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Onshore challenges for UAE ‘offshore companies’ under UAE Corporate Tax laws

The Offshore companies must evaluate most relevant route under UAE CT law to remain tax efficient post the implementation of UAE CT law.

1/1/20267 min read
Tax
#Tax#Corporate Tax#UAE

Background:

  • UAE offshore companies are considered an effective vehicle for doing international business, asset protection and wealth management. It enjoys several benefits; including –
  • 100% foreign ownership
  • Privacy, limited administration,
  • No need to have physical office space in UAE
  • At the same time, Offshore companies operate subject to certain restrictions. Since they are designed for international business, they can not do business in UAE. The offshore companies are not allotted any visa, therefore, it cannot hire employees.
  • UAE Offshore company does not get a business license, but, receives a certificate of incorporation.
  • The Offshore companies in UAE also enjoyed tax relief prior to introduction of UAE Corporate Tax (‘CT’) Law which is effective for accounting years starting on or after 1 June 2023.
  • This article seeks to analyse whether the UAE offshore companies would continue to enjoy the tax relief post implementation of the CT law.

Key tax considerations for UAE Offshore companies

Should Offshore company obtain Corporate Tax Registration Number (‘CTRN’) and file annual Tax return?

  • Yes. An Offshore company is a legal person incorporated in UAE and thus regarded as ‘Taxable Person’ for the purpose of UAE CT law. Accordingly, every offshore company will be subjected to compliances under UAE CT law including but not limited to; 1) Obtaining UAE Corporate Tax registration number, 2) Filing of Annual Tax return etc.

Whether Offshore companies would be eligible for 0% tax rate under UAE Free zone tax regime?

  • The headline corporate tax rate of UAE is 9%. However, CT law provides for 0% tax rate to companies operating in free zone and meeting the relevant qualification criteria. Where Offshore companies are incorporated in free zone, it would be pertinent to evaluate whether the Offshore companies could qualify for concessional 0% tax relief.
  • The evaluation requires understanding of the UAE Free Zone tax regime. Briefly, a company in UAE Free zone has to meet certain criteria to qualify as Qualifying Free Zone Person (“QFZP”) in order to avail benefit of 0% tax rate.
  • Qualification criteria to become QFZP are –
    1. Derives qualifying income
    2. Maintains adequate substance within free zone / Designated free zone
    3. Complies with the Transfer pricing provisions
    4. Non-qualifying income does not exceed the de-minims level (lower of 5%, AED 5 mn)
    5. Prepares and maintains audited financial statement
    6. Not elected to be subject to Corporate Tax

Each of the above qualification criteria have further explanations under UAE CT law and require detailed study in order confirm the qualification.

The economic substance conundrum to qualify as QFZP

The qualification criteria pertaining to maintaining adequate substance (Sr 2 above) requires special consideration in the case of Offshore companies. The CT law suggests certain tests to meet the qualification criteria of adequate substance, which include (not limited to) –

  • Performing Core Income Generating Activities within freezone
  • Maintaining adequate assets within UAE
  • Employing adequate number of qualified full-time employees

Given the regulatory framework around the Offshore companies which do not own office and also are unable to have employees (inability to issue Visa’s), it would be impossible to meet the substance test specified above.

That being said, it is imperative to note that the substance test is required to be applied qua the economic activity i.e. it varies depend upon the type of revenue generated / economic activity performed etc. For example, it must be seen whether the Offshore company is generating active revenue (example, international trade) or passive revenue (example, holding of investments).

Where the offshore company is generating any active revenue (example, revenue from international trading activity), it would have to show that it had employees, assets, office premise etc to prove the substance within free zone. Which would be very challenging to demonstrate for the reasons mentioned above. Accordingly, it may be fair to assume that an offshore company generating any active revenue would not qualify the test of substance, thus, shall be taxable at 9% on its taxable profit.

On the other hand, where the offshore company is generating passive income such as Dividend income, Capital gain, Bond Yields etc. it will be subjected to reduced substance criteria as clarified by the Federal Tax Authority (FTA) in the UAE Free Zone tax guide.

All in all, substance is one of the important pillar of the overall UAE Tax framework, however, the companies must evaluate and plan their operations at start of the year.

Alternative (other than Free zone relief) to claim 0% tax relief

Principally, the UAE CT law does not seek to tax passive incomes, especially, when the underlying assets have been held for long term. Briefly, participating Interest is a significant, long-term ownership interest in a juridical person (the Participation) that suggests some degree of control or influence over the Participation. In order to qualify an ownership interest as a participating interest, the following tests must be satisfied:

  • Minimum ownership test – Ownership interest of atleast 5% or more should be held in a Participation. Alternatively, the minimum ownership test can be satisfied if the acquisition cost of the ownership interest is more than or equal to AED 4 million
  • Holding period test – The Participating Interest must be held, for an uninterrupted period of at least 12 months.
  • Subject to tax test – The Participation must be subject to tax in its country of residence at a rate of 9% or more.

The above route of participation exemption can be of particular interest to Offshore companies only engaged in investment activities.

Concluding remarks

The Offshore companies must evaluate most relevant route under UAE CT law to remain tax efficient post the implementation of UAE CT law. Especially, given the fact that the non-election of free zone regime in one year will disqualify the company for subsequent 4 years as well. Therefore, a careful evaluation of most suitable route to remain tax efficient is a necessary for all Offshore businesses.