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By way of a Cabinet Resolution, the UAE has introduced Country by Country reporting (“CbC reporting”). Almost simultaneously with the introduction of economic substance regulations, the UAE further implements international tax standards and joins around 80 other countries which have implemented the CbC reporting. The impact of this reporting on international corporations in the UAE cannot be understated.
In the Framework of the Base Erosion and Profit Shifting (“BEPS”) project of the OECD and the G20, countries agreed, amongst others, to implement BEPS action 13 in order to tackle the shortcomings of the international tax system.
This action prescribes that countries implement legislation requiring multinational enterprises (MNEs) to report annually and for each tax jurisdiction in which they do business certain relevant tax related information and exchange this information with other countries.
The UAE’s legislation very much mirrors the standards imposed by the OECD which have been adopted in countries which have already implemented CbC reporting. It is applicable to groups which have subsidiaries in at least two tax jurisdictions. The threshold for the consolidated revenues is AED 3.15 billion.
Ultimate Parent Entities in the UAE will therefore have the obligation to file a CbC report to the Ministry of Finance (“MoF”). Certain entities in the UAE may become Alternate Parent Entities as a result of the legislation.
The Federal Tax Authority is not involved in the process, even though according to its Establishment Law it is also competent.
There is currently no requirement to prepare master files and local files. There is additionally no requirement to file a Controlled Transactions Disclosure Form or similar, which KSA has implemented.
Information to be shared by 31 December 2019
The CbC report needs to include the amount of revenues, profits (losses) before income tax, income tax paid, income tax payable, declared capital, accrued profits, number of employees, and non-cash or cash-equivalent assets for each country. In absence of any UAE Generally Accepted Accounting Principles, it will be interesting to see what accounting methods will be used to share the information.
In addition to the above information, the tax residency of the subsidiaries needs to be disclosed, the nature of its activity or main business activities.
The UAE will be using the Model Form prescribed by the OECD. The filing deadlines will be determined later this year.
Sharing of the information
The collected information will be shared by the UAE Ministry of Finance with other countries with which it has information sharing agreements. These could be bilateral treaties or the Convention on Mutual Assistance in Tax Matters. The bilateral treaties concluded by the UAE generally include a provision allowing the exchange of information.
Internationally the intention is to move towards an automatic exchange of the CbC reports. The first automatic exchanges have taken place in June 2018.
Penalties for non compliance
If businesses fail to file to comply with their obligations under the CbC reporting, they run a penalty exposure of up to AED 2,250,000.
The UAE is the third GCC country to implement CbCr reporting after Qatar and KSA had done so previously. The context of the UAE is slightly different, given the current absence of Federal Corporate Income Tax. Both Qatar and KSA have a form of corporate income tax.
How useful the CbC reporting is for MoF currently in absence of any Federal Corporate Tax remains to be seen. However, the introduction of the reporting will allow the UAE to be removed from domestic, European and other blacklists.
The Federal Tax Authority may be interested in the file for VAT purposes and ask tax payers to reconcile the amounts in the CbC report, as it can do today already with audited financial statements.
The importance of the introduction of CbC reporting cannot be understated. The UAE’s important neighbour, Saudi Arabia, will be very keen to examine the information in the CbC reports filed by UAE companies to verify whether it is receiving the right end of the tax portion.
At a glance
On 30 April 2019, the United Arab Emirates ("UAE") issued Cabinet Decision No. 31 concerning economic substance requirements ("Economic Substance Regulations"). UAE onshore and free zone entities that carry on specific activities mentioned in the regulations will need to examine whether they meet the economic substance requirements. Failing to meet those will trigger penalties. But why is this at first glance inane looking piece of legislation so important for the UAE?
The introduction of a legal framework regulating the economic substance criterion in the UAE is a direct consequence of the Organisation for Economic Co-operation and Development's ("OECD") ongoing efforts to combat harmful tax practices under Action 5 of the Base Erosion and Profit Shifting ("BEPS") project.
It also follows the increased focus by the European Union (EU) Code of Conduct Group ("COCG") on companies established in jurisdictions with a low or no income tax regime, resulting in the publication of the first EU list of non-cooperative jurisdictions, which currently includes the UAE (“EU Blacklist”). In response to the EU COCG initiatives, the governments of the Bahamas, Bermuda, British Virgin Islands (BVI), Cayman Islands, Guernsey, Isle of Man, Jersey, Mauritius and Seychelles introduced economic substance rules with effect from 1 January 2019.
There has also been growing interest and scrutiny from the public opinion as to whether entities established in such jurisdictions should be required to have sufficient economic substance before being able to benefit from beneficial tax regimes.
The purpose of the Economic Substance Regulations is to curb international tax planning of certain business activities, which are typically characterised by the fact that they do not require extensive fixed infrastructure in terms of human and technical capital, in a way which allows profits to be shifted to no or nominal tax jurisdictions, as opposed to taxing profits where the company has actually created economic value.
One of the reasons why the UAE has attracted so many businesses is because there is currently no income tax regime at a federal level. The economic substance legislation is specifically targeted at businesses that do not have genuine commercial operations and management in the UAE.
The main reason why the UAE has decided to introduce economic substance legislation lies in the country's aim to further align its legislative framework with international tax practice and the standards set out in the OECD BEPS action plan.
What is economic substance?
Economic substance is a concept introduced to ensure that companies operating in a low or no corporate tax jurisdiction have a substantial purpose other than tax reduction and have an economic outcome that is aligned with value creation. In other words, economic substance requirements are used to analyze whether a company’s presence has a purpose besides the mere reduction of a tax liability.
Which entities are in scope?
The Economic Substance Regulations apply to UAE onshore and free zone entities that carry out one or more of the following activities:
- Fund management
- Holding company
- Intellectual property (IP)
- Distribution and service centre
Entities that are directly or indirectly owned by the UAE government fall outside the scope of the Economic Substance Regulations.
Economic Substance Test
Entities are required to meet the Economic Substance Test when they conduct any of the above activities.
For each Activity, the regulations have defined the so-called Core Income Generating Activities (“CIGA”). This is a list of activities that must be conducted in order to meet the Economic Substance Test. For example, for intellectual property the CIGA would consist of research and development.
In general, the Economic Substance requirements will be met:
- If CIGA are conducted in the UAE;
- If the activities are directed and managed in the UAE;
- If there is an adequate level of qualified full-time employees in the UAE,
- If there is an adequate amount of operating expenditure in the UAE,
- If there are adequate physical assets in the UAE.
In case the CIGA are carried out by another entity, these need to be controlled and monitored.
In accordance with EU recommendations, the regulations provide for less stringent requirements for Holding Company Businesses (“Holding Companies”).
The CIGA may be outsourced, if there is adequate supervision and the outsourced activity is conducted in the UAE. Economic substance requirements will not be met if multiple Licensees outsource the same activity to the same service provider. There is no possibility for double counting the same service provider.
Reporting and compliance
Licensees will need to prepare and submit an annual report to their Regulatory Authority (Free Zone Authority or DED), within a period of twelve months after the end of each financial year. The Regulatory Authority will then submit the report to the Ministry of Finance (“Competent Authority”).
Since the Economic Substance Regulations came into effect per 30 April 2019, for existing entities, the first report will have to be submitted in 2020.
Administrative penalties and sanctions
- Failure to meet the economic substance test
AED 10,000 to AED 50,000 (First Financial Period)
AED 50,000 to AED 300,000 (Consecutive Financial Periods)
- Failure to provide information
AED 10,000 to AED 50,000
In case of continuous non-compliance, Regulatory Authorities may suspend, revoke or deny renewal of an entity’s license.
Exchange of information
If a Licensee fails to meet the Economic Substance Test for a financial year, the Regulatory Authority will inform the Minister of Finance for the financial year in question.
The Minister of Finance will then inform the foreign competent authority where the parent company, ultimate parent company or ultimate beneficial owner is established of the non compliance. This may lead in these countries to denying treaty benefits. This requires that the UAE has entered into a Treaty or similar arrangement with that country.
Takeaway - much ado about?
UAE entities involved in banking, insurance, fund management, investment holding, financing and leasing, distribution and service center, headquarter companies and intellectual property (IP) activities should asses whether their current presence and activity level meets the newly introduced Economic Substance requirements.
Where required, they make the necessary adjustments to ensure that their business is compliant with the UAE regulations which entered into force on 30 April 2019, in order to avoid administrative penalties, and potentially deregistration.
Moving away from the dusty provisions of the law, what consequences does the Economic Substance law now really trigger?
Operational companies should be little worried. They will not be impacted. The very small companies should be slightly worried. The businesses that were attracted by 50 year tax holidays and other promises and failed to develop any substantial activity in the UAE should be more worried.
How much the UAE will be effectively policing this legislation remains to be seen. Merely taking the example of Switzerland, that country had signed up to multiple exchange of information obligations but dragged its feet for the longest time.
For now though, the UAE has an argument towards the EU and, more importantly, individual countries, to get the UAE off their blacklists. This is important, since some UAE headquarters are currently being denied double tax treaty benefits in a number of countries, because of its failure to comply with international norms.
The legislation may potentially become obsolete though, if the UAE introduces Corporate Income Tax at a rate considered high enough to no longer be considered as a low tax jurisdiction.
Read our previous article on the introduction of Economic Substance Requirements in the UAE here.
The Holy Month of Ramadan is the ninth month of the Islamic calendar, observed by Muslims worldwide as a month of fasting, prayer, self-reflection and enhanced community spirit. The annual observance of Ramadan is one of the five pillars of Islam.
Ramadan is regarded as a time of piety, charity and blessings. Charities and foundations are noticeably more active during the Holy Month, providing assistance to those in need. Meals are provided at mosques, malls and other public places in a spirit of generosity.
Businesses see the Holy Month of Ramadan as an opportunity to organize sales and offer promotions, deals, discounts, gifts and benefits of all kinds. For example, companies may offer "buy one, get one free” or "two for the price of one” promotions or combined offers, where certain products are offered for free or at a reduced priced when bought together with another product (e.g. receiving one year of car insurance free of charge when buying a new car).
Traditionally, businesses also celebrate the Holy month by hosting Iftar parties, hand out Iftar snack boxes or give gifts in cash or in kind during Eid al Fitr, the religious feast which marks the end of Ramadan.
This article discuss how to deal with UAE VAT in the spirit of generosity.
There is no such thing as a free lunch?
VAT does not like free items. It taxes so-called deemed supplies, where businesses give things away for free for which it previously deducted input VAT. However, not all free supplies are deemed supplies. Even though both look similar, i.e. a third party seemingly receives something without paying for it, only deemed supplies carry VAT consequences.
As part of its sales strategy, a business may provide a customer with a free item. A supermarket could offer a ‘buy one get one’ formula, for example for shampoo bottles. Although it is providing the second bottle for free, the customer has actually paid a lower price for two bottles. Therefore, this situation is rather a so-called joint offer, and not a deemed supply.
The same reasoning holds for promotional discounts, where a business is slashing its prices with 50% during Ramadan. A business is not offering half of the product for free, but rather a discount on the price.
Perhaps a business considers giving a different item in addition to the item bought. Upon purchase of an electrical toothbrush, the seller offers 2 free tubes of toothpaste. Although the item is given for free, it is still not a deemed supply. The free item is given with the objective of increasing sales of the main item and is ancillary to it.
It is a very different situation when a grocery store decides to donate food supplies to a shelter or to allow all employees to pick an item from its stock for Ramadan. Those constitute deemed supplies and VAT needs to be charged on them. This means that VAT on these deemed supplies constitutes a cost for the business since it is giving the items for free.
If employers upon purchase however already know that they are purchasing items which are not intended for taxable supplies, they cannot recover the input VAT (and the subject of the deemed supplies is not even on the table).
The business making the deemed supplies needs to issue a tax invoice for the deemed supply and ideally deliver it to the recipient. The VAT on the tax invoice is not deductible in the hands of the recipient.
In the UAE, the taxable value of deemed supplies is its cost. This constitutes the taxable basis on which VAT should be accounted for.
However, even though a supply may constitute a deemed supply, two thresholds apply. If a business stays below the thresholds, it can continue to recover the input VAT and does not have to account for VAT on the deemed supply.
There are two thresholds:
- The output tax chargeable on all deemed supplies should not exceed AED 2,000 in a 12 month period (i.e. AED 40,000 of costs VAT exclusive), and;
- The value per person does not exceed AED 500 in a 12 month period (i.e. AED 10,000 of costs VAT exclusive) and it concerns samples or commercial gifts.
These thresholds allow businesses to occasionally provide small benefits or gifts to their employees and third parties without incurring VAT liabilities.
Given the fact that these thresholds are very low, a business will easily exceed the threshold. Taking into account the substantial administrative burden of having to monitor the thresholds and put a process in place, a business could chose to ignore the thresholds and always account for output VAT. That is also what most informed businesses seem to do.
Entertainment and personal expenses made during Ramadan
VAT is only recoverable when it is paid for goods and services bought for making taxable supplies. However, even though a business may exclusively make taxable supplies, there may still be expenses which are non-recoverable.
When an employer buys items and gives them to its employees for no charge and for their personal benefit, the employer cannot recover the input VAT. For example, if the employer decides to purchase chocolate dates for Ramadan to give to its employees, the input VAT paid is irrecoverable.
The same holds for so-called 'entertainment expenses’. Entertainment services are “hospitality of any kind”. This includes hotel stays, food and drinks, tickets for shows and events and trips for entertainment.
Therefore, if a business organizes an iftar for its employees and for third parties, the input VAT is not deductible. Even though the event is held with the objective of improving social cohesion and increase sales, and therefore it has a clear business purpose, it is considered an entertainment expense.
In a public clarification published by the Federal Tax Authority, it did confirm however that VAT on certain entertainment costs is recoverable when used for a genuine business purpose, or when incidental to a business purpose. For example, VAT on food and drinks provided during a business meeting, is recoverable, if:
- The hospitality is provided at the same venue as the meeting;
- When the meeting is interrupted, it is only by a short break for the provision of the hospitality and then resumes as normal e.g. a lunch break;
- The cost per head of providing the hospitality does not exceed any internal policy the business has established;
- The food and beverage provided is not accompanied by any form of entertainment e.g. a motivational speaker, a live band etc.
On the other hand, where the hospitality provided becomes an end in itself and is the purpose for attending an event, it will be considered as entertainment costs and VAT is not recoverable.
In other words, if the staff comes for the party or for the Ted talk, the business will not be able to recover the input VAT. If the gathering is serious business, the input VAT will be recoverable.
Despite the fact that charities will mostly carry out transactions which are out of scope of VAT, given they do not charge any consideration, they may still occasionally render taxable supplies and therefore incur certain VAT obligations, such as the obligation to register for VAT purposes.
Charities will mostly receive their income from subsidies or donations. Such income is outside of the scope of VAT. Occasionally, it may provide sponsoring opportunities to business, which are subject to VAT.
Under normal VAT recovery rules, input tax is only recoverable where it relates to taxable supplies. In most cases, charities will therefore be required to allocate and apportion VAT recovery between taxable activities (recoverable) and non-taxable activities or exempt activities (non-recoverable). The input VAT recovery may therefore prove to be quite complex.
A special refund scheme applies to so-called Designated Charities, which meet the criteria set by the Federal Tax Authority.
The Holy Month of Ramadan triggers VAT consequences for businesses. Businesses making sales promotions are required to examine the VAT consequences of these sales promotions. Business also may need to not recover input VAT on certain purchases or charge VAT on a deemed supply when providing employees with entertainment or gifts. Charities also do not have an easy task ahead in calculating their VAT liabilities.
Given the very strict penalty framework, it is important to be aware of the VAT consequences of these activities in order to avoid VAT claims or penalties.