The Participation Exemption – Dividends and Capital Gains

Ownership of shares by companies usually results in tax being payable for dividends received or capital gains realised upon sale. However, in the UAE, the Corporate Tax law (Federal Decree No. 47 of 2022) (“CT Law”) provides an exemption to Corporate Tax in a certain scenario referred to as the Participation Exemption.

 

Article 23 of the CT Law states:

 

“Participation Exemption”

 

1. Income from a Participating Interest shall be exempt from Corporate Tax, subject to the conditions of this Article.

 

2. A Participating Interest means, a 5% (five percent) or greater ownership interest in the shares or capital of a juridical person, referred to as a “Participation” for the purposes of this Chapter where all of the following conditions are met:

 

a.) The Taxable Person has held, or has the intention to hold, the Participating Interest for an uninterrupted period of at least (12) twelve months.

 

b.) The Participation is subject to Corporate Tax or any other tax imposed under the applicable legislation of the country or territory in which the juridical person is resident which is of a similar character to Corporate Tax at a rate not less than the rate specified in paragraph (b) of Clause 1 of Article 3 of this Decree-Law.

 

c.) The ownership interest in the Participation entitles the Taxable Person to receive not less than 5% (five percent) of the profits available for distribution by the Participation, and not less than 5% (five percent) of the liquidation proceeds on cessation of the Participation.

 

d.) Not more than 50% (fifty percent) of the direct and indirect assets of the Participation consist of ownership interests or entitlements that would not have qualified for an exemption from Corporate Tax under this Article if held directly by the Taxable Person, subject to any conditions that may be prescribed under paragraph (e) of this Clause.

 

e.) Any other conditions as may be prescribed by the minister.

 

This Article provides that income from a Participating Interest, such as dividends and capital gains, is exempt from Corporate Tax. A Participating Interest is defined as a significant, long-term ownership interest in a juridical person (the Participation) that suggests some degree of control or influence over the Participation and that meets the conditions of this Article 23. With respect to dividends, Article 23 is usually used for dividends received by a UAE company (which is a Resident Person) from a foreign company. Dividends received from a UAE company (which is a Resident Person) are exempt from Corporate Tax with no further conditions (Article 22 (1) of the CT Law).

 

As an example, if a UAE Company owns a German Company (Participating Interest) and it receives dividends and later sells these shares and receives capital gains, then the dividend income and the capital gains income can be exempt from Corporate Tax if the following condition are met:

 

a.) the UAE company has held, or has the intention to hold, the Participating Interest for an uninterrupted period of at least (12) twelve months. The UAE Company should hold the shares of the German Company (Participating Interest) for an uninterrupted period of 12 months.

 

b.) The Participation must be subject to Corporate Tax (or equivalent) of 9% or more. This condition requires the Participation (ownership of shares by the UAE Company in UAE Company) to be subject to Corporate Tax or any other tax imposed under the applicable legislation of the country or territory in which the juridical person is resident which is of a similar character to Corporate Tax. In this case, it would be subject to Corporate Tax if it were not for this exemption and it would be subject to a similar or higher tax rate in Germany. Hence this test is satisfied.

 

c.) The ownership interest of the UAE Company in the Participation entitles the UAE Company to at least 5% of the profits and liquidation proceeds. In this case, the UAE Company would be entitled to 100% of the profits and liquidation proceeds of the German Company as the 100% owner. The ownership interest must entitle the UAE Company to at least 5% of the Participation’s profits available for distribution and at least 5% of the liquidation proceeds upon cessation of the Participation. As a result, this test is satisfied. Note that if the acquisition of the Participating Interest exceeds AED 4 million then this test is also satisfied (Ministerial Decision 116 of 2023).

 

d.) 50% or less of the assets of the Participation consist of non-qualifying ownership interests. An ownership interest in a Participation will be deemed a passive or portfolio investment that does not qualify for the Participation Exemption if 50% or more of the Participation’s assets, on a consolidated basis, consist of ownership interests or entitlements that by themselves do not meet the conditions of this Article had they been held directly by the Taxable Person.

 

Assets that would not qualify for the Participation Exemption include, for example, ownership interests in foreign juridical persons that are not subject to a corporate income tax in the relevant foreign jurisdiction, unless such ownership interests meet the conditions of Clause 3, or any other conditions as may be prescribed by the Minister under Clause 2(e).

 

In this case, the assets of the UAE Company that are shares in the German Company would be subject to tax in the UAE. Hence, the shares in the German Company are qualifying ownership interests which should satisfy this condition.

 

e.) The Participation Interest must meet any other conditions as may be prescribed by the Minister. As of the date of this memorandum, the other prescribed conditions are not relevant to these facts.

 

Based on the above, the following income (as specified under Article 23(5) of the CT Law) being capital gains and dividend income shall not be taken into account by the UAE Company in calculating its Taxable Income for Corporate Tax:

 

  • Dividends and other profit distributions received from a foreign Participation that is not a Resident Person under paragraph (b) of Clause 3 of Article 11 of this Decree-Law.

 

  • Gains or losses on the transfer, sale, or other disposition of a Participating Interest (or part thereof).

 

  • Foreign exchange or impairment gains or losses in relation to a Participating Interest.

 

For the sake of illustrating the use of the Participation Exemption, the above analysis does not discuss the effects of any applicable double taxation treaty.

 

*****

 

Please contact Shahram Safai (ssafai@afridi-angell.com) if you require advice with respect to Corporate Taxation in the UAE. ■

The Tax Benefits of using a UAE Free Zone Company as a Holding Company

UAE companies can offer significant tax benefits when used as holding companies in certain scenarios.

 

As an example, assume that an Italian limited liability company (“ItalianCo”) holds a 90% stake in a Moroccan operating subsidiary (“MoroccanCo”) and does not have a permanent establishment in Morocco. The ItalianCo is considering transferring its ownership in MoroccanCo to a wholly-owned holding entity located in the United Arab Emirates (“UAE HoldCo”).

 

Refer to the attached PDF for the full image of illustration

 

In this scenario, the ownership by a UAE free zone holding company (UAE HoldCo) of shares of a company that is established in another jurisdiction can be advantageous from a tax perspective, subject to the provisions of the applicable double taxation treaty. This is because in such holding of shares scenario, it is advantageous from a tax perspective (i.e. 0% tax rate on dividends, interest payments and capital gains received by the UAE HoldCo) for the UAE HoldCo to be a UAE free zone company, and specifically and according to the UAE Corporate Tax Law (Federal Decree Number 27 of 2022) (“CT Law”), for it to be a Qualifying Free Zone Person (with Qualifying Income).

 

The reasoning for the above is described below:

 

0% Tax Rate

 

Article 3 of the CT Law states:

 

“Corporate Tax shall be imposed on a Qualifying Free Zone Person at the following rates:

 

a.) 0% (zero percent) on Qualifying Income.

 

b.) 9% (nine percent) on Taxable Income that is not Qualifying Income under Article 18 of this Decree-Law and any decision issued by the Cabinet at the suggestion of the Minister in respect thereof.”

 

Hence the UAE HoldCo should be incorporated, firstly, as a Qualifying Free Zone Person (QFZP) that, secondly, should derive Qualifying Income to qualify for the 0% tax rate.  We review both of these requirements in turn below.

 

Qualifying Free Zone Person

 

To be a Qualifying Free Zone Person, the provisions of Article 18 of the CT Law must be satisfied which state:

 

“Qualifying Free Zone Person

 

1. A Qualifying Free Zone Person is a Free Zone Person that meets all of the following conditions:

 

a) Maintains adequate substance in the State.

 

b) Derives Qualifying Income as specified in a decision issued by the Cabinet at the suggestion of the Minister.

 

c) Has not elected to be subject to Corporate Tax under Article 19 of this Decree-Law.

 

d) Complies with Articles 34 and 55 of this Decree-Law. [our note: Article 34 of the CT Law relates to Requirement of Arm’s Length Principle as between Related Parties) and Article 55 of the CT Law relates to Compliance with Transfer Pricing with Related Persons or Connected Persons of the CT Law].

 

e) Meets any other conditions as may be prescribed by the Minister.”

 

Accordingly, the definition of QFZP must also be satisfied by UAE Holdco as a Free Zone Person (a juridical person incorporated, established or otherwise registered in a UAE Free Zone). The most important practical component of the above definition is the deriving of Qualifying Income.

 

Qualifying Income

 

Qualifying Income is defined as follows in Cabinet Decision 55 of 2023 (“Cabinet Decision 55”):

 

“Article 3 – Qualifying Income.  

 

1. For the purposes of application of Article (18) of the Corporate Tax Law, Qualifying Income of the Qualifying Free Zone Person shall include the below categories of income, provided that such income is not attributable to a Domestic Permanent Establishment or a Foreign Permanent Establishment in accordance with Article (5) of this Decision or to the ownership or exploitation of immovable property in accordance with Article (6) of this Decision:

 

(b) Income derived from transactions with a Non-Free Zone Person, but only in respect of Qualifying Activities that are not Excluded Activities …”

 

Accordingly, and pursuant to Article 3(1)(b) of Cabinet Decision 55, Qualifying Income of UAE HoldCo (as a QFZP) shall include income derived from transactions with a Non-Free Zone Person, but only in respect of Qualifying Activities that are not Excluded Activities (which should not be attributed to a Domestic Permanent Establishment, a Foreign Permanent Establishment or to the ownership or exploitation of immovable property).

 

As a result, income derived from UAE HoldCo’s ownership of MoroccanCo’s shares is Qualifying Income because it is income derived from transactions with MoroccanCo as a Non-Free Zone Person in respect of the Qualifying Activities of holding of shares of the MorrocanCo. Qualifying Activities are defined in Ministerial Decision No. 139 of 2023 (“Ministerial Decision 139”) as including the “holding of shares and other securities”.

 

Excluded Activities

 

As discussed, such Qualifying Activities should not be Excluded Activities, pursuant to Article 3(1)(b) of Cabinet Decision 55. Article 3 of Ministerial Decision 139 defines Excluded Activities to include activities related to (subject to certain exceptions) transactions with natural persons, banking activities that are subject to regulatory oversight, insurance activities that are subject to regulatory oversight, ownership or exploitation of immovable property and ownership or exploitation of intellectual property assets.

 

The holding of the MorrocanCo shares by UAE HoldCo is none of the foregoing which means that it is not Excluded Activities.

 

Hence in summary, and based on the above, UAE Holdco should derive Qualifying Income because it conducts Qualifying Activities (holding of shares of MoroccanCo) which are not Excluded Activities, and such income should not be attributable to a Domestic Permanent Establishment, a Foreign Permanent Establishment or immovable property.

 

***

 

Such UAE CT Law tax benefits provide significant opportunities for using UAE free zone companies as holding companies for foreign shares in order to reduce applicable taxes (i.e. possibly to 0% tax rate on dividends, interest payments and capital gains received by the UAE HoldCo with respect to ownership of such foreign shares) that may have otherwise been much higher in the foreign jurisdiction. ■

 

UAE Cabinet Decision No. (49) of 2023 dated 8 May 2023 (effective 1 June 2023)

UAE Cabinet Decision No. (49) of 2023 dated 8 May 2023 (effective 1 June 2023) states that for the purposes of Clause 6 of Article 11 of the Corporate Tax (CT) Law, Businesses or Business Activities conducted by a resident or non-resident natural person shall be subject to CT only where the total Turnover exceeds AED 1,000,000 for a calendar year.   Importantly, the Decision also states that activities of resident or non-resident natural persons that result in Turnover from Wage, Personal Investment Income or Real Estate Investment Income shall not be considered Businesses or Business Activities that are subject to the CT Law.  Therefore, such natural persons shall not be required to register for CT assuming they do not conduct any other Businesses or Business Activities that are subject to CT. ■

The Ministry of Finance publishes an Explanatory Guide on the Corporate Tax Law

Last Friday, on 12 May 2023, the UAE Ministry of Finance (Ministry) published an Explanatory Guide which provides an explanation of the meaning and intended effect of each article of the Corporate Tax (CT) Law. The Explanatory Guide may be accessed here.

 

The Introduction to the Explanatory Guide states that the Explanatory Guide may be used in interpreting the CT Law and how particular provisions of the CT Law may need to be applied, and that it must be read in conjunction with the CT Law and the relevant decisions issued by the Cabinet, the Ministry and the Federal Tax Authority. The Introduction also makes it clear that the Explanatory Guide is not meant to be a comprehensive description of the CT Law and its implementing decisions.

 

Some highlights of the Explanatory Guide include:

 

  • For CT purposes, a civil company (which under the UAE Civil Code enjoys the status of a separate legal person) will not be treated as a separate legal person and be treated as the natural person or persons owning them because of their direct relationship and control over the Business and their unlimited liability for the debts and other obligations of the Business;

 

  • Certain qualifying activities conducted by free zone persons are eligible for the zero percent CT benefit;

 

  • Tax residency for CT purposes is not dependent on legal residency;

 

  • No time limitation for carry forward of tax losses;

 

  • Details transfer pricing documentation requirements and thresholds for maintaining master file and local file;

 

  • Scope of ‘Qualifying Income’ for free zone establishments remain undefined; and

 

  • Acknowledgement that taxpayers are permitted to optimize their tax position in a manner consistent with the CT Law.

 

The Afridi & Angell Tax Team is closely reviewing the 106-page Explanatory Guide and will continue to provide more details in the coming days. ■

Planning for Canada’s Departure Tax

We have written previously about the importance of planning for the tax consequences of emigrating from Canada; see our previous inBrief here. In this inBrief, we will describe a number of more advanced planning options for Canadian residents who are considering giving up their Canadian residency. Bear in mind that not all of the approaches discussed in this inBrief will be right for any particular person, as each person’s individual circumstances will differ.

 

Upon becoming a non-resident, Canada imposes a departure tax in the form of deemed disposition of certain capital assets, causing any unrealized capital gains to be realized in the year of departure. It is common for high net-worth individuals in Canada to hold their public and private investments through holding companies (Holdcos), so one major source of capital gains upon emigration is the shares they own in their Holdcos. We will also touch upon foreign trust planning, Canadian real estate holdings, and charitable donations.

 

With respect to Holdco shares, much emigration planning focuses on how to minimize the departure tax by reducing the fair market value of those shares prior to exit. Some potential options to achieve this may include.

 

Strategic Dividends: Causing Holdco to pay out dividends to the maximum extent it can out of tax-preferential accounts maintained by it, which may include Holdco’s capital dividend account (CDA), eligible refundable dividend tax on hand (ERDTOH) and non-eligible refundable dividend tax on hand (NERDTOH). Dividends can be paid out of Holdco’s CDA tax-free, and dividends that are paid out of its ERDTOH and NERDTOH result in tax refunds to the company, making them somewhat more tax-efficient. In advance of doing this, it may be advisable for Holdco to sell some of its investments, thereby realizing capital gains and creating additional CDA that can be dividend out tax free. The payment of dividends in this manner will reduce the fair market value of Holdco’s shares, thereby reducing the amount of the deemed capital gain on such shares upon emigration.

 

The other reason you should be sure to dividend out all CDA in any Holdco prior to emigration is because such dividends lose their tax-free status when paid to a non-resident shareholder. Once you are a non-resident, Holdco will be required to apply a withholding tax to any dividends paid to you, and you will be taxed on such dividends personally under the laws of your new country of residence. If Holdco will continue to operate after you emigrate and will continue to have Canadian resident shareholders, it would be prudent to create separate classes of shares that allow for dividends out of CDA to be paid to Canadian shareholders (who can receive them tax-free), and other dividends to be paid to you (as you may very well be in a position to receive them much more tax-efficiently than a Canadian shareholder[1]).

 

Life Insurance: Cause Holdco to acquire life insurance on your life, acquiring a policy that is maximum funded at the outset but with attributes that result in the policy having a low fair market value. This expenditure in exchange for an asset that is initially low-value (the life insurance policy) reduces the value of the Holdco shares. There are several other potential benefits to this approach that stem from the value of the insurance policy itself, because its value will increase after you have emigrated and can be leveraged as a valuable asset of Holdco going forward (i.e., front-end or back-end leveraging strategies to extract value from the policy during your life), in addition to the security of the death benefit.

 

If Holdco does leverage the life insurance policy by borrowing against it, Holdco will be able to use those funds for income-generating investments and will be permitted to deduct the interest on the loan. This can be an attractive arrangement.

 

You may wish to consider whether it makes sense to introduce a foreign ownership structure that is more forward-looking and supports your wealth and estate plans more broadly. For example, if you intend to establish a family trust structure in an offshore jurisdiction as part of your post-emigration planning, it may be prudent to transfer the shares of Holdco to the foreign trust at approximately the same time that you emigrate from Canada. You would do this after having taken any available steps to reduce the value of Holdco’s shares, as described above. If Holdco’s value is derived primarily from Canadian real estate holdings, this approach could be beneficial if you foresee a sale of Holdco in the future. In that case Holdco shares will be “taxable Canadian property” and will be taxed in Canada, and you can reduce the impact of that tax by reducing the value of Holdco’s shares through dividends after you are a non-resident (at the lower beneficial treaty rate).

 

There are special considerations with respect to Canadian real estate holdings. Canadian real estate is “taxable Canadian property” and is not subject to the deemed disposition upon emigration.[2] How you can best structure your holding of Canadian real estate as a non-resident will depend on whether it is property for your personal use, or if it is a rental property. If it is for personal use, you will need to consider whether your ownership of it puts you at risk of being deemed to be Canadian resident for tax purposes even after your emigration.[3] If it is a rental property, you will likely wish to transfer ownership of it to a Canadian holding company, otherwise the tenant will be required to withhold an amount in respect of tax from every rent payment they make to you as a non-resident owner.

 

Finally, an option that is not to be overlooked is simply making a charitable donation of assets that have significant accrued capital gains before you emigrate, which will have the effect of reducing both the value of your holdings as well as reducing your departure tax exposure. It will also generate a charitable tax credit which you may use to further reduce your tax burden on exit. If your charitable intentions are relatively large and you wish to maintain some ongoing involvement and control over the how the endowment is managed, you may wish to establish a charitable foundation instead of simply donating funds or assets to an existing charity. A charitable foundation that is registered as such with the Canada Revenue Agency will qualify as a registered charity and can issue charitable tax receipts, and can carry out activities and funding in line with its charitable purpose in Canada and overseas. The charitable options should, of course, only be considered where the primary objective is furthering the chosen charitable purpose with any tax incentives being secondary.

 

The strategies discussed in this inBrief are intended to illustrate that there may be effective pre-emigration planning that you can consider, aimed at reducing the impact of Canada’s departure tax. All such strategies are complex in their planning and application and professional advice is required to evaluate and execute them. If you are interested in exploring planning of this nature, please contact us and we will be delighted to assist. ■

 

[1] The withholding tax that Holdco would be required to apply to dividends paid to you as a non-resident would be a default rate of 25% if you reside in a non-treaty country, or could be 5%, 10% or 15% if you  reside in a treaty country.  You may need to hold your shares through a company established in your new country of residency to access these reduced rates.

[2] You may elect to trigger a deemed disposition of taxable Canadian property if you prefer, in order to trigger gains or losses which you are able to offset against other losses or gains on exit, respectively.

[3] Very briefly, owning a residential property which is available for your personal use in Canada will cause you to be deemed tax resident in Canada, unless there are tie-breaker rules in the applicable treaty with your new country of residence.  Ensuring that you will indeed be non-resident for tax purposes is a critical aspect of non-residency planning.

 

UAE Corporate Tax Law (CT) – the Conditions under which the Presence of a Natural Person in the UAE will not Create a Permanent Establishment for a Non-Resident Person

The UAE Minister of Finance by Ministerial Decision No.83/2023 dated 10 April 2023 has set out the conditions under which the presence of a natural person in the UAE would not create a Permanent Establishment for a Non-Resident Person.

 

For the sake of context, Article 12 of CT provides that a Non-Resident Person is subject to Corporate Tax on Taxable Income in certain circumstances, which include, the Taxable Income attributable to the Permanent Establishment of the Non-Resident Person in the UAE.

 

While Article 14 (1) and (2) of the CT deals with circumstances under which a Non-Resident Person is considered to have a Permanent Establishment in the UAE. Article 14 (3) of the CT sets out the circumstances a fixed or permanent place of a Non-Resident Person in the UAE will not be considered as a Permanent Establishment.

 

Article 14 (7)(a) of the CT also provides that for the purpose of Article 14(3), the Minister may prescribe the conditions under which the mere presence of a natural person in the UAE does not create a Permanent Establishment for a Non-Resident Person where the presence of such natural person in the UAE is due to a ‘temporary and exceptional situation’. The conditions are set out in Ministerial Decision No. 83 of 2023 which states that, a ‘temporary and exceptional situation’ is where all of the following conditions are met:

 

a) The presence of the natural person in the UAE is due to exceptional circumstances of a public or private nature;

 

b) The exceptional circumstances cannot reasonably be predicted by the natural person of the Non-Resident Person;

 

c) The natural person did not express any intention to remain in the UAE when the exceptional circumstances end;

 

d) The Non-Resident Person did not have a Permanent Establishment in the UAE before the occurrence of the exceptional circumstances; and

 

e) The Non- Resident Person did not consider that the natural person is creating a Permanent Establishment or deriving income in the UAE as per the tax legislation applicable in other jurisdictions.

 

The Ministerial Decision states that ‘an exceptional circumstance’ is a situation or an event beyond the natural person’s control, which occurred while such person was already in the UAE, which he could not reasonably predict or prevent and which prevented him from leaving the UAE as originally planned.

 

The Ministerial Decision continues to provide further guidance on what ‘exceptional circumstances of a public nature’ and ‘exceptional circumstances of a private nature’ are:

 

Exceptional circumstances of public nature include: (a) adoption of public health measures by the competent authorities in the UAE or in the jurisdiction of the original workplace or by the World Health Organization; (b) imposition of travel restrictions by the competent authorities in the UAE or in the jurisdiction of the original workplace; (c) imposition of legal sanctions on the natural person preventing them from leaving the UAE; (d) acts of war or occurrence of terrorist attacks; (e) occurrence of natural disasters or force majeure beyond reasonable control.

 

Exceptional circumstances of a private nature include occurrence of an emergency health condition affecting the natural person or their relatives up to the fourth degree, including by way of adoption or guardianship. ■

Corporate Tax: Threshold for “small business relief” set at AED 3 million or less

The UAE Ministry of Finance today issued a new ministerial decision providing the threshold for “Small Business Relief”. Accordingly, taxable persons that are resident persons can claim “Small Business Relief” pursuant to Article 21 of the Corporate Tax Law if their revenue in the relevant tax period is below AED 3 million for the taxable period. If however the revenue threshold of AED 3 million for each tax period is exceeded, the “Small Business Relief” will not be available. This means that a taxable person that generates revenue of AED 3 million or less for each taxable period may elect to be treated as not having derived any taxable income.

 

The AED 3 million revenue threshold will apply to tax periods starting on or after 1 June 2023 and subsequent periods ending on or before 31 December 2026. ■

Cross-Border Holding Companies: The New Normal

Holding companies are an important part of almost any deliberately planned corporate structure. By “holding company” we are referring to a legal entity whose primary, or possibly sole, function is to own other assets. They are important for asset protection, segregating lines of business or assets, limiting liability, tax planning and estate planning, among other things. This inBrief discusses the continued utility of holding companies against the backdrop of a heightened regulatory focus in recent years.

 

For those operating in higher tax jurisdictions like Canada, the United States, the UK and the EU, establishing holding companies in tax-preferential jurisdictions has been a popular strategy, as there were legitimate tax advantages available by doing so. Those tax advantages would have generally involved either accessing a benefit (reduced rates) under a tax treaty, or deferring the tax on income accumulated in the holding company.[1] There is a misconception that holding companies operate to conceal ownership or tax information from tax or law enforcement authorities or that they otherwise facilitate illegal activity, or that a taxpayer can simply decline to disclose foreign assets or holdings thereby shielding them from tax. While that may once have been true (perhaps before the internet era), it is not true now and has not been for many years.

 

There has also been a perception that holding companies have facilitated a practice known as profit-shifting: the practice of deliberately shifting revenue from being earned in a high tax jurisdiction where the substantial business actually takes place, to a company established in a low/no-tax jurisdiction where the business has little or no substantial economic activity. This was indeed a common and lawful practice and was usually not considered to be abusive.[2] Over the last seven to eight years, such arrangements have been recharacterized as abusive as a result of OECD initiatives in that regard, most notably what is known as the BEPS project (which stands for base erosion and profit shifting). The BEPS project is an OECD initiative that is aimed at promoting policy and legislative changes globally that are designed to increase tax revenues for OECD nations by combatting what they characterise as abusive practices.[3] The use of holding companies has been a major focus of the BEPS initiative and the holding company landscape has radically changed as a result.

 

The arrival of “economic substance” requirements in low/no-tax jurisdictions is perhaps the most important change, as such requirements have made prior profit-shifting practices difficult or infeasible. One of the action items under the BEPS project (Action 5)[4] is to deal with what the OECD has identified as “harmful tax practices”, which includes profit-shifting to low/no-tax jurisdictions. To prevent profit-shifting, low/no-tax jurisdictions were required to implement “economic substance” rules, which operate essentially as follows: if a company is foreign-owned and carries on activities that are typically associated with passive income (such as holding investments or IP, or acting as a regional headquarters, or offering passive financing, among other things), then such companies must demonstrate that they have adequate economic substance in the country of incorporation, failing which they will be fined and ultimately shut down. Adequate economic substance is demonstrated by having physical premises in the country, local full-time employees, local assets, local expenditures, a local bank account, and physically present local board and management activity.[5] Put another way, if the entity meets the economic substance test, it is no longer really a holding company in the traditional sense, it is simply an active company.

 

For an entity that solely carries on “holding” activities as narrowly defined in economic substance legislation and has no other function (acting as a region headquarters or owner of group intellectual property, for example), the level of economic substance required is significantly reduced. The economic substance rules (including the lesser requirements for pure holding entities) adopted into law are generally consistent across all conventionally popular low/no-tax jurisdictions, as they follow OECD guidance.[6]

 

The general expectation several years ago was that the BEPS initiatives would cause companies to move their assets and operations back to the higher tax jurisdictions in which the parent company or group was physically based, rather than seeking out the most tax-efficient location. Instead, the more common reaction was for companies to develop the required economic substance (genuine active business, full time employees, physical offices, etc.) in the low/no-tax jurisdictions, in order to continue to legitimately benefit from preferential tax regimes. The landscape has changed so that companies in tax-preferential jurisdictions are only useful if they actually carry on an active business and meet the economic substance requirements, or, in the case of pure “holding” companies as defined in the legislation, they meet the reduced economic substance requirements. These developments have made offshoring more expensive than it used to be, but it is clearly still a worthwhile proposition for many businesses for which at least some of their active business can be conducted in preferential jurisdictions.

 

Another area in which holding companies have been affected by the BEPS initiative is with respect to eligibility for tax treaty benefits. Access to treaty benefits has been limited for holding companies, pursuant to BEPS Action 6 (Prevention of Tax Treaty Abuse).  Previously, a holding company established in a country with which Canada[7] has a tax treaty was treated as a resident of the treaty country and was therefore entitled to the treaty benefits. That typically means that payments to the holding company from Canadian entities or sources were subject to reduced withholding tax rates, and capital gains in the holding company could often be realised entirely tax free. It became popular to establish holding companies in treaty countries specifically to access the treaty benefits for a particular transaction or category of transaction and for no other reason; a practice viewed by the Canadian courts, incidentally, as consistent with the purpose of the treaties, and not abusive.[8] As was the case with profit-shifting, the use of a mere holding entity without adequate economic substance whose purpose was primarily to access a tax benefit was recharacterised as abusive pursuant to BEPS Action 6. The OECD addressed this form of “abuse” by introducing the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI), which has one primary effect: to amend existing tax treaties to deny the application of benefits under the treaties if “one of the principal purposes” of any arrangement was to access the treaty benefits.[9] The MLI is controversial as there is significant uncertainty around how the “principal purpose test” will be applied in practice.  Pending further clarity on this, the availability of treaty benefits will be uncertain in almost any circumstances, and any planning that relies on treaty benefits will be riskier. For further discussion of the potential conflicts and uncertainty caused by the MLI in Canada, please see our earlier inBrief here:  Tax Minimization is Every Canadian’s Right:  Supreme Court of Canada.

 

To recap, holding companies have been the focus of global tax reforms, resulting in the advent of economic substance requirements in low/no-tax jurisdictions, and the introduction of the MLI which is aimed at preventing “treaty shopping”.  Today, as a result, foreign-owned companies established in low/no-tax jurisdictions are only beneficial from a tax perspective if they can demonstrate the required economic substance through people, premises, assets, and expenditures.  Passive holding companies with no local presence in such jurisdictions are no longer viable, and while it is open to debate, it is generally acknowledged that this is a positive step towards global tax fairness.

 

There remain many situations in which a holding entity is necessary as part of a corporate or family wealth structure where no tax advantage is being sought or realised, and as such, they should arguably not be subject to the same economic substance requirements as holding companies which do result in tax advantages. For example, it is often advisable for a family trust to establish one or more holding companies that are owned by the trust and which are useful for legitimate asset protection, segregation and management.  Such holding entities also enable the adoption of bespoke family governance mechanisms at the holding company level through the use of shareholders’ agreements, board structures, and a family charter, for instance. If the trust has been established in a tax-effective manner (e.g., if the trust assets originated from persons resident in a tax-preferential jurisdiction, and depending on the domestic tax treatment of its beneficiaries), the purpose of the holding company would likely not be tax-driven beyond simply a wish to avoid making the position worse. However, in the current landscape, the addition of a holding company under the trust can have negative consequences, even though such consequences do not arise for the trust itself.  These sorts of holding companies have been caught in the crossfire, so to speak.  Where the trust has EU or US beneficiaries, for example, the mere introduction of a holding company may trigger punitive sets of rules known as “controlled foreign affiliate” (or CFC) rules, where such rules would not have otherwise applied if the trust held the assets directly, even though the use of a holding company provides no tax advantage to the trust.[10]

 

A potential solution in the above example of a trust that requires a holding vehicle for non-tax reasons is the use of tax-transparent “flow through” entities, such as limited partnerships and certain limited liability companies. Such entities are typically established in high-tax jurisdictions like Canada and the United States, where economic substance rules have not been adopted. Generally speaking, such entities allow for a tax-neutral result while interposing a layer of segregation, management and control, and a limitation of liability, and can therefore often present an effective alternative to conventional offshore holding vehicles.[11]

 

Cross-border tax planning has always been complex, and the rapidly changing environment has only made it more so.  It is essential to obtain fact-specific professional advice before implementing any such planning.  Please contact us if you wish to explore whether international planning for yourself, your business, or your estate can be beneficial for you. ■

 

[1] The deferral advantages have not been available for several years in most jurisdictions due to comprehensive domestic legislation in every high-tax country, and the treaty advantages are quickly disappearing as a result of the BEPS initiative (discussed below).

 

[2] It was generally not an abusive practice because such practices were already very heavily monitored and regulated by domestic tax legislation which applies to interests in foreign entities, transfer pricing, thin capitalization, along with many anti-avoidance and attribution rules.

 

[3] More information about BEPS can be found here:  https://www.oecd.org/tax/beps/about/#mission-impact

 

[4] The BEPS project consists of 15 separate “Actions”, each focused on a particular issue or category of issues.

 

[5] A physically present board is no longer achieved with a “fly in, meet, fly out” approach, as was the case (and continues to be) for purposes of the company’s “residency”.  A company may be tax resident in the country of incorporation but still not meet the economic substance tests.

 

[6] We note that some low/no-tax jurisdictions have not yet adopted economic substance legislation, such as Nevis or the Cook Islands, although most have.

 

[7] We are using Canada as an example, although the concept is applicable to many other countries.

 

[8] See Canada v. Alta Energy Luxembourg S.A.R.L, 2021 SCC 49.

 

[9] The list of signatories to the MLI can be found here:  https://www.oecd.org/tax/treaties/beps-mli-signatories-and-parties.pdf

 

[10] This is a general statement meant to illustrate the problem.  The rules are complex and there can be exceptions if there is adequate opportunity to plan at the outset, and each set of facts should be reviewed on their own merits.

 

[11] As noted, each specific set of facts should be reviewed on its own merits, and professional advice is essential in such planning.

UAE Corporations and Businesses Tax – Registration of Taxable Persons

The Federal Tax Authority (FTA) has launched early registration for corporate and business tax (CT) through the EmaraTax platform for digital tax services pursuant to Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (CT Law). The CT Law states that Taxable Persons will become subject to CT from the beginning of their first financial year that starts on or after 1 June 2023.

 

The FTA has stated that the early registration period is available from January 2023 to May 2023 for certain categories of companies operating in the UAE. These selected companies are to receive invitations from the FTA by email and SMS, allowing them to register via the EmaraTax platform.

 

Following this phase, the FTA has stated that it will announce when registration will open for other companies and businesses, with priority being given to companies and businesses that have a financial year starting on 1 June 2023. ■

Tax Residency in the UAE: who qualifies as a UAE Tax Resident?

Recently approved Cabinet Decision 85 of 2022 (the Decision) outlines the requirements and conditions for classification of persons as a “Tax Resident” of the UAE. We briefly outline below who qualifies as a UAE tax resident.

 

Afridi & Angell have assisted a variety of clients in procuring tax domicile certificates and are well versed in the procedures and requirements. If you are interested in learning more about whether you may qualify as a Tax Resident, or the procedures for obtaining a tax domicile certificate, please reach out to one of our team members. Tax domicile certificates are an important and valuable component in the tax-planning structures that we implement for many of our clients.

 

Companies as UAE Tax Residents

 

Article 3 of the Decision provides that a company shall be deemed as a Tax Resident where it meets one of the following criteria:

 

(1) it is established, formed or recognised according to the legislation in force in the UAE. The Decision expressly excludes branches of foreign companies registered in the UAE from the definition of a Tax Resident; or

 

(2) it is otherwise deemed as a Tax Resident by virtue of a different federal law imposing tax (Tax Law).

 

Natural Persons as UAE Tax Residents

 

Article 4 outlines the requirements for a natural person and provides that such a person shall be deemed as a Tax Resident where they meet one of the following conditions:

 

(1) the habitual or primary place of residence of the individual is located in the UAE, so long as it is considered to be the place of fiscal and personal interests of the individual and where it meets the conditions and standards as applicable and determined from time to time;

 

(2) the individual is physically present in the UAE for a minimum of 183 days, within the duration of 12 consecutive months; or

 

(3) the individual may qualify as a Tax Resident where they have been physically present in the UAE for a minimum of 90 days within the relevant duration of 12 consecutive months, if the individual holds UAE nationality or a valid UAE Residence Permit or the nationality of any of the GCC Countries, and meet either of the following conditions:

 

a. the individual holds a “Place of Permanent Residence” in the UAE; or

b. the individual holds a position or is exercising “Activities” in the UAE.

 

A “Place of Permanent Residence” means a place located in the UAE which is deemed available to the individual at all times and “Activities” includes any activity practiced on a regular, ongoing and independent basis by a natural person.

 

The Decision provides that any person deemed as a Tax Resident in the UAE may submit an application to the Federal Tax Authority for issuance of a tax domicile certificate. ■