UAE increases attractiveness as holdco location
The Double Tax Treaty (“DTT”) between the UAE and the KSA provides a significant tax incentive for businesses operating in the two contracting states. A positive impact on investment and trade between the two contracting States is expected in the aftermath of its entry into force.
This is the first DTT signed between two GCC countries. KSA is a member of the G20 and a key player in the GCC economy and on the global oil markets. It is keen to reinforce its promising investment environment. On the UAE side, the signing of this DTT reinforces its status as a regional hub for foreign investments and shows its commitment to its continued attractiveness and excellence.
Both contracting countries are members of the BEPS inclusive framework and signed the Multilateral Instrument (“MLI”). Signing such a bilateral DTT is a new step towards compliance with BEPS minimum standards – notably regarding transparency and tax avoidance. It goes hand in hand with the extensive TP legislation recently published in KSA.
This article highlights the key features of the DTT and analyses its tax implications for businesses operating in the two contracting states.
1. About the Treaty
Due to lengthy negotiations, the treaty is based on the 2014 OECD Model Tax Convention, even though the model was updated in 2017.
However, the KSA has already included this DTT in the list of its Covered Tax Agreements (“CTA”) in the MLI. It is yet to be included by the UAE, since the UAE signed the MLI shortly after the treaty.
2. Key Features
Only the “residents” of the contracting states shall benefit from this treaty.
This residence principle is generally adopted by the KSA in most of its recent treaties, contrary to the UAE which has recently opted for a citizenship criterion, such as for its recent DTT with Brazil.
As a primary definition for “resident”, the treaty uses the standard language of the OECD Model Tax Convention.
An additional interesting provision is that the DTT expressly qualifies as resident, any legal person established, existing and operating in accordance with the legislations of the contracting states and generally exempt from tax:
• if this exemption is for religious, educational, charity, scientific or any other similar reason; or
• if this person aims at securing pensions or similar benefits for employees.
Although the treaty does not specify whether the residence concept is applicable to businesses established in the Free Zones (UAE) or the Special Economic Zones (KSA), the competent tax authorities are required to coordinate to determine the requirements and conditions to be satisfied to be entitled to any tax benefit granted by this treaty.
Permanent Establishment “PE” Clause
The PE clause is largely based on the OECD Model Tax Convention, but features two elements inspired by the UN Model. It notably qualifies:
• As a PE: a building site, construction or installation project after 6 months (12 in the OECD Model)
• As a service PE: providing services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose if their presence lasts for a period or periods aggregating more than 183 days in any 12-month period
Taxes covered, rates and double taxation elimination
The DTT covers income tax and Zakat in the KSA and income tax in the UAE, inspite of the absence of a federal income tax law in the UAE.
No withholding tax regime applies in the UAE. The table added to this article shows the impact on the withholding tax rates in the KSA and the consequences of the treaty.
The DTT will not apply for royalty payments in case the beneficiary has a PE in the source country (exceptions apply). Similarly, excessive interest payments made between related parties shall not benefit from the DTT exemption.
The treaty provides for source country taxation only on income from natural resources exploration and development. The elimination of double taxation is performed through the tax credit method.
Zakat and the Treaty
Zakat is covered by the treaty (for the KSA). An interesting provision, introduced in several DTTs concluded by Saudi Arabia (e.g. Georgia, Mexico and Kazakhstan), states that “In the case of the KSA, […] the methods for elimination of double taxation will not prejudice the provisions of the Zakat collection regime.”
This provision may have an impact on Zakat for UAE businesses, considering the recent update of the Zakat implementing regulations. This notably impacts PE headquarters that might be subject to Zakat in the KSA, if specific criteria are met.
3. MAP and other provisions
The treaty provides for a Mutual Agreement Procedure (“MAP”) which can be requested to the competent authority in any of the contracting states within 3 years from the first notification of the action resulting in taxation not in accordance with the provisions of the Convention.
Investments owned by Governments (e.g. investments of Central Banks, financial authorities and governmental bodies) shall be exempt from taxes in the other contracting state. The income from such investments (including the alienation of the investment) is also exempt. The exemption does not include immovable properties or income derived from such properties.
There is no provision in the treaty for non-discrimination, assistance in the collection of taxes or territorial extension.
The entitlement to the benefits of the treaty will not be granted in case the main purpose of the transactions or the arrangements at stake is proved to be the enjoyment of such a benefit.
Even though this DTT between the KSA and the UAE is largely based on the OECD model 2014, the PE definitions it provides adopted from the UN model, broadens the scope of the activities taxable in the source countries, and will require specific attention.
The relief of withholding tax on royalties and interests, along with the MAP will reinforce the business relationships between these two countries. It is regretful that there is not a clear framework for Free Zone or Special Zone companies.
Finally, it is to be expected that the treaty will soon be notified by the UAE as a CTA under the MLI. In such case, businesses willing to benefit from this DTT will have to satisfy the Principal Purpose Test for the concerned transactions or other investment arrangements.
Since the introduction of its Anti Dumping law in 2017, the UAE has recently imposed anti dumping duties again to tackle goods dumped on the UAE market. Even though many countries have had a legal framework in place to take such measures since a long time, the UAE only adopted Federal Law No. 1 on Anti-dumping, Countervailing and Safeguard Measures in 2017.
This law implemented the 2011 GCC Common Law on Anti-dumping, Countervailing and Safeguard Measures. The law only applies to trade practices by non-GCC countries and not between GCC States.
Dumping occurs when goods are exported to the UAE at substantially lower prices than the sales price in the country of export. The sellers can for example offer these lower prices because of subsidies or other financial support provided by the government of the exporting country.
In a wider perspective, as illustrated by the US-China trade war, countries are increasingly looking at trade measures to tackle trade imbalances. In 2015, the US decided to impose a 500% antidumping duty on Chinese steel.
In January 2019, the UAE Cabinet decided to increase customs duties applicable to rebar and steel coils from 5% to 10% as a means to provide trade protection to iron producers in the UAE. This article discusses the provisions of the mechanics of such trade measures in the UAE.
Dumping measures are taken after a complaint by the UAE industry or the minister. The complaint demonstrates the link between imports and similar domestic products and the damage caused to the domestic industry.
If the complaint is accepted, an investigation will be started and notified in the Official Gazette and UAE’s top two newspapers.
An Advisory Committee will send questionnaires to interested parties to obtain essential data, notify the countries concerned, inspect the exporter’s facilities, hold public hearings and prepare a preliminary report before making a decision.
The investigation will be terminated in cases the complaint is withdrawn, the dumping margin is less than 2% of the export price, the volume of imports is less than 3% of the total imports or if there is insufficient evidence to support the dumping claim.
What is the damage?
The damage caused to the domestic industry may take the form of material damage (e.g. a drastic drop in sales volume), a threat of material damage or material retardation to the establishment of a domestic industry.
The damage can be demonstrated by an increase in the volume of imports which leads to a significant depressing or suppressing effect on domestic prices.
Determining the dumping margin
The dumping margin is the fair comparison between the normal value and the export price of these goods. This will be the base for levying anti-dumping duties or alternative measures.
The normal value is the comparable price at which the goods under complaint are sold, in the ordinary course of trade, in the domestic market of the exporting country. The export price is the price at which goods are exported to the UAE. It is generally the value at ex-factory level.
Imposing anti-dumping measures
During the investigation, provisional measures can be taken for 4 months. Provisional measures can be for example imposing temporary duties or requesting a security deposit upon import.
The investigation will be suspended or terminated if the exporter is willing to increase prices or cease exports at dumped prices.
The final decision of the investigation will either include the termination of the provisional measures or the imposition of a definitive measure. A definitive measure will be in the form of a duty valid for a maximum of 5 years or until the damaging effects of dumping have been eliminated (or any other trade measure).
The anti-dumping duty on imports of car batteries from South Korea is a prime example of a definitive measure imposed by the UAE since the introduction of the law. The duty remains effective for 5 years starting from 25 June 2017 onwards.
The Advisory Committee will review these measures to ensure that they have the desired effect on the domestic economy. A review will also take place on the need for imposing anti-dumping duties for new exporters of like goods from the same country.
Effect on customs valuation and VAT
In the GCC, anti-dumping duties are levied over and above the normal customs duties applicable on on imports of goods. Customs duties and VAT are intrinsically linked. VAT applies on top of these customs duties. Since in the EU VAT also applies on top of anti dumping duties, presumably VAT also applies on top of anti-dumping duties.
Following the publication of the VAT legislation in Bahrain and the start of a new year, VAT has now become a reality in Bahrain. Bahrain is the third GCC country introducing VAT and the National Bureau of Taxation (“NBT”) will be policing it. In this article we will touch upon the most interesting and striking parts of the VAT legislation.
Unlike the UAE and KSA, the Bahraini VAT legislation provides for an exemption for the supply or lease of both residential and commercial buildings. Bahrain is the first GCC country that implements a VAT exemption for the supply and lease of commercial buildings. The exemption may have far reaching consequences for the real estate market.
Furthermore, a zero rate is applicable on construction services related to new buildings (residential and industrial). Goods supplied by a business that supplies construction services and which are supplied in the course of providing construction services for a new building, are also zero rated. This includes for instance building materials and materials necessary to construct specialised raised flooring for computer server rooms.
However, goods like furniture that is not affixed to the building, swimming pools and decorative lighting, paintings, carpets and murals and other artwork are not zero rated.
The zero rate is also not applicable on restoration works, demolition of existing buildings and architects and interior design fees. VAT incurred on these purchases will therefore constitute a cost for businesses who want to sell or lease their new constructed building.
Bahrain implemented the optional provision in the GCC VAT Agreement and applies a zero rate on the supply and import of certain basic food items. Bahrain is again the first GCC country doing this. The Bahraini Tax Authority published the list with zero rated items, indicating that 94 types of food will fall under this special rule. The list includes ten categories:
- Meat and fish
- Fruits and vegetables
- Coffee, tea and cardamom
- Wheat and rices
- Children’s food
- Egg products
Note that the supply of food by restaurants, coffee shops or caterers will still be subject to the standard rate. There is a great deal of conflict expected around the interpretation of mixed supplies which include a zero rated part, or between take in and take out products.
Bahrain has taken an unoriginal position in line with KSA and UAE. Financial services are exempt from VAT, except where the consideration for the service is expressly determined as a fee, commission or commercial discount. Financial services are defined as services related to cash transactions in the VAT Executive Regulations.
Additionally the regulations also include a list with examples of financial services that are exempt (e.g. depositing money in current accounts, savings accounts or deposits, granting and transferring loans, borrowings and credit, issue or cancellation of cheques, debit cards and credit cards).
Some services like the issue, allotment, or transfer of ownership of an equity security or debt security and life insurance and reinsurance contracts, will be exempt, irrespective of how the consideration for them is payable.
Furthermore the supply of financial services to non-residents will be zero rated.
In case the financial institution supplies services which do not fall under the VAT exemption nor the zero rate, the standard rate will have to be charged. Consequently the financial institutions will have to issue compliant invoices. In this regard the regulations clarify that a bank statement shall be treated as a tax invoice provided it contains certain information like the name, address and registration number of the bank in the Kingdom and the name and address of the customer.
Similar to the UAE and KSA, in Bahrain a zero rate is applicable on the international transport services of goods which begin in, end or pass through its territory, including services and the supply of related means of transport. The zero rate is also applicable on the supply of services and goods directly or indirectly associated with the international transport of passengers and goods, including goods and services supplied for use or consumption on board a means of transport.
A zero rate is also applicable on the local transport services of goods and passengers by land, water or air. Exceptions apply, i.e. the standard VAT rate is applicable in the following five cases:
- Transport services provided by a person who does not meet any regulatory or licensing requirements from the authorised body to provide such services,
- Services of vehicle rental without a driver,
- Transport services for sightseeing or leisure purposes,
- Food delivery services provided by a person supplying food,
- A transport service which is ancillary to the principal supply of goods or services which is taxable at the standard rate, and is not priced separately to the supply of a good.
By default, VAT on imported goods will be payable to Bahrain’s customs authority prior to the release of the goods. The tax authority may allow the deferral of payment of VAT on import if the importer is registered for Tax purposes and if the Taxable Person is bound by Customs Affairs records at the Ministry of Interior.
Further details are expected soon. The import VAT deferral mechanism should be implemented by the end of Q1 2019.
Non-resident suppliers supplying services which are taxable in Bahrain to Bahraini customers, will have to account for the VAT themselves unless the customers are registered taxable persons. In that case the Bahraini recipient will have to account for the VAT himself under the reverse charge mechanism.
The export of goods and services are zero rated, provided that certain conditions are met (e.g.). Exporters who are primarily engaged in making exports can apply for a domestic reverse charge on certain purchases that are subject to the standard rate and received from taxable persons in Bahrain, allowing them to benefit from cashflow advantages. This burdensome procedure is also used in France but the French authorities have to spend important resources in policing it.
In order to get the approval from the NBT to apply the reverse charge mechanism, the taxable person should be able to fully recover any input VAT, export more than 50% of its turnover, show that he will be in a refund position on a recurring basis and that the refund will have a material impact on his financial position.
So-called “exports of services” (a term absent in the GCC treaty) supplied by a taxable person in Bahrain are subject to the zero rate if certain conditions are met. For instance the services should be supplied to a person who does not have a place of residence in Bahrain and who was outside Bahrain when the services were provided. The services should be performed and enjoyed outside the country and should also relate to tangible goods or real estate located outside the country. It remains to be seen whether the NBT will take an equally very restrictive view like its KSA counterpart.
Telecommunication and electronic services
Telecommunications and electronic services supplied to a non-registered customer shall be taxable at the place of use and enjoyment of the services on the date of supply. Supplies made to taxable customers will be taxed at the place of residence of the customer.
The regulations provide some further information on the determination of the place of use and enjoyment as well as how to determine the place of residence of a customer who is a taxable person.
With the influx of more than 25 million visitors expected from around 190 countries for Expo 2020, the UAE FTA has implemented two special VAT refund mechanisms to ensure that business visitors do not incur any VAT.
The first mechanism targets exhibitions and conferences attended by international businesses. The second one benefits business visitors who will be able to claim the refund of VAT paid on expenses incurred in UAE. Below the two mechanisms are discussed.
VAT refund for exhibitions and conferences
The VAT refund for exhibitions and conferences is beneficial for the organizers as well as the business visitors attending such events in the UAE.
This scheme enables both suppliers and their international customers to save 5% VAT payment on selected services. This particular refund mechanism covers services such as the rental of exhibition space or access to exhibitions and conferences.
Only international customers, those who are not established in the UAE or are not registered for VAT purposes in the country, can avail this benefit. The international customer must inform the supplier that the business is not resident in any manner or registered in the UAE for VAT purposes.
The supplier, on the other hand, needs to be registered for VAT purposes in the UAE, as well as inform the FTA before the event takes place to be able to grant this benefit to its international customers.
Once registered, the conference and exhibition supplier should issue an invoice with VAT but not collect VAT on the relevant exhibition or conference services from their customers. Instead, he claims the VAT refund equal to the output VAT charged on the subsequent VAT return.
Since the payment of this VAT will de be deferred to the VAT return and compensated with a simultaneous deduction in the same return, it does not impact the supplier’s cash flow, while also providing the customers with immediate VAT refund.
Refund for business visitors
Similar to the business VAT refund scheme available in the European Union, the UAE has implemented a scheme whereby all VAT costs incurred by a non-resident business which are not registered for VAT in the UAE, are reimbursable through the VAT refund mechanism for business visitors.
Some of the most common expenses by non-residents include the local purchase of goods, employee travel and lodging, training, service charges for vendors and others. It is important to note that the VAT reclaimed must be directly related to the business activities and cannot be for entertainment or any other legally blocked expense, which are specifically excluded from all input VAT recovery.
Foreign business will only be entitled to claim a VAT refund in case they are from a country that has VAT and also provides refunds of VAT to UAE entities in similar circumstances. KSA currently does not provide this refund to UAE businesses. Therefore, the UAE will also not refund businesses from KSA.
The minimum amount of each application for refund of tax is AED 2,000 which may be the amount of single or multiple purchases. The application should be submitted by a calendar year. The FTA will start receiving claims in respect of VAT incurred in 2018 as from April 2019. The opening date for refund applications in subsequent calendar years will be 1st March.
The FTA will soon release further guidance concerning the exact process for claiming the VAT refund. However, it is expected that businesses will have to provide the original tax invoices for which they intend to reclaim the VAT as part of the application.
VAT obligations for non-resident business
Conferences and exhibitions generate significant opportunities for businesses to show their products and close some deals.
However, non-resident businesses who intend to sell goods or provide services during a conference or exhibition in the UAE might need to assess their VAT obligations in the country. For non established businesses, the obligation to register for VAT purposes with the FTA arises from the first taxable supply.
Importantly, non-resident businesses making taxable supplies in the UAE are not entitled to the business visitor refund scheme or to benefit from the VAT refund for exhibitions and conferences.
Overall, these guidelines will not only put UAE top of the list for the hosting of conferences and exhibitions, but it also encourages conference and exhibitions providers, as well as international customers to organize and attend such events in the UAE.