In the Free Spirit Oct – Dec 2013 edition Adriaan Struijk discusses the new tax treaties by the UAE that increases the attractiveness of the country as a foreign investment destination:
The UAE offers an extensive and steadily expanding tax treaty network, enabling investors to reap the tax benefits of using a UAE-based entity as a vehicle to hold investments worldwide, while also increasing the attractiveness for the foreign investors to set up business in the UAE.
While countries in the past have often been hesitant to allow for significant benefits in treaties with low- or zero-tax countries like the UAE, many newer treaty partners have realised the advantages of making it attractive for inward investments by investors in one of the wealthiest countries on earth. Some of the UAE’s recent treaties have been very favourable for the UAE investor, despite the fact that the UAE is blissfully free of taxation.
There are several key features to look out for in a treaty with the UAE, which can make it attractive: low or zero withholding tax rates, absence of a liable-to-tax’ requirement, the UAE source income is exempted rather than tax credits being given, limited anti-avoidance provisions and whether a UAE tax residence certificate is required.
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Low or zero withholding tax rates.
In the absence of a tax treaty, a country might withhold tax on a variety of different payments to a person in another country such as interests, royalties, payments for know-how and the like, directors’ fees, consultancy fees for commercial and technical advice, fees for hiring out labour, employment income, dividends, capital gains, rental incomes, distributions of private foundations, and income derived by partners in a partnership.
If a tax treaty is concluded, withholding taxes are normally restricted to dividends, interests, royalties and capital gains payable to a person in the treaty-partner country. Ideally, the withholding taxes on these types of payments are limited to low or no withholding taxes.
Traditionally, countries have been hesitant to conclude tax treaties with low or no tax jurisdictions, mostly because they did not like the thought that the income was subsequently not subjected to further tax.
However, in the recent years, common sense in this area has prevailed because a favourable tax treaty makes the jurisdiction more attractive to invest in, and if there is a lot of wealth in the low-tax country to access then this goes some way to explaining why a ‘principled’ stance might give way to common sense.
This is likely the reason why the UAE has been able to negotiate favourable treaties in the recent years. Below is a list of countries where in one or more respects the UAE offers the best way out of the source jurisdiction for dividends, interests, royalties and capital gains (that are not associated with immovable property or a permanent
establishment in the source country), which are payable to a company considered tax resident in the UAE under the treaty:
• Austria: 0%-0%-0%-0%
• Bulgaria: 5%-2%-5%-0%
• China: 7%-7%-10%-0%
• Georgia: 0%-0%-0%-0%
• Indonesia: 10%-5%-5%-0%
• Mozambique: 0%-u*-5%-0%
• The Netherlands: 5%-0%-0%-0%
• India: 10%-12.5%-10%-0%**
• Poland: 5%-5%-5%-0%
*u = unlimited (no treaty protection)
** While there is no protection againstcapital gains tax levied in India on the sale of an Indian company by a UAE company, there is protection against capital gains attributed indirectly to the UAE company. So, if a UAE company holds shares in an Indian company through an intermediary jurisdiction, and the UAE company sells its shares, then India cannot levy capital gains tax on the basis that it was an indirect transfer, as it tried to do in the Vodafone case when a Cayman Island company directly sold its shares in an Indian company.
Liable to tax
This requirement is relevant in the context of investments going into the UAE, and payments of income and gains going out. It is usually a requirement be negated entirely if the other country taxes the currentin the tax treaties that in order to benefit from a treaty, a person needs to be liable to tax. Partnerships, trusts and companies, which are operated under a special beneficial investment regime, are often not liable to tax, and therefore, these cannot benefit from a tax treaty, if
liability to tax is a requirement.
In the case of the UAE, such a clause would introduce a certain amount of doubt. Since, if there is no tax, can a person be liable to tax?
This would force one to look at the domestic law of the country providing the tax relief in order to answer that question. Most countries grant that a resident of the UAE is considered liable to tax since the UAE could impose tax, and no special tax exemptions exist (except guarantees against possible future taxation) since there is simply no tax. If one would take a position that companies in the UAE are not liable to tax, then the treaty does nothing to make the UAE more attractive to the foreign investors.
Nonetheless, certain treaties do not have a liable-to-tax requirement for an entity to be considered tax resident of the UAE and thus be able to benefit from the double taxation treaty. This is certainly preferable since it removes an element of doubt. The UAE’s treaties with these countries for instance do not have this requirement:
Austria, Bulgaria, Georgia, Malta, Mozambique, the Netherlands, and New Zealand.
In these treaties, it is either sufficient for the legal person to be incorporated in the UAE or to be managed and controlled from the UAE in order to be considered tax resident here.
Tax exemption for UAE source income
This feature of a treaty is relevant in conjunction with the previous one because it matters for the investor investing into the UAE and the payments going out. The possible UAE income sources can for instance be: a UAE subsidiary, a permanent establishment in the UAE, real estate, employment in the UAE, or director of a UAE company.
The benefit of the absence of tax in the UAE can be negated entirely if the other country taxes the current income even if it has not been remitted. In such cases, the shareholder of a UAE company would be taxed on the profits of its UAE subsidiary in proportion to its shareholding even though dividends have not been remitted yet.
This regime, which is referred to as ‘controlled foreign company’ taxation, is a piece of anti-avoidance legislation, which is a feature of the tax regime of many western countries. It usually applies if the subsidiary generates mostly passive income and is based in low or no tax country. Passive income comprises normally dividends, interests, royalties and rental incomes.
Furthermore, the benefit of generating untaxed income in the UAE is dependent on the mechanisms agreed in the treaty to prevent double taxation. There are two mechanisms: tax credits and tax exemption.
Where the tax credit system is applied, the other country gives a tax credit that can be offset against local taxes. Under this type of system, a credit is given for taxes paid in the source country, which can be offset against taxes in the other country. This system is often applied on dividends or on employment income.
In the case of the UAE, this is of no help, since there is no tax here, there is nothing to offset either. However, under the credit system, the tax would only be due when the income is remitted to the other country, so there is still the advantage of tax deferral.
The most attractive tax treaties are those where certain sources of the UAE income are exempted from tax altogether. In such a case, the advantages of the absence of tax in the UAE are retained in full.
A third variant is to provide for ‘exemption with progression’, which means that the foreign income is exempted, but the local income is taxed against an average tax rate, which is calculated on the basis of the total income, which includes
the foreign income. This means that if the other system has progressive tax rates that the local income ends up being taxed against a higher tax rate than it otherwise would be in the absence of the foreign income, thus partially offsetting thebenefit of exemption of the foreign income.
The Netherlands and Cyprus are examples of countries that provide for the exemption of income and gains from a subsidiary as well as that of a permanent establishment. This is a feature of their domestic law rather than the tax treaty. It does not apply to the passive income although the Netherlands, exceptionally, does not consider the income derived from real estate passive.
A few countries follow an exemption (with progression) system for foreign employment income that is derived from an employer, resident in a source state. So, for instance, in case a resident of the Netherlands works for a UAE company in the UAE, then the salary that can be attributed to that work is exempt from tax (with progression) in the Netherlands.
Anti-avoidance provisions are sometimes included in tax treaties. Also, the domestic law provisions, which are not included in the text of the treaty, may be applied. The question is whether the domestic anti-avoidance provisions may be applied if they are not included in a treaty because they would override that what was agreed on in the treaty. But, in the recent years, it has sadly become a more established doctrine that it is acceptable.
The controlled foreign corporation legislation mentioned above is one example of the anti-avoidance legislation, but there are many different types. So, when looking at whether a UAE tax treaty can be beneficially used, check the anti-avoidance provisions in the treaty and take into account the domestic anti-avoidance provisions as well.
The countries listed in the withholding taxes paragraph above have some of the most attractive treaties with the UAE. If you have, or are considering, business operations in one of these countries, consider the UAE as an attractive holding, financing or IP-holding jurisdiction, to accumulate profits tax-free and to reinvest them in a tax advantageous manner making use of the increasingly wide treaty network.
Tax residence certificates
A tax residence certificate is a statement that a treaty partner considers a person qualified to enjoy the benefit of a tax treaty. It is sometimes one of the administrative requirements of a source state that the person based in the other state is required to show a tax residence certificate before the source state will grant the benefits agreed on in the treaty.
You will not find the legal basis in tax treaties typically – the most you will find is a statement saying that the method of obtaining tax treaty benefits will be determined under the domestic law or by mutual agreement. These mechanisms may be documented through an exchange of letters between the contracting states.
Outside of this context, the source states would determine under their own domestic law what requirements are needed and a tax residence certificate may be one of the requirements. For this reason, it is important to check beforehand, when one is going to rely on a treaty, whether the source state imposes this requirement and what the policy of the UAE Ministry of Finance is regarding the issuance of tax residence certificates in the context of this treaty. For instance, the
ministry does not issue tax residence certificates for international companies.
The recent trend of the conclusion of the tax treaties by the UAE with clauses favourable to it increases the attractiveness of the UAE further. It shows that the world is increasingly eager to access the wealth of the UAE.
Hopefully, there will be more treaties where the UAE can use its position as an economic powerhouse where it insists on an absence of a liable-to-tax requirement and low or no withholding tax rates. And, it may help spread awareness of the unique alternative economic model that the UAE offers, and which brings so many entrepreneurs, investors and visionaries to these shores.
It stands as a lone beacon in a world plagued by confiscatory taxation and in the recent years even more so. It offers an economic model distinctly different from anywhere else in the world, which is centred around a respect for private property and the creation of wealth, with no taxes on personal or corporate income, very low import duties, no taxes on luxury goods, de facto free immigration (for anyone willing to work), no VAT, no forced contributions to a social security or pension scheme, limited interference in the labour markets, and free trade.
You also might be interested in this: UAE Tax Treaties And Anti-Avoidance Provisions
And in case you wish to know more about creating substance as inside the UAE to ake use of these tax treaties: Creating Economic Substance In The UAE Using Offshore
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