Free zones and double tax treaties-history- rates comparison- RAK FTZ- offshore and onshore- substance - unique low tax jurisdiction

1. I
t is a well known fact that the
United Arab Emirates (UAE)
does not levy any income or
capital taxes. It is a lesser known
fact that the UAE has a comprehensive
network of double tax treaties that may
be used to reduce the burden of taxation
in the home countries of foreign
investors, or corporations with their
headquarters in the UAE.
An important aspect for foreign
investors and global companies is the use
of a UAE “free zone” in establishing a
UAE presence. The free zones are used
by foreign investors to retain 100%
beneficial ownership and to avoid the 5%
import duty on goods. The benefits of the
double tax treaties will also apply to free
zone entities established by foreign
investors.
This article will focus on the use of
the UAE treaty network for head office
operations, or legitimate tax minimisation
and tax planning by corporations and
individuals.
The combination of a free zone entity
with an international company (the
offshore vehicle) and a trust or
foundation can also be extremely effective
in providing for confidentiality where
required in tax planning. Indeed the UAE
is the only OECD “white list” jurisdiction
that has no taxes for international
companies, free zone or local companies
or individuals.
Specifically, two emirates, Dubai and
Ras Al Khaimah, have also established the
system of “International Companies”
(ICs).
It is the combination of the IC and the
free zone entity, providing a confidential
flexible company with a physical presence
that becomes a powerful key unlocking
the benefits of the UAE bilateral treaty
network.
The current UAE treaties and their
bases are as follows1
:
LLC’s, Free Zone Entities and
International Companies
A foreign investor wishing to establish a
local company in the UAE must have a local
partner with a 51% share. Foreign direct
investment is possible only via the free zones
where a foreign investor can retain 100%
beneficial ownership.
The first UAE free zone was established in
JebelAli in 1985. The first bilateral tax treaty
with a major OECD country was entered into
with France on 15 November 1989,years after
the free zone was established.
More recently,the RAK FreeTrade Zone
was established in 2000 and the RAK
international company registry in 2006.
Do the UAE double tax treaties apply in
the free zones?
Prima facie,bilateral treaties do not
distinguish between companies established in a
free trade zone and companies incorporated as
local LLC’s within the UAE.
One clear exception is the UAE-
Netherlands bilateral treaty which specifically
excludes companies or individuals who are
exempted from tax by a special tax regime
under the laws of one of the contracting states.
Three issues may effect the application of a
bilateral treaty:
1.Is the entity a“person” to whom the
treaty has potential application;
2.Is the person“resident” in the UAE;
3.Is there a limitation within the treaty that
prevents or limits the treaty from applying?
“Persons” are defined inArticle 3(1)(a) of
the OECD Model Convention,as an individual,
company,and any other body of persons.This
could potentially allow for resident trusts,
foundations and company hybrids to fall within
the definition of person.
There has been debate over point two.
The OECD Model refers to “Resident” as“a
person that is liable for tax”. The immediate
assumption becomes that as there are no taxes
in the UAE then the treaties are inapplicable,
however,this is incorrect. Bilateral treaties were
entered into with the UAE with full knowledge
that there are no taxes and that the free zones
exist. It would be illogical to deny the benefit of
a treaty where theArticles do not expressly
limit or refer to any special economic zones.
The question of liability to tax does not mean
the actual payment of tax,but rather it is a legal
notion that covers the undisputed right of the
UAE to impose taxation. Whilst the free trade
zones are established by decrees to allow for
tax holidays,it is the sovereign right of the UAE
to impose taxation on these entities by virtue
of their incorporation,presence,or activities in
the UAE.
In order to avoid confusion,many of the
UAE treaties do not follow the standard OECD
Model definition of“Resident” for example the
2007 Protocol of the UAE-India treaty is clearly
intended to apply to companies incorporated,
managed and controlled wholly in the UAE and
to individuals present in the UAE for a period of
183 days or more in a calendar year. A few of
The UAE as a true
global financial centre
By Jas Sekhon, International Tax Lawyer
and Regional Director of RAK Free Trade Zone,
Ras Al Khaimah
The Jurisdictions: United Arab Emirates
offshoreinvestment.com16

2. the UAE treaties use the term“subject to tax”,
which arguably is a weaker link than“liable to
tax”,for example,treaties with Lebanon,
Morocco and Syria.
The practical result is that bilateral tax
treaties will apply to FreeTrade Zone entities,
entities which are incorporated in the UAE,and
individuals who are resident in the UAE for tax
purposes.
It is of more importance to consider the
limitations in the use of treaties or the anti-
abuse provisions as these are usually the areas
under which the availability of taxation benefits
may be denied.
The “place of incorporation” criterion
is part of many of the UAE treaties and simply
put,if a company is incorporated or created in
the UAE,then it will be a resident for the
purposes of that particular treaty eg,Armenia,
Finland,Mauritius,Mongolia,Luxembourg,Sri
Lanka,Austria,Switzerland,Mozambique,and
New Zealand.
Some countries impose the additional test
of place of effective management eg,Germany,
Korea,Spain,Romania,India and Canada. This is
determined as a question of fact. Important
factors include:
• Registered office location.
• Place where meetings are held or initiated.
• Domicile of controlling individuals.
• Banking relationships.
• Property and Intellectual Property held.
• Head office mailing address.
• Location of auditor and accounts.
• Residence of the Manager or Management.
The free zones offer facilities such as
offices,managers,call centres,banking
relationships etc.allowing companies to change
their place of effective management,subject to
the provisions of the treaties.
Limitation on Treaty Benefits (LOB)
Only a few UAE bilateral treaties include a
LOB clause,although the more recent treaties
tend to include them. Treaties including LOB
clauses include:
• India (New 2007 Protocol),requiring a bona
fide business activity;
• Luxembourg (consultation where treaty
shopping is found);and
• Belgium (requires special attention to be
given if improper use of the agreement is
found).
A bona fide business activity can easily be
established through the use of a free trade zone
entity where trade,commercial or consulting
licenses are available together with resident
visas for staff.
Exchange of Information
The majority of UAE treaties do not
contain the new OECD exchange of
information clause.This is of critical importance
asArticle 26 on exchange of information has
been greatly expanded since July 2005. Prior to
2005 one contracting state could not request
another contracting state to provide
information that could not be sought under the
laws of the other contracting state (in the
absence of criminal activity). The new
provisions make it clear that a state cannot
refuse a request for information solely because
it has no domestic tax interest in the
information (paragraph 4) or solely because it is
held by a bank or other financial institution
(paragraph 5).
Even with a post 2005 OECD information
exchange clause,countries are not at liberty to
enter into“fishing expeditions”.
Information exchange even under a new
treaty is far more restricted than,for example,
information exchanges pursuant aTax
Information ExchangeAgreement (TIEA),that
many OECD grey list countries will be forced
to enter into.
Strategies for utilising the UAE bilateral
tax treaties
Suggested below are some general
strategies for advisors considering the UAE for
basing head office,or global head office
companies.
Strategy One - Establish a free zone
entity
The free zones allow you to have a UAE
entity that is 100% foreign owned and yet take
advantage of:
• low formation and annual costs;
• visa sponsorships;
• a range of options for physical presence
from flexi desks(virtual desks) to complete
buildings and industrial developments;
• no taxes;
• no exchange controls or thin capitalisation
restrictions;
• access to the UAE double tax treaty
network;and
• an individual acts as the“Manager” and is
required to be nominated for each
company.
Strategy Two - Combine a free zone
entity with an International Company.
Owning a free zone entity or creating a
free zone branch of the IC provides the
following benefits:
• confidentiality of ownership and
operations;
• physical presence or management as
required by some treaties for treaty
protection;
• restricted Custodian and Nominee
shareholdings;
• ability to have investments in the UAE (but
not carry on business);
• choice of any law (common law,civil law
etc.);
• no local meetings,audits,or local presence
requirements;
• migration in and out of the jurisdiction;and
• OECD white list jurisdiction.
Strategy Three- global head office
company/ IP holding company
In the majority of the UAE tax treaties
which have look through limitation provisions,
the use of the UAE as a head office of a
company to minimise global taxes is a vastly
underestimated and underutilised strategy.
The relocation of the head office of the
iconic US company,Halliburton to Dubai is one
notable example of this strategy,however,for
the majority of practitioners,the use of UAE
treaty networks in this manner has been
ignored mostly for a lack of information.
The choice of law for ICs provides for the
head office company to own patents,
trademarks,confidential know how and
copyright under the laws of any jurisdiction and
to license this technology to a free zone entity
or to other countries worldwide. The treaty
network will reduce withholding taxes,impose
no taxes in the UAE and allow for peace of
mind in terms of legal enforceability,licensing,
securities and charges outside the ambit of the
local UAE or DIFC laws which may be a
concern when otherwise considering the UAE
as a base to hold and develop intellectual
property.
Strategy Four- Residence and domicile
for directors and senior staff
Whilst domicile in the UAE may not be
possible depending on the laws of the home
country,certainly with a renewable residence
visa that is issued to persons or associates of a
free zone entity,individuals may reduce or
eliminate home country taxation.In many cases,
following the OECD model,the treaties
provide for directors fees paid to a non-
domiciled director of a UAE entity to be
exempt from tax in the home country.
The UAE presents a unique window of
opportunity. The system of International
Companies combined with the benefits of the
free zones and the extensive network of double
taxation treaties make the UAE a very
attractive proposition.
Jas Sekhon is an international tax lawyer and
the views expressed in this article are his personal
views and not those of the RAK FreeTradeAuthority.
END NOTES:
1. Based on a list published by the UAE Ministry of
Finance and the official English versions of the
text, published by the same department, where
available. This list is also partly the result of
discussions with, and a paper presented by
David Russell QC at the Offshore Investment
conference, Dubai, March 2009.
2. The dates have been taken from the official
UAE Ministry of Finance publication and may
indicate the date of entry into force. In many
cases these are not the dates of execution as
stated in the aforementioned publication.
UnitedArabEmirates
OI 197 • June 2009 17