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One of the most interesting aspects of the upcoming corporate income tax regime in the United Arab Emirates is the interaction between free zone entities and mainland entities. For businesses established on the mainland, moving to a free zone may look attractive when planning for the upcoming regime. However, doing so is not that simple and has some consequences, which will be discussed in this article.
Current status and impact of the second pillar of corporate income tax in the UAE
First, let’s assume that the OECD Pillar II system is in place in the coming years. Now, the transition to Pillar 2 is certainly attractive in some countries, including the UK and Switzerland, but momentum has been rather slow in others.
Nonetheless, the second pillar seems to have more public recognition than the first pillar, and large businesses operating in the UAE must be aware that even if operating in a free zone, the profits of such free zone entities will in any case be subject to 15 % Impact. Even if the UAE government does not tax such free zone entities, through the application of the income inclusion rules, the country of residence will in any case tax the profits generated in the UAE free zones. Therefore, for large companies with a global turnover of more than €750 million, operating in a free zone will not actually provide many tax benefits.
There are recent news reports that the UAE’s draft corporate income tax legislation will define “large companies” as companies with a global turnover of more than 750 million euros. Most likely, any tax exemptions generated by operating in a free zone will be offset with the launch of Pillar 2. Likewise, since the tax rate for mainland entities is also quite modest (9%, below the global minimum tax rate of 15%), large companies operating in the mainland will also lose the benefits of the 9% tax regime compared to competitors with a turnover of less than 750 million euros. compared to.
Considerations for large companies
An interesting aspect worth discussing is whether the 15% minimum tax threshold applies only to UAE businesses (when most OECD/G-20 Inclusive Framework countries apply this threshold in their domestic tax systems), Or will it apply immediately when the corporate income tax regime is implemented in the UAE? After all, the public consultation document makes it clear that one of the reasons for implementing a corporate income tax system is to respond to the anticipated second pillar system. To answer the above questions, we need to review the draft corporate income tax law. Logically, the 15% minimum tax rate for large companies should only apply if the majority of countries in the Inclusive Framework essentially accept the second pillar regime, because otherwise the UAE has no incentive to impose a 15% tax on such large companies.
This brings us to another interesting question. If our above assumptions are correct, then for those large mainland corporate entities that move to free zones in anticipation of the upcoming corporate income tax regime, they will enjoy the benefits of a 0% tax rate before the implementation of Pillar 2, and once the Pillar is implemented ,What will happened? Second, after implementation, will it be necessary to pay a minimum tax of 15%? This is perhaps the best option that large companies can take before Pillar 2 is implemented, because even if a company continues to operate on the mainland, it will still be subject to a minimum tax rate of 15% – compared with its non-large company competitors, which Mainland China only pays 9% tax.
For moving from the mainland to a free zone, the impact of corporate income tax should not be the only factor to consider. Businesses must weigh the pros and cons, regardless of any corporate income tax benefits the business may receive. When deciding to stay on the mainland or move to a free zone, businesses may need to consider other factors such as logistics infrastructure, rent, operating expenses, banking infrastructure/credit availability, and VAT consequences.
If the corporate tax rate is effectively kept at 15%, there is a clear advantage to staying in the mainland. In the Mainland, companies can conduct transactions with non-related parties within the Mainland without losing any tax benefits. Of course, mainland entities can also generate income from outside the UAE, obtaining passive income while ensuring that the other party can retain its tax deductions, etc.
On the other hand, free zone entities face a much greater risk when it comes to ensuring that active income is not derived from unrelated mainland entities, as this would deprive the free zone business of all free zone benefits. Such businesses must be more stringent in terms of processes and compliance to ensure that not a single active business transaction is conducted with unrelated mainland entities.
In reality, this is a decision that companies must weigh the pros and cons.
For businesses with a turnover below €750 million, the choice is much simpler – for the reasons mentioned above, it is better from a tax perspective to move to a free zone, assuming that it is feasible from an operational/operational perspective of. financial perspective. Such businesses should again be careful to ensure that they do not earn active income from unrelated mainland entities to ensure that they retain the 0% tax benefits of the free zone.
The reality is that the costs of running a business in a free zone are higher (higher rent, local compliance costs, etc.) and not every business can move their operations so easily, especially if they are more brick-and-mortar focused. In this case, you can choose to establish a subsidiary in one of the free zones and transfer part of the business there if possible; then record the profits to the free zone subsidiary based on the functional, asset and risk analysis (after the implementation of the corporate income tax system , the OECD Transfer Pricing Guidelines will also apply to the UAE).
in conclusion
We will have to wait and see how the draft corporate income tax law is structured to answer the questions raised in this article. Tax advisors and tax managers are already very busy preparing for the new laws, and they will become even busier in the coming months. There will be more open questions for companies in the free zones and on the mainland. It will also be important to track Pillar 2 developments in other countries, as the UAE will likely formulate policies based on how successful Pillar 2 proposals are in other countries.
This article does not necessarily reflect the views of National Affairs, the publisher of Bloomberg Law and Bloomberg Tax, or their owners.
Comments in this article are for general information only and are not intended as advice. Readers should seek professional advice where relevant.
Author information
Parwin Dina is Global Tax Leader, Global Tax Services
The author can be contacted at: parwin.dina@global-taxservices.com
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