Dividend Taxation in the Home State
Do you have an FZ-LLC or an onshore LLC in the UAE? Or maybe even an “International Company” (offshore) that generates profits? You are still taxable in your home country with your international income? Or are you now only subject to limited taxation in your home country? All of this makes a significant difference in the taxation of the dividend payment received by a profit distribution from your corporation.
If you only have limited tax liability in your home country, the solution is quite simple. Profits that you earn with your company in the UAE and the distribution of these profits to you, as a shareholder, is taxable in the UAE, i.e. zero. The situation is different if you are still subject to unlimited taxation in your home country. This is the case, for example, if you still own an unlet condominium or a house in Germany, if your family still lives in Germany or if your children go to school there, i.e. if the centre of your life interest is still in Germany, Austria or Switzerland.
Let us take a closer look at Article 10 of the Double Taxation Treaties between Germany, Austria, Switzerland and the United Arab Emirates.
Paragraph 1 states unequivocally that dividends must be taxed in the country in which the shareholder is resident. However, paragraph 3 of the DTA Austria is interesting, almost identical in wording to paragraph 5 of the Swiss DTA and paragraph 4 of the German DTA, which reads as follows:
“Paragraph 1 shall not apply if the beneficial owner resident in a Contracting State carries on a commercial activity in the other Contracting State in which the company paying the dividends is resident through a permanent establishment situated there or works independently through a permanent establishment situated there and the holding for which the dividends are paid actually belongs to that permanent establishment or permanent establishment. In that case, Article 7 or Article 14 shall apply.”.
In the German DBA, Art 14 is missing, but this does not make any significant difference in the assessment, since the company profits in Art 7 also apply to self-employment. This provision in Article 10 thus constitutes an exception to the rule in paragraph 1 that dividends must always be taxed in the recipient country of the shareholder.
Here the DBAs demand either a permanent establishment or independent work by a permanent establishment located there – whereby located there means just in the UAE. A further criterion is that the dividends distributed by the corporation belong to this permanent establishment or fixed establishment.
According to UAE company law, every permanent establishment or even independent work must be “licensed”, i.e. have a state right to exercise. It does not make sense to establish a new corporation as a shareholder of the corporation paying dividends, as the problem only shifts one level up. A permanent establishment must therefore be established which, although it can acquire a license under UAE law, is not a corporation. The “partnerships” such as commandite or general partnership are suitable. According to the Commercial Companies Law of the UAE, the personally liable partner in such partnerships (Partnerships or Limited Partnerships or Commandite Partnerships) must also be a UAE National. Such a partner will be difficult to find, largely because of the personal liability associated with this position. We must therefore look for other options.
An alternative would be to establish such a partnership in the home country (Germany, Switzerland, Austria) and to open a branch of such a partnership in a free zone. A branch, if it maintains an office and a certain minimum form of organization, is to be regarded as a permanent establishment for tax purposes. This partnership established in Europe thus becomes a partner in the UAE corporation, and you, as the owner of this partnership, receive these profits in the UAE, as Article 7 and 14 of the DTA apply here.
The second alternative would be to establish a partnership under UAE Commercial Companies Law in a UAE Free Zone. Some Free Zones are ready for such a formation, whereby the personally liable partner can also be a foreigner and does not have to be UAE National.
The third alternative would be the establishment of a sole proprietorship “independent work” as proclaimed in Article 10 paragraph 3 DBA. Such a licensed individual enterprise is offered in most Emirates by the respective Department of Economic Development (DED). You need a “Local Service Agent” who is not involved in this individual enterprise and has no say in it.
All three variants have one thing in common: the need for a permanent establishment. Therefore, for this partnership (be it a European partnership with a branch in a Free Zone or a partnership founded in a Free Zone) and also for the latter mentioned sole proprietorship, an office must be rented and equipped accordingly (with telecommunication connections, own bookkeeping, preferably own employees, e.g. a secretary, etc.). In the case of a sole proprietorship it would probably be sufficient if the owner of this company – you – could use the office regularly and prove this. According to the respective national tax laws, it would still have to be examined whether this partnership can draw its income entirely from the dividends of the corporation, or whether they must be proven to have other sources of income in addition to the income from capital assets, in order not to lose the privilege from the DTAs.
Article 7 of the DTA speaks of corporate profits. If a company operates a permanent establishment in the UAE, the profits from this permanent establishment are also taxable in the UAE and not in the country of the company owner. Article 14 of the Austrian and Swiss DTA speaks of income from self-employment. The criteria to be applied here are practically the same as in Article 7, i.e. that the person carrying out this independent work also maintains an actual permanent establishment in the UAE. Neither the application of Article 7 DBA nor Article 14 DBA requires that the partner of the partnership or the sole proprietor with his own license in the UAE lives or resides in the UAE for a certain period of the year.
Of course, the independent dividend recipient will have to spend the appropriate amount of time in his permanent establishment. If, however, he was only a limited partner and the limited partnership (KG) had a permanent establishment, the profit distributions to the limited partner would be corporate profits that would be taxed at zero in the UAE. Such constructions have already been successfully created by us.
We’ll sum it up: How can you save yourself the taxation of dividends from a corporation incorporated in the UAE in your home country in the event that you are still subject to unlimited taxation?
- You set up a partnership, be it in your home country and then a branch in the UAE or such a partnership in the UAE or obtain a license from a sole trader in the UAE.
- As a result, you set up a tax-watertight permanent establishment which can also be located on the premises of the corporation and which must also have its own organizational form (preferably its own room, desk, own employees, etc.).
- The partnership or you, as a sole proprietor licensed in the UAE, become a shareholder of the corporation.
- The corporation then distributes the dividends to this partnership or to you as a sole proprietor. You can then withdraw these profits tax-free within the meaning of Articles 7 and 14 of the Double Taxation Convention.
Unfortunately, we have found that many of our clients who have created a structure in the UAE without our advice have misread this exception in Article 10 DBA. The clients thought that tax exemption in the home country would already occur if the shareholder of the corporation had a desk in the company and actively cooperated. However, such a desk does not fulfil the requirement of a permanent establishment.
Further information and case-related advice can be obtained by contacting our office directly.