Offshore companies in the Jebel Ali Free Zone Authority (JAFZA) are a special breed in the UAE. An offshore company incorporated under the recently amended 2018 JAFZA Offshore Companies Regulations (“Regulations”) is not subject to the federal commercial laws in the UAE and is not able to conduct any commercial business activities in the country. They are considered as non-resident for commercial purposes but are in fact treated as resident for VAT purposes.
The benefit of incorporating a JAFZA offshore company, amongst others, is to allow foreign investors to hold shares in other companies within the UAE as well as to own property in freehold areas in Dubai.
Assessing the VAT Impact
Like many other companies in the UAE, JAFZA offshores have been impacted by the introduction of VAT on 1 January 2018. Although for all intents and purposes JAFZA considers such companies as “offshore”, for VAT purposes they are not.
JAFZA offshore companies still need to determine whether they need to register for VAT with the UAE's Federal Tax Authority (FTA). Any business making taxable supplies with a total value exceeding the mandatory threshold of AED 375,000 (+/- USD 100,000) must get registered. Whether or not the JAFZA offshore companies need to get registered will depend on their activity. Although they are not allowed to conduct business in the UAE as per the Regulations, from a VAT perspective they may still receive a business income.
JAFZA Offshore and Rental Income through Property Ownership
In accordance with the Regulations, JAFZA offshore companies are allowed to own property in Dubai, and therefore many offshore companies choose to exercise this right. The purpose of such property ownership would most likely be to obtain some form of rental income.
Any rental income obtained from a residential property is exempt from VAT (in most cases) and does not trigger an obligation to register for VAT.
The situation differs however for offshore companies leasing commercial units and obtaining their rental income as such, since the leasing of commercial properties is considered a taxable supply for VAT purposes, and is subsequently subject to 5% VAT. When the value of such supplies exceeds the VAT mandatory threshold, VAT registration is required. Therefore, any JAFZA offshore company which owns property in Dubai needs to carefully assess the criteria they fall under in order to determine their VAT liability.
Receiving Dividends and Selling of Shares
Since such JAFZA offshore companies act as holding companies, they will often be receiving dividends or income from selling participations.
The receiving of dividends from UAE companies and the sale of shares to UAE companies are transactions which are VAT exempt. They impact negatively the right to recover input VAT of the holding company.
The fact that the receiving of dividends is exempt in the UAE is unusual from a VAT perspective. Generally, the payment of dividends is out of scope of VAT, like for example in the Kingdom of Saudi Arabia or like in all EU countries.
As such, if the JAFZA offshore company only receives dividends from UAE companies or only sells shares to UAE companies, it will not have to get registered for VAT purposes.
However, when these same transactions are done with non-resident recipients, they are no longer VAT exempt, but they are zero rated. Accordingly, dividends paid to a JAFZA offshore company by a foreign company and shares sold to foreign investors are, for VAT purposes, treated as taxable supplies. Therefore, if the total amount of these transactions exceeds AED 375,000, the JAFZA offshore company needs to register for VAT. Since one of the purposes of setting up a JAFZA offshore company is holding participations, this will often occur.
The rationale behind this rule copied from the EU is not to disadvantage the financial sector when it has to compete with businesses in countries which do not have VAT. However, the unusual position taken by the UAE on dividends has the strange consequence that these JAFZA offshore companies may be required to register for VAT purposes.
Due to the nature of its revenue, more often than not, a JAFZA offshore company will indeed have to register for VAT.
The FTA does provide certain exceptions from registration in the event a taxable person’s supplies are exclusively zero rated. Therefore, if the offshore company solely exports financial services - by virtue of receiving dividends from participations abroad or selling shares to non-residents - an alternative is to apply for this exception from registration for VAT with the FTA, in order to mitigate the impact of the offshore company’s VAT obligations.
The exception from registration cannot be granted when the offshore company is leasing commercial property and it cannot be granted retroactively.
Penalties and Consequences
All JAFZA offshore companies need to assess whether they need to register for VAT with the FTA. In practice, most JAFZA offshore companies have been under the impression that they do not need to register.
The FTA imposes very strict fines for companies which have not yet registered for VAT. The penalty for late registration is AED 20,000. In addition, a penalty of up to AED 2,000 per return will apply for not filing the VAT return.
Furthermore, in case VAT is due (e.g. leasing of commercial property) and is not paid to the FTA, a daily penalty of 1% may be charged on any amount that is still unpaid one calendar month following the deadline for payment (with a maximum of 300%). In addition to that, a penalty of 50% on the amount unpaid to the FTA will be imposed as well.