country of residence would be obliged to provide double tax relief for taxes paid in the UAE. Even though the UAE has a primary right to tax, due to the fact that it does not tax employment income, the state of residence retains the right to tax the income of the employee.

As an exception, in cases where the country of employment applies an exemption system, the person may not pay tax in the country of residence and exercise his employment tax-free in the UAE.

E.g.: Roberto is a tax resident of country A, employed by a company incorporated in country A. Roberto moved to Dubai in December 2020 to benefit from the virtual working scheme. Roberto is not a resident in the UAE for tax purposes and is not aiming to be a resident in the UAE for the near future.

The Double Tax Agreement between country A and the UAE applies the credit method to eliminate double taxation, which entails that country A shall deduct from the taxes calculated, the Income Tax paid in the UAE. As there is no Income Tax in the UAE, country A shall request the tax due in totality and fully retain its right to tax.

The situation would differ if Roberto is a tax resident of country B and relocates to Dubai, and the Double Taxation Agreement between the UAE and country B applies an exemption method. Under the exemption system, any income which may be taxed by the UAE will be exempt from tax in country B. In the absence of the conditional subject to tax rule, the exemption system would effectively allow Roberto to escape the burden of Personal Income Tax in Country B, and pay no taxes in the UAE.

Scenario 3: Double Taxation Treaty in place between UAE and country of employment and the person qualifies as tax resident in the UAE.

This situation may lead to a so-called Dual Residency issue, where two jurisdictions consider a person a tax resident. Given that the person in our assumption qualifies as a tax resident in UAE in addition to being a resident in his country of employment as well, the tie-breaker rule would apply to determine the residency of that person.

On the basis of the tie breaker rule, it may not be that easy to consider a person who just moved as a tax resident in the UAE, if he still has his first home in the country of employment, and if his economic and social interest alongside his habitual abode are in the same country, and if he hold nationality in the country of employment.

In case the person is considered to be a resident in the UAE under the tie-breaker rule, the UAE has the exclusive right to tax, even if such right is not exercised. The other country may argue however that the person is neither liable nor (effectively) subject to tax in the UAE. What happens next depends highly on the other jurisdiction’s tax policy.

Given that there is no Personal Income Tax in the UAE, there are also no domestic legal criteria to consider a person a tax resident in the UAE. There is however a means to obtain a tax residency certificate, based on criteria prescribed by the UAE Ministry of Finance. To obtain such a certificate, the applicant amongst others has to be resident in the UAE for a period exceeding 183 days, and submit an annual lease agreement documented by the competent authority.

E.g.: Roberto in this scenario qualifies as a tax resident in the UAE and also in country A due to his employment ties in country A. Both countries may consider Roberto as a tax resident on under their domestic law. The dual-residency tie-breaker rule in the treaty between country A and the UAE, based on the OECD Model, dictates that Roberto’s residency shall be decided on the basis of:

a) Place of permanent home. If in both/none of the states then;

b) Centre of vital interest. If cannot be determined then;

c) Habitual abode. If in both/none of the states then;

d) Nationality. If national of both states;

e) Competent authority shall determine by mutual agreement.

If it is determined on the previous basis that Roberto is a resident of the UAE, he shall be taxed exclusively in the UAE because the job is executed in the UAE where he is resident even though the employer is resident in country A.

As a consequence, Roberto will effectively not be subject to any Personal Income Tax.

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To Qualify or not to Qualify: Analysis and Tax Advisory on the UAE Free Zone Regime, Interaction with Pillar Two, and Beyond

Post author By Liam Purcell
Post date April 12, 2023

To Qualify or not to Qualify: Analysis and Tax Advisory on the UAE Free Zone Regime, Interaction with Pillar Two, and Beyond

Introduction

On 31 January 2022, the Ministry of Finance (“MoF”) announced that the United Arab Emirates (“UAE”) will introduce a federal Corporate Income Tax (“CIT”) on business profits that will be effective for financial years starting on or after 01 June 2023. This was followed by the release of a Public Consultation Document (“PCD”) in April of 2022 before the publication of the CIT legislation on 9 December 2022.

One of the key elements addressed in the PCD and CIT legislation is with respect to the UAE’s Free Zone Regime. The UAE Free Zone Regime is a system of economic zones established in the UAE that offer favourable conditions for doing business. The Free Zones offer a range of benefits, including 100% foreign ownership, certain tax incentives (including 0% CIT) and simplified administrative procedures.

Subject to certain conditions (summarised in further detail below), “Qualifying Income” of a Qualifying Free Zone Person (“QFZP”) will remain subject to a 0% tax rate under the CIT law for the remainder of the tax incentive period, as provided for in the applicable legislation of the Free Zone in which the QFZP is registered.

As we approach the introduction of the UAE’s CIT regime, many of the burning questions for businesses operating in the UAE revolve around the UAE Free Zone Regime. In particular, the central theme of many people’s inquiries concerns the definition of “Qualifying Income”, which remains subject to a Cabinet Decision.

Given that Non-Qualifying Income shall be subject to CIT at the standard rate of 9%, it is critically important for businesses to understand this definition to appropriately forecast their future tax liability, distributable reserves and manage shareholders’ expectations regarding post-tax profitability etc.

In addition, there are many other practical considerations which taxpayers will be keen to understand going forward. Below we give a short summary of where we stand as well as our thoughts on a number of the key queries and recommendations for businesses in relation to their Free Zone operations.

Where We Stand

According to Article 18 of UAE CT legislation, an entity operating in a Free Zone is considered a QFZP where it meets all of the following conditions:

Where all these conditions are met, a QFZP shall be subject to zero percent CIT on its Qualifying Income while being subject to tax at 9% on its non-Qualifying Income. Another condition, although not expressly provided in CIT legislation but based on Ministerial Decision No. 73 issued on 6 April 2023, is that a QFZP cannot elect for the Small Business Relief under Article 21 of UAE CT legislation, such that the two regimes are fundamentally alternative.

As discussed above, however, the most critical aspect is that a definition of Qualifying Income is not provided in the CIT legislation but remains subject to a Cabinet Decision yet to be published.

Our Thoughts

In the wait for the Cabinet Decision, one can only advance some hypotheses regarding the scope of application of CIT to QFZP. Below we have outlined some initial thoughts and considerations in relation to each of the abovementioned conditions:

Adequate Substance: We expect this condition will be linked to the Economic Substance Regulations (“ESR”) and the specific criteria used therein. This is primarily due to the Federal Tax Authority’s (“FTA”) familiarity with this approach. Moreover, many Free Zone Persons are already subject to ESR reporting requirements, so it should not cause a major additional administrative burden for the tax administration or the taxpayers. Finally, the lexicon used in the ESR reporting requirements (i.e., “Relevant Activity” and “Core Income Generating Activity”) may suggest a possible analogy between the two pieces of legislation.

Free Zone Persons that do not currently file ESR reports should familiarise themselves with the content and structure in order to best prepare for the future substance requirements.

While we expect that the substance requirement will be linked to the ESR, at the same time, one of the comments that was made by the MoF in its UAE CT Awareness Sessions was that they have so far not decided on whether the ESR regime itself will continue after the CT regime is implemented. More details on this aspect will be issued by the MoF.

Qualifying Income: As outlined above, the definition of Qualifying Income remains the most controversial issue for most businesses operating in the UAE or looking at this geographical area to expand their activities. .Although it is not definitive, the expectation is that the scope of Qualifying Income under the UAE CIT legislation will be broadly in line with the PCD.

In this regard, it is worth noting that while the PCD did not include the terms Qualifying or non-Qualifying Income, it did outline certain types of income earned by Free Zone entities that will be subject to zero percent UAE CIT. We have summarized these below:

Income earned from transactions with businesses located outside of the UAE or income from trading with businesses in the same or another Free Zone.
Passive income earned from UAE-mainland. Such income includes interest, royalties, dividends, and capital gains from owning shares in UAE-mainland companies.
Income earned from transactions with a UAE-mainland group company. However, to maintain tax neutrality, the UAE-mainland group company will not be able to deduct the corresponding expense.
Income earned from the sale of goods from Designated Zones to buyers in the UAE mainland where the buyer is the importer of record. We have written a piece explaining the nuances of the interplay between the VAT Regime and the Free Zone regime earlier on our website.

Currently, it is assumed that the above income streams would constitute Qualifying Income. However, this ultimately remains subject to the anticipated Cabinet Decision. Being a critical issue for many businesses, we expect specifications in this regard to be disclosed imminently.

Although the PCD remains our best point of reference for Qualifying Income, we note some critical divergences between the PCD and the CIT legislation. For example, reference to both Qualifying and non-Qualifying Income in the CIT legislation suggests partial qualification is available, whereas the PCD implied an “all or nothing” approach whereby any amount of other UAE-mainland sourced income would disqualify a Free Zone Person from the 0% rate in respect of all their income.

While this is a welcome change for businesses with a mix of mainland and foreign-sourced income, it does present some additional practical questions in terms of the calculation of CIT payable on the Non-Qualifying Income of a QFZP. For example:

· Would the AED 375,000 income threshold before applying the 9% CIT rate be charged to the non-Qualifying Income of a QFZP, or would Qualifying Income also be taken into account for the calculation of the AED 375,000 income threshold?

· What is the appropriate method for allocating cost between Qualifying and non-Qualifying Income to determine the final tax liability?

In relation to the first question, it would be prudent at this stage to assume that the income threshold would not apply to non-Qualifying Income of a QFZP. This is supported by the fact that the tax rates applicable for QFZPs are defined in a separate section of Article 3 of the CIT legislation. However, this should become clearer upon issuance of the Cabinet Decision.

With respect to the second question, this should be determined through a combination of appropriate management accounting, transfer pricing policies (for intercompany transactions) as well as preparation of adequate documentation to support the allocation in the event of future audits. In this regard, we expect this to be an area that the FTA will scrutinize due to the potential for manipulation and ultimate reduction of tax payable.

Election for 9%: Under the CIT legislation, QZFPs have the option to ‘elect’ to be subject to tax at the 9% standard rate. Many readers may question why anyone would elect out of such a beneficial regime, if available to them. In this regard, notwithstanding the obvious benefit of the 0% rate there are some restrictions associated with being a QFZP.

For instance, a QFZP cannot become a member of a tax group, it cannot transfer losses to related parties or offset losses from related parties where those related parties are subject to the standard 9% rate. Furthermore, some of the benefits associated with the Free Zone Regime may be largely diminished for multi-national groups that are within scope of Pillar Two. This is discussed in further detail below.

In spite of the above, we expect the Free Zone regime to remain attractive to the large majority of taxpayers. However, our recommendation would be for businesses to perform a holistic assessment of their UAE operations to determine whether the election may be convenient for them once the Cabinet Decision is made public. This should include an assessment of the group’s entire presence in the UAE as well as a cost-benefit or financial modelling exercise to understand whether there is sufficient value in availing of the Free Zone regime.

Transfer Pricing: As part of introducing CIT legislation, the UAE shall also adopt formal Transfer Pricing (TP) regulations for the first time. TP is predicated on the arm’s length principle, which states that the commercial and financial arrangements between related parties are conducted in a manner that is consistent with arrangements between independent enterprises.

In the event that foreign-sourced related party income meets the definition of Qualifying Income, there will be additional scrutiny on payments made to QFZPs going forward from the counter-party jurisdiction. The requirement for transactions to meet the arm’s length principle aligns with the UAE’s commitment to transparency and alignment with international best practices. Additionally, it is important to note domestic transactions are also in scope of TP. As such, Free Zone entities that only transact domestically would still be required to meet this obligation.

The CIT legislation also includes a requirement for taxpayers to prepare adequate TP documentation to support the arm’s length nature of their related party transactions. The UAE’s TP documentation requirements include three components. These components are summarised in the table below:

Businesses should be pro-active in determining an appropriate operating model and transfer pricing policy for their Free Zone operations, including a policy for their transfer pricing documentation.

Other Conditions: Currently, we are not aware of any other conditions that will be announced by the MoF. We expect that this section was included to allow the MoF and FTA some flexibility to make an assessment on whether the current criteria are fit for purpose following the introduction of CIT in the UAE. For example, additional conditions may regard the need to counter abusive arrangements, such as the artificial separation of companies or activity lines to obtain illegitimate tax benefits.

As such, businesses should remain vigilant and attentive to future announcements to ensure they remain fully compliant and can continue using the tax incentives available under the Free Zone Regime.

Pillar Two

The BEPS Pillar Two proposal aims to introduce a global minimum tax rate of fifteen percent on multinationals with annual consolidated revenue above EUR 750m (AED 3.15b). The proposal is designed to ensure that multinational companies pay a fair share of tax wherever they operate, and to prevent them from artificially shifting profits to low-tax jurisdictions.

There are prescribed rules issued by the OECD to calculate a group’s Effective Tax Rate (“ETR”) on a jurisdictional basis to determine the appropriate level of top-up tax required.

Additionally, there are prescribed charging mechanisms to collect any top-up tax payable. These include:

Qualified Domestic Minimum Top-Up Tax (“QDMTT”) which may be optionally applied domestically at the local entity level (for example, the minimum tax as enacted by Qatar at 15% on excess profits);
Income Inclusion Rule (“IIR”) where the tax is payable by the parent entities of a low-tax jurisdiction; and
Under-Taxed Payments Rule (“UTPR”), which acts as a back-stop mechanism where the other two options are not available or applied.

Although the UAE has not announced much in relation to its intentions regarding Pillar Two, many countries and jurisdictions have confirmed they will implement the rules by January 2024 (EU, Switzerland, the UK, South Korea etc.). However, notable nations that have not made any announcements in relation to Pillar Two include the US, India, and Saudi Arabia. We have captured in one of our earlier pieces on the steps available for GCC countries as the world gradually moves towards Pillar Two.

Notwithstanding this, given the wide range of charging mechanisms noted above combined with the ever-growing number of jurisdictions that have announced they will implement, it is clear that the impact of Pillar Two will permeate through to the UAE regardless.

For qualifying multinationals with a QFZP, the benefit of the zero percent rate will likely be reduced through the ETR calculation and subsequent top-up tax payable. However, there may be some reprieve for entities with significant substance in the UAE due to certain measures the OECD has included as part of the Pillar Two model rules which promote substance, such as the Substance Based Income Exclusion and the Routine Profits Test Safe Harbour.

Multinationals should stay alert for future updates from the MoF and the FTA on the UAE’s intentions with Pillar Two and the possible impact on their Free Zone arrangements.

Conclusion

As outlined above, there remains a lot of uncertainty in relation to the UAE Free Zone Regime and how it will interact with the wider introduction of CIT in the UAE. However, it is clear that the Free Zone Regime shall remain a staple of the UAE economy and in most instances will provide a significant tax benefit to entities which qualify as a QFZP. As such, taxpayers should continue to remain attentive and prepare for the journey ahead.

UAE Tax

Updates on UAE CT Registration

Post author By Thomas Vanhee
Post date February 2, 2023
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Updates on UAE CT Registration

Here are some updates on the Corporate Income Tax registration procedures in the United Arab Emirates’ (UAE):

· Pre-registration for CT for certain categories of companies operating in the UAE has begun. This early registration phase is available until May 2023, after which the UAE’s Federal Tax Authority (FTA) opens the process for other businesses.

· The FTA released ‘Corporate Tax Registration User Manual’ (Version 1.0.0.0) (Manual). This Manual explains the procedure to navigate through the EmaraTax portal and submit the CT Registration application. For being eligible for registration, the applicant must be either a natural person (such as an individual), or a legal person (such as a Public Joint Stock company). The Manual provides the steps involved for filing the application and displays detailed screenshots at every step of the application process.

The FTA’s Press Release covering the update on CT pre-registration is available at https://lnkd.in/g2cjMhhk.

Aurifer released a newsletter summarizing all the facets of the UAE CT Law last month, which is available here. Aurifer also conducted a webinar on the CT Law last month, which is available at https://lnkd.in/dQCM8gMg.

UAE Tax

UAE Tax Residency Criteria

Post author By Thomas Vanhee
Post date February 1, 2023
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UAE Tax Residency Criteria

The Federal Tax Authority (FTA) issued Cabinet Decision No. 85 of 2022 (dated 2 September 2022), setting new criteria for determining tax residency for juridical and natural persons, and this decision will be effective from 1 March 2023.

The below takes note of everything you need to know about determining a natural person’s tax residency.

In addition, the document with all amendments is now available on the website of FTA.

For English: https://bit.ly/3RlfgXz

For Arabic: https://bit.ly/3JtxvrZ

Get in touch with our team of experts if you need help understanding these criteria!

UAE Tax

How anti-avoidance provisions can curtail the application of Double Tax Treaties, including in the UAE?

Post author By Thomas Vanhee
Post date September 2, 2022
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How anti-avoidance provisions can curtail the application of Double Tax Treaties, including in the UAE?

The Ministry of Finance (MoF) of the United Arab Emirates (UAE) recently announced that the draft Corporate Tax (CT) law is going to be released soon, and likely within the month of September. This is impactful news for businesses in the UAE. Many businesses are already in the process of taking steps to plan their affairs in such a way that their operations are tax compliant and tax optimized at the same time.

The UAE’s international position will change after the implementation of corporate tax. Some jurisdictions may no longer view the UAE as a tax haven (although the Free Zone businesses may still benefit from a 0% rate). Other tax authorities may therefore change their perspective on the UAE and be more inclined to grant the benefits under the double tax treaties.

Businesses on the other hand, will no longer view the UAE as a conduit jurisdiction with an extensive treaty network, through which they can avail tax treaty benefits. While the 9% headline rate is still comparatively low, the implementation of CT may also discourage taxpayers seeking out the UAE solely for tax purposes.

A recurring point of dispute between the tax authority and businesses in almost every country having a CT regime has been drawing the line between tax planning, tax avoidance and tax evasion. Once the UAE CT regime settles, the Federal Tax Authority (FTA) of the UAE may indeed pay more attention towards countering tax avoidance and tax evasion arrangements or transactions.

In this article, we will revisit the evergreen discussion of tax planning, tax avoidance and tax evasion, with an emphasis on the Gulf Cooperation Council (GCC). To begin, let us examine the meaning of the terms tax avoidance and tax evasion and the differences between the two terms.

Tax avoidance has traditionally been considered as lawful. It can be described as planning for the purposes of minimizing the tax burden within the legal framework. Tax evasion on the other hand is considered unlawful, and often requires an intentional and a potential fraudulent element.

In the GCC, tax authorities resort rather quickly to suggesting a taxpayer has committed tax evasion, even when the situation concerns simple non-compliance.

While not considered unlawful, tax avoidance has been considered harmful. This is why countries around the world, including the GCC Member States, are implementing domestic rules to counter aggressive or harmful tax planning in line with international standards.

The OECD tried to address this point by way of the ‘Main Purpose Test’ (MPT). The MPT was included in the OECD’s Model Tax Convention in its 2003 version. We are paraphrasing, but the principle stated that benefits under a double tax treaty should not be granted where the main purpose of setting up a structure was for tax purposes as the tax benefits resulting from that structure would go counter the object and purpose of those treaties.

Another common mechanism proposed in tax treaties to avoid the improper use of tax treaties, is the ‘Beneficial Ownership’ (BO) requirement. It mainly applies to passive income (e.g., dividends, interests, and royalties). The BO concept provides that where an item of income is paid to a resident of a Contracting State acting in the capacity of an agent or a nominee, it would be inconsistent with the object and purpose of the source state to grant an exemption or relief, merely because the direct recipient is a resident of the other Contracting State. In such a case, the direct recipient, on account of being merely an agent, nominee, conduit, fiduciary, or administrator, would not be able to obtain the benefits of the treaty. This is especially evident if such recipient is legally or contractually bound to pass on the payment received to another person. BO disputes often end up before the courts, because the burden of proof for the taxpayer is not easily met.

The 2008 Financial Crisis put the discussion on tax avoidance and aggressive tax planning firmly on governments’ agenda. Following the Financial Crisis, public opinion shifted towards ensuring that big corporations pay their fair share of taxes and pressured countries to implement rules to discourage such behaviors.

As a result, the OECD established what is known as the ‘Inclusive Framework’ (IF), which was open to both OECD and non-OECD members (currently at 141 members) to engage in discussions and create rules for countering Base Erosion and Profit Shifting (BEPS). It is formally known as the OECD/G20 BEPS Project (BEPS Project 1.0) which identified 15 Action Points in 2015.

Out of the 15 Action Points, one of the most important action plans was BEPS Action 6 – Prevention of Tax Treaty Abuse, which also formed one of the four minimum standards. BEPS Action 6 addresses treaty shopping activities that would be viewed as avoidance.

BEPS Action 6 requires IF members, amongst others, to include an express statement in their treaties that their common intention is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements.

Anti-avoidance rules aim amongst others to avoid conduit arrangements. For example, State A has a domestic withholding tax rate for dividends of 25%. State A and State B have negotiated a tax treaty where the source withholding tax rate for dividends is reduced to 5%. A resident in State B receives dividends from State A and claims the reduced treaty rate of 5% source withholding.

However, the resident in State B has an obligation to redistribute the dividend income to a resident in State C. State A and State C do not have a tax treaty in place. It can be observed that there is no BO in State B due to its obligation to pass the payment onto another party. Clearly, such payment is not made for the benefit of any resident in State B nor for enhancing economic cooperation between States A and B. Instead, the benefit would be received by the resident of a third State (i.e., State C). This clearly shows that the treaty has been misused or abused by the resident of State B, against the intention, object, and purpose of the treaty between States A and B.

To combat misuse of the treaty like the case described above, BEPS Action 6 seeks IF members to implement a ‘minimum standard’ in all its treaties. The minimum standard can be either of the following:

The combined approach of a Limitation of Benefits (LOB) and a Principal Purpose Test (PPT) rule,
The PPT rule alone, or
The LOB rule supplemented by a mechanism that would deal with conduit financing arrangements not already dealt with in tax treaties.

As a consequence, many IF members’ tax treaties have been updated to include, at least, a PPT rule. This is done by way of signing and ratifying the Multilateral Instrument (MLI) as it allows IF members to update multiple bilateral tax treaties simultaneously. The PPT rule looks a lot like the MPT. True to its name, if one of the principal purposes of an arrangement is to obtain a benefit, the PPT rule may be triggered. This clear intention has also been expressed in the wordings of the preamble incorporated in the OECD Model Tax Convention 2017.

Due to the lack of case law, the impact of the PPT rule is rather uncertain for now and the interpretation of the PPT rule may vary across jurisdictions. It may be possible that the cases that were successfully tested before the courts of law earlier may not survive the PPT rule if they were to be presented before the courts today, provided that the PPT rule was applicable at the time of the transaction or arrangement.

What is certain is that taxpayers ought to be very careful in tax planning so that the structures do not fall foul of the PPT rule. When deciding on the country to make an investment in or the structure of a transaction or arrangement, taxpayers ought to clearly record the non-tax reasons (main/principal purposes) for selecting a certain jurisdiction over another. Evidence can be maintained through internal emails, memos, and minutes outlining the reasons for selecting a country. For example:

A country is preferred due to a favourable corporate law regime.
A country is preferred due to the presence of multilingual or highly qualified employees.
A country is preferred as it is politically and socially stable.
A country is preferred as it has a strong banking infrastructure where it is easy to obtain credit.

Despite the above safeguards, if the tax authority does reasonably conclude that one of the principal purposes of invoking the treaty was to obtain a tax benefit, the taxpayer ought to ensure that it can establish (i.e., prove) that the benefit obtained was indeed within the object and purpose of the tax treaty.

Finally, as mentioned before, public opinion against tax avoidance is stronger than ever. The relevance of the PPT to future transactions cannot be overstated. Arrangements that may have been successfully litigated before the courts of law until a few years ago, may not be as successful from now on. Therefore, taxpayers may find advance rulings to be attractive as it is important to avoid future issues.

It will be interesting to see how the UAE and the other GCC countries will approach such abusive arrangements and its possible disputes. In the meantime, it is apparent that either through the MLI or through bilateral double tax treaties, the PPT continues to be important. It is vital to consider such anti-avoidance provisions now in order to create future proof structures.

UAE Tax

The UAE Crypto Central – also for tax purposes?

Post author By Thomas Vanhee
Post date January 3, 2022
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The UAE Crypto Central – also for tax purposes?

The UAE is aspiring to become a leader in the cryptocurrency business in the region and it is aiming to attract more than 1,000 cryptocurrency businesses in 2022. To position itself against the regional and global competition, it has recently developed an advanced regulatory framework. Both central, on-shore authorities such as the Central Bank of UAE (“CB”) and Securities and Commodities Authority (“SCA”), and some of the free-zones, such as DIFC, ADGM and the DMCC have enacted advanced legal frameworks, while DWTC has announced an important partnership with a Crypto Exchange. It is expected that DWTC will also implement a comprehensive regulatory framework.

While the regulatory environment is quite advanced for this part of the world, the tax framework in the UAE is still relatively immature. In light of the UAE VAT law, it will be interesting to see how the Federal Tax Authority will take position vis-a-vis different transactions involving cryptocurrencies, crypto assets, and related services (wallets, brokerage, decentralised finance). Furthermore, in light of the potential introduction of Corporate Income Tax in the UAE as a consequence of the Global BEPS 2.0 initiative, it would be interesting to see the position of the UAE authorities taken towards taxation of the crypto space.

The authors aim to answer some of these questions, from the viewpoint of different possible taxes. This article does not aim to be comprehensive, nor explain how blockchain works.

The article has a focus solely on the UAE’s tax and regulatory framework, as it constitutes at least the most ambitious jurisdiction in the region, intending to stimulate the development of a crypto sector in the UAE. Other jurisdictions, such as Bahrain, have also enabled exchanges to establish themselves there. Bahrain has a relatively comparable tax framework to the UAE. The other GCC countries are largely absent in the field.

We will not be covering the Emirate Banking Tax Decrees nor the General Tax Decrees in the Emirates, which constitute taxation on a local (i.e. Emirate) level.

The framework is fast paced and subject to fast evolution, as adoption spreads. It is also shaky, with Tesla accepting and then again denying cryptocurrencies as payment for its cars, and China cracking down on crypto.

Regulatory Context
The Regulatory Framework in the UAE which could impact crypto is determined on the one hand for mainland companies by the Securities and Commodities Authority (SCA) and the Central Bank (CB), and on the other hand by the Federal Financial Free Zone Authorities established in the Dubai International Financial Center, and the Abu Dhabi Global Markets.

In on-shore UAE, the CB and the SCA share responsibility for the regulatory oversight of the UAE’s financial and capital markets. This includes the non-financial free zones, such as the Dubai Multi Commodities Centre (DMCC) and Dubai World Trade Center (DWTC). On the other hand, financial free zones, i.e. ADGM and DIFC have provided their separate regulatory framework for the entities established within their jurisdictions.

From the on-shore side of regulation, the CB has regulated crypto assets and included digital tokens (such as digital currencies, utility tokens or asset-backed tokens) and any other virtual commodities,^[1] While the CB maintains that crypto-assets are not legal tender, the CB explicitly allows crypto-assets to be used as a stored value when purchasing other goods and services.

The SCA framework^[2] applies generally to SCA regulated “Financial Activities” in respect of crypto-assets in the UAE, which include promotion and marketing, issuance and distribution, advice, brokerage, custody and safekeeping, fundraising and operating an exchange of crypto assets.

The DIFC freezone regulates only “Investment Tokens” which are basically securities or derivatives based on the blockchain technology. This means that key cryptocurrencies, as well as stablecoins, will remain unregulated under the Investment Tokens regime.

The ADGM freezone issued the most advanced and comprehensive framework regulating the operation of crypto-asset businesses. It has regulated virtual assets (such as non-fiat virtual currencies), digital securities, fiat tokens (i.e. stablecoins), and derivatives and funds (i.e., derivatives over any digital assets and collective investment funds investing in digital assets) while other crypto assets remain unregulated. From a regulatory policy perspective, the FSRA treats virtual assets as commodities. Even though not all virtual assets are specified investments, any market operator, intermediary or custodian is required to be approved by ADGM as a financial service permission holder in relation to the applicable regulated activity.^[3]

One topic that has not been regulated both on-shore and in the free zones is the growing DeFi industry, which is becoming central to the blockchain and crypto space globally. There are no incentives for permissionless peer-to-peer systems and DeFi to develop. It remains to be seen whether this stance will change in the near future, and hence we will not analyse the tax consequences in the DeFi industry. A further area of uncertainty is the status of NFTs as they remain undefined.

DeFI, Investment Tokens (digital securities), and utility tokens asset based tokens are not further discussed in this article.

The VAT conundrum – Out of scope as money, or a service?

The mining, exchange or disposal of cryptocurrencies, as well as other transactions occurring in the crypto industry may have VAT consequences. Hence, the definition of the crypto-assets and related services is particularly important in determining their VAT treatment. VAT is a consumption tax with a wide scope, and therefore it is imaginable that some transactions may be subject to VAT.

In contrast with income taxation, where the accounting treatment is usually followed directly, with some adjustments, in the comparative VAT practice, cryptocurrencies are often treated as akin to fiat currencies in the VAT treatment of transactions involving their exchange or disposal.

Regulatory definitions and the framework can give some guidance when interpreting the potential VAT treatment of different types of crypto-assets and the related services. There is a relatively broad similarity among EU countries as to the VAT treatment for transactions involving cryptocurrencies. There is greater divergence among countries comparatively in the treatment of “related” or “back-office” services, such as custodial services, online wallet services and exchange services.

GCC and UAE VAT for Financial Services

The Gulf Cooperation Council’s VAT Agreement of 2016 was based on the EU VAT directive in a version after 2011 but before 2013. However, for the Financial Sector, it allowed significant leeway to implement local policies. Article 36 of the GCC VAT Agreement prescribes that financial services provided by licensed banks and financial institutions are exempt from VAT. It further allows that Member States apply fixed refund rates for financial institutions (with inspiration drawn from Singapore), and in its second paragraph allows full freedom to apply “any other tax treatment”.

In the Financial Services sector, the UAE and the Gulf Cooperation Council have deviated significantly from the European VAT directive, which do not grant the same liberty in terms of setting tax policy to its Member States.

When the UAE and KSA issued their laws in 2017, and with KSA being the first, they had prescribed a system where financial services where the provider makes money on the basis of a spread are VAT exempt (see here for our article on VAT exempt persons: https://www.aurifer.tax/news/special-tax-payers-in-the-gcc-exempt-taxable-persons/?lid=438), and where these are fee-based, they are taxed. Since then Bahrain in 2019, and Oman on 16 April 2021, have not deviated from their predecessors.

Far clearer than the VAT regimes applicable to financial services in Europe, given that the scope is narrower, it also entails more services are subject to VAT. This is a double edged sword, as the input recovery increases, but also the cost for customers that do not recover input VAT.

The VAT laws in the UAE and the GCC focus on more traditional banking services, and do not discuss the novelties which are the subject of this article. Neither do the laws in the rest of the world for that matter. That is not surprising, as the VAT laws are general set of rules, intended to apply widely on a large number of situations.

In the UAE, the UAE VAT law in article 46, 1 simply refers to financial services as being exempt from VAT and relies on the UAE VAT Executive Regulations. Article 42, 2 of the UAE VAT Executive Regulations then refers to “services connected to dealings in money (or its equivalent)”. The same article then goes on the list a number of services by way of illustration which would constitute such exempt financial services. None of these services listed link directly to cryptocurrencies.

The only principle to go by, is that the UAE’s FTA states that “the starting point for the UAE VAT treatment is that VAT should be charged on financial services where it is practicable to do so”. This is however not easy to implement, and may even seem at odds with the exemption for interest on loans, since it may be practicable to add VAT to interest.

Tax authorities are usually late to the game with this type of novelties, and therefore the GCC are no different. However, given that the UAE wants to position itself on the matter, it may be good if it considered a clear position. We have therefore analysed below a number of typical transactions involving crypto and their applicable VAT regime.

It is to be noted, that even in the carved out Federal Financial Free Zones, in terms of taxation, currently in the UAE, no exceptions apply to the general regime.

Starting with mining crypto

There is a relatively broad consensus among countries as to the VAT treatment for transactions involving the mining of virtual currencies. The mining of virtual currencies is their creation through mining activities. The person mining the currency therefore acquires assets in the process of mining.

There is no public position from the UAE’s Federal Tax Authority on the matter, but it may draw inspiration from research conducted by the OECD (OECD (2020), Taxing Virtual Currencies: An Overview Of Tax Treatments And Emerging Tax Policy Issues, OECD, Paris. www.oecd.org/tax/tax-policy/taxing-virtual-currencies-an-overview-of-tax-treatments-and-emerging- tax-policy issues.htm).

In that research, the OECD cites an EU VAT Committee report (an advisory body with no legal power; you can find the VAT Commitee’s Working Paper 854 on Bitcoin here), which found that mining activities should be out of scope of VAT.

This is largely attributed to the fact that there is no direct link between the remuneration of the mining and the activity itself.

The possible alternative qualification in the EU is that mining constitutes a service related to currency, and is therefore exempt from VAT.

Small jurisdictions which exempt the mining of cryptocurrencies domestically but allow it to be zero rated when dealing with foreign customers, could offer substantial advantages, since the zero rate would allow the sellers to recover the input VAT. This may be a potential tax policy option for the UAE or Bahrain.

As Bitcoin reaches its capped supply, and there will be no more mining, its economics will alter. The incentives for various members in its ecosystem, such as miners and traders, will change. For example, miners may rely less on block rewards and more on transaction fees to earn revenue and profits for their operations. Those transaction fees might be regarded as taxable financial services in the UAE.

If it is considered that mining is in scope of VAT, which we are not advocating, unless it would be VAT exempt, the multitude of actors may still see different VAT regimes applicable, since some of the smaller miners may not reach the mandatory registration threshold.

Holding crypto

The holding of cryptocurrency as such should be equated to holding on to an asset. From a VAT point of view, since it is a transaction tax and holding it involves no transaction, there should be no impact. That holds true as well even if the currency appreciates or depreciates in value.

Selling and buying crypto

The main discussion therefore evolves around whether the sale and purchase of a crypto currency is a service (and therefore constitutes a barter transaction), or should be considered as the equivalent of using and purchasing money.

In the EU, to exempt financial services from VAT, and also money services, the VAT directive states that the EU Member States shall exempt “transactions, including negotiation, concerning currency, bank notes and coins used as legal tender” (article 135, 1, e Recast EU VAT Directive 2006/112/EC).

The European Court of Justice (C-264/14, Hedqvist) had judged that the exchange of legal tender against bitcoin, a cryptocurrency, is a service, and an exempt one at that. Bitcoins are treated as akin to fiat currencies (i.e. traditional currencies).

While the definitions in the GCC are different, and while above we had discussed that the GCC Agreement allows for much more tax policy room than the EU VAT Directive, the guidance clearly points towards the concepts in the EU. The ECJ ruling therefore does not constitute a source of law, but is definitely an authority on the matter.

The ruling is potentially subject to challenges, and not all authors would agree with the position taken. The ECJ only ruled on bitcoins, however the reasoning can be applied to similar cryptocurrencies which function in the same way.

Especially the comparison with legal tender in terms of its functionality can be flawed, as not all cryptocurrencies are accepted for payment purposes.

When considering the sale of cryptocurrency as in scope of VAT and exempt, small jurisdictions which allow the trading of cryptocurrencies to be zero rated when dealing with foreign customers, could offer substantial advantages, since the zero rate would allow the sellers to recover the input VAT.

In the authors’ modest opinion, for the sale and purchase of crypto itself, it can be broadly considered as the equivalent of fiat currency for the purpose of VAT treatment, and therefore should be considered as out of scope of VAT.

Using crypto to acquire goods or services

Considering that the SVF Regulation of the Central Bank allows crypto-assets to be used as a stored value when purchasing other goods and services, it is an argument in favor that it could be regarded as an equivalent of using the fiat currencies, and therefore using it to acquire goods or services should not entail any VAT consequences, in the same way as one would use fiat currency to purchase a good or service.

The supply of goods and services, subject to VAT and remunerated by way of Bitcoin, for example, would for VAT purposes be treated in the same way as any other supply. VAT should therefore be levied on the value of the goods or services provided.

However, if UAE would consider that the buyer is rendering a service by paying with cryptocurrencies, the transaction will constitute a barter, and is therefore taxable because of the sale of the good or service, and is taxable on the value of the cryptocurrency handed over to the seller.

There are a number of technical complexities associated with such a barter, such as the valuation and the use of an exchange rate, but to avoid complexities it would be better to stay consistent with considering cryptocurrency like a traditional currency, considering that treating the use of crypto to acquire goods or services as bartering would lead to an awkward result.

Crypto brokerage and wallet providers

As for crypto intermediation services – services related to crypto exchange, brokerage, and wallet/custodial servicesproviders, the question is would it be qualified simply as services or would it fall under financial services.

As for the crypto exchanges and brokerages, even though the EU VAT Committee has taken a position that their services should be taxable, in practice EU countries (such as Germany, France and Italy) are exempting their services from VAT, following the ECJ decision in Heqvist. The same approach is taken in the UK where these services are exempt in line with the treatment of the financial services.

An argument to consider these services as financial services is that their activities are regulated by the SCA regulation and that they are specifically referred to as Financial activities in the Crypto Assets Regulations Explanatory Guide issued by the SCA.

However, given the GCC VAT specifics and the different structure of the fees charged to the customers, crypto exchanges might be exempt on the spreads/margins made while any flat fees/ fixed fees might be taxable, except if the customer is based abroad where such services would be zero rated with a possibility of a deduction. Finally as there are different types of traders and exchanges (centralized / decentralized, principal trading / brokerage trading) the analysis of their fees, agency arrangements and taxation should be further analysed and may be complex.

However, given the UAE’s goal to give a competitive advantage to the crypto businesses set up locally compared to other jurisdictions, it should be taken into account that VAT would be putting the consumers in UAE at a disadvantage compared to other consumers globally, who can buy and sell cryptocurrencies without VAT. Furthermore, it would harm the competitiveness of the local UAE based exchanges against the exchanges abroad.

Finally, the UAE should take into account that VAT exemption in other jurisdictions was also based on the fact that taxing each and every transaction would lead to disproportionate administrative burden given the volatility of crypto prices and the amount of trades and transactions concluded on a daily basis.

On the side of wallet / custodial services, there are different types of wallets and related services – the so called “hot” (software based) or “cold” (hardware based) wallets, or arranging for third party storage of private keys. Service providers might or might not charge a fee for the provision of such services, as these services might be provided standalone or related to other, main services (sale and purchase of cryptocurrency or trading services and similar). There are different approaches in taxing these fees comparatively, and some countries exempt those fees on the grounds that these services are closely linked to the main, exempt service or tax them as a separate – non financial service. In the UAE, the situation is much clearer and such wallet or custodial services are simply standard rates.

Other indirect taxes

While at first sight, there would be no other indirect taxes applicable, potentially real estate transfer taxes would come into sight with tokenisation of real estate – i.e. the asset backed tokens. Although set at a different level, and not a direct property right or a right in rem, anti-avoidance rules may trigger the application of transfer duties nonetheless.

Not subject to Personal Income Tax

Contrary to the discussions one may have in other jurisdictions as to the categorization of the gains of the sale of crypto for tax purposes, given the absence of personal income tax in the GCC, the discussion whether the gains constitute professional income, trading income, speculative income, income from capital or other taxable income, does not play.

However, one could imagine that tax authorities which have corporate tax systems may want to be tempted to consider the income as business income and tax it.

Equally so, for the same reason, the creation or mining of cryptocurrency would not lead to taxation under personal income tax in the UAE, or the wider GCC.

As a comparison, reportedly in the US, the creation of bitcoins through mining needs to be included at the fair market value of the virtual currency in gross income at the date of receipt. If the taxpayer is conducting a trade or a business, the taxpayer is considered self-employed.

The planned introduction of Personal Income Tax for high earners in Oman in 2023 may see the first discussions around the topic.

Transfer pricing complexity and potential CIT treatment.

The UAE only has a fairly light transfer pricing (“TP”) framework, with no requirements for master files or local files, and only the requirement for an Ultimate Parent Entity to file a Country by Country Report (Cabinet Resolution No. 44 of 2020).

This may very soon change, with the implementation of BEPS 2.0, which may entail significant changes to the UAE’s tax regime, where we can potentially expect some form of Corporate Tax together with a Transfer Pricing regime.

Even though the UAE has a fairly light transfer pricing framework, it is by nature a very international jurisdiction, and therefore it is common for UAE businesses to have voluntarily adopted a transfer pricing framework applicable to the UAE.

Two interesting aspects of TP of the crypto universe are the intercompany transactions done in crypto and the intercompany transactions of the international groups involved in the crypto industry.

Given that some of the large investment funds and other companies are now investing in crypto as an asset or a hedging mechanism against inflation, and that the cryptocurrencies could facilitate cross border payments, it is reasonable to expect that, as the cryptocurrency adoption increases, multinational corporate groups could hold cryptocurrencies and transfer them within the group in exchange for fiat currencies or other goods and services.

How would the TP methodology apply to such types of transactions? The First option is to perform the analysis at the level of profitability of the involved entities based on their functional analysis and the Group’s value chain. Conversely, pure cryptocurrency transactions that cannot be justified with profit based methods would need to rely on CUPs (Comparable Uncontrolled Prices) where accurate valuation of the crypto assets at the moment of a transaction would be a key issue.

Given the volatility of the cryptocurrency prices (excluding the stablecoins), the traditional benchmarking ranges might not be precise enough. Yet, in case of a high volume of transactions, tracking each and every transaction and comparing the prices at the date of the transaction would lead to a significant administrative burden in documenting the intercompany transactions. Furthermore, such prices could not be compared directly with the market prices as they would have to be discounted or increased for various intermediary fees, to reflect the arm’s length conditions. This will present a challenge for Transfer pricing practitioners and benchmarking software providers as well as an opportunity to potentially solve this matter with some new software benchmarking solutions and adjustments that could allow for accurate CUP benchmarking.

Cryptocurrency related businesses such as crypto exchanges, traders, brokerages, crypto advisors, custody (wallet) providers, marketing and other ancillary services providers, which will be still be in between different growth stages from a start up to a larger multinational would have a different set of TP issues on their side. We can expect to see a value chain that combines the elements of a technology/IT based business, commodity trading business and typical back office and marketing support businesses. The value chains would largely revolve around key technologies employed, company branding and distinctive products/services offerings as the key high value adding drivers. Following the usual TP methodology, the key would be ensuring that these functions are appropriately remunerated with higher margins and/or appropriate residual profits. Given that many crypto businesses would enter the UAE market, we can expect their regional HQs to be subject to scrutiny on their transfer pricing arrangements in other jurisdictions in the region given the rapidly evolving TP landscape in the Middle East as well as the BEPS 2.0 developments that are targeting the large international businesses based in low tax jurisdictions.

Finally, if UAE indeed takes a leap into CIT as a consequence of the BEPS 2.0, it is important to note that CIT typically follows the accounting treatment. IFRS IC has classified holding cryptocurrencies as intangible assets (rejecting the qualification of financial assets or cash), unless they are held for sale in the ordinary course of business, in which case cryptocurrencies would be treated as inventories. In case of a longer holding period, the gains / losses realised should be treated as capital gains while in cases of shorter holding periods and therefore purchases and sales at the level of inventory, the gains/losses should be taxed as ordinary business income. Valuation of these assets is another matter that should be sorted by the IFRS or the separate guidance of the corporate income tax law.

A few other novel topics come to mind such as Permanent Establishment risks for overseas traders, Withholding tax implications for technology and financially based cross border transactions, but we can only expect that tax implications will largely lag behind the industry developments. It is fair to say that much can and still will be said, and that further technological developments will challenge the tax framework.

Milos Krstic – Head of Tax at Rain, the first Middle East crypto brokerage

Thomas Vanhee – Tax Partner, Aurifer

^[1] UAE Central Bank, Stored Value Facilities (SVF) Regulation, available at https://centralbank.ae/sites/default/files/2020-11/Stored%20Value%20Facilities%20%28SVF%29%20Regulation%20AR%20%26%20EN.pdf

^[2] https://www.sca.gov.ae/en/regulations/regulations-listing.aspx#page=1

^[3] https://thelawreviews.co.uk/title/the-virtual-currency-regulation-review/united-arab-emirates

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