Tim Elliot: Welcome to Lawgical, the U.A.E.’s first, and still the only, regular legal podcast. My name’s Tim Elliot. I’m with the Managing Partner of the Dubai-based legal firm, HPL Yamalova & Plewka, here in Dubai, and it is Ludmila Yamalova I’m with. Nice to see you.
Ludmila Yamalova: Good to be here with you, Tim.
Tim Elliot: Now in this episode of Lawgical, we’re going to be talking corporate tax law once again. We talked about this very recently. It’s just come into effect, Ludmila, on June 1st. We recorded an introductory look then. Now, as we record this, we’re a few weeks on. I guess it’s good to start with a reminder of where we are, the ins and outs of U.A.E. corporate tax law right now.
Ludmila Yamalova: Well, where we are is that as of June 1, 2023, now the U.A.E. corporate tax is, in fact, in effect. Now we have a corporate tax. Before we just had draft laws. We had expected laws, and we had the actual law, but it had not really come into effect until June 1st. It is now in effect. It does not yet apply to everyone. It only applies to all those businesses whose financial year starts in June. For all of the other ones whose financial year matches the calendar year, they will be subject to this law as of January 2024. But the law is final. It’s here. Not only that, the law continues – like an amoeba – it keeps growing. It is like a spiderweb. After the original corporate tax law was introduced, there have been a number of degrees, resolutions, regulations, executive orders and clarifications, and so on and so forth. This little organism continues to grow and expand. It is certainly not going away. Because I have to tell you, when we first heard about a corporate tax law potentially being introduced, we were all in denial. Then when it was formally, at least announced, that it would be coming, we were like, it is not really going to. Then when it was actually already published, we said, okay, yeah, yeah, but they will delay it. Well, it ain’t so. It’s here, and it’s here to stay. Not only that, it truly is layering on, developing with a multitude of layers, and it’s obviously going to be a very complex body of law, but it is not going anywhere.
Tim Elliot: This is true. Are you anywhere near acceptance yet? Are you just out of denial? How are you doing?
Ludmila Yamalova: I am a little bit still in denial or willful ignorance. (Laughing). For my business, our fiscal year is the calendar year, so we are not yet formally subject to it now, but we are certainly very aware of it (1) based on what we do in the industry and (2) for many of our clients, and to be honest with you, (3) I have been in the U.A.E. but I am a U.S. citizen, a very privileged breed, we have to pay U.S. taxes no matter where we are and no matter where we live or where we work. As long as I have been in the U.A.E., I have had to declare and pay taxes to the U.S. always, so I have not had a break. It’s not like I’m not familiar with the concept or that the concept has been long forgotten. It’s always present because I have been doing my taxes through the U.S. authorities. We know and we are prepared. To add to that, when the VAT was introduced as a business and obviously for all of our clients, this was like a soft introduction or entryway into the tax world. A lot of businesses have obviously now adapted in terms of the bookkeeping practices, the auditing and the accounting practices, and just even issuing invoices and corresponding receipts. It’s at least lingo now, because until 2018 it wasn’t. It was a completely foreign language.
Tim Elliot: It’s so interesting because wherever you go in the world, it is always, the t word, it’s a dirty word, isn’t it, tax. It’s something you don’t mention except under the breath.
Ludmila Yamalova: We were very proud for a long time to not have that dirty word in our vocabulary in the U.A.E., but we have now been – it has seeped into this world as well.
Tim Elliot: You made an interesting point just now actually, the fact that not everyone needs to register right now. You said you’re not subject right at this moment, and that’s because it depends on your tax year, isn’t it, to start with?
Ludmila Yamalova: Correct. As a starting point, we have dedicated a previous podcast on this topic, and any kind of business ultimately will have to register with the FTA, the Federal Tax Authority and would have to do the tax returns on an annual basis. But not every business will actually have to pay tax. Only if you meet the threshold will you actually be subject to paying the tax. But in terms of registering with the authorities, we’re all required to do so. For the purposes of perhaps gradual implementation of this law, for the time being it applies to all of those businesses that start their fiscal year in June. Those businesses should by now have registered with the FTA. They don’t really need to do anything other than register with the FTA for the time being because they don’t have to pay tax until the year after. But they should register. A business like ours and all the other businesses whose fiscal year is the calendar year, we have the option of registering between now and January, but we are not required to do. Obviously, the sooner we do it, the more comfortable we will be by the time this is obligatory for us to have that registration. The interface and the services are evolving before our eyes, so it’s actually not a bad thing to be registered early on so you can learn and evolve along with the system.
Tim Elliot: That’s about the extent of my knowledge, and my knowledge is based on the podcast we did three weeks ago. Aside from the fact that the rate is 9%, is there anything new? Have you learned anything in the last three weeks? Any changes? Any additions?
Ludmila Yamalova: There are many. There are many. My starts spinning when I think of it. I think it will not stop spinning for probably ever because this is typical of so many other tax laws in other countries, and there is something is always evolving, something changing, something developing in the tax world. I assume it’s going to be a very similar pattern here.
For the time being, what we wanted to discuss and focus on today in particular is regarding the application of this corporate tax, as you said, 9%, to free zones. For all those who are familiar with the U.A.E. and our business environment here, we have what is called the mainland and these are companies that are set up on the mainland under the authority of what is called the Department of Economic Development (DED), and then we have free zones. Every emirate has its own free zones and within the free zones there are specific regulations that apply to companies for company purposes. Historically, there are certain benefits of being within a free zone, one of which – and a lot of these benefits have been fading over the years because of other changes in the law – one of the benefits was if you set up in the free zone is you did not need to have an Emirati sponsor or partner. That was one of the big benefits. Now, for the most part, you don’t really need that kind of a partner even on the mainland, so that benefit is of less relevance now.
However, one of the other benefits that was advertised for free zones is being tax free for 50 years. Now the big question when the law was introduced for all of those businesses that are based in free zones, or outside for that matter, free zones are tax free, so does that mean we are going to be exempt, or as a free zone company we don’t have to pay the tax because of being tax free. That is one big question that is on many people’s minds. Now we have more clarity on what that means. In short, free zones, just to highlight once again, will have to register with the FTA because the law applies to all types of businesses, irrespective of how much they make per year, where located, and what type of business. They all have to register with the FTA. They all have to do a tax return, including free zones. With regard to whether free zones have to pay tax, it depends. In other words, free zone companies located in the free zone, just because it is called a free zone and under the terms and conditions of being almost basically free zone is tax free for 50 years, it still depends, for the purposes of corporate law. Businesses may still have to pay 9%.
Tim Elliot: You know what my question is going to be. What does it depend on?
Ludmila Yamalova: Yes. It depends on the type of business and perhaps the location of your clients, your customer base, and ultimately the source of your revenue stream. For example, and this perhaps is how the authorities have been able to combine the two concepts of free zones and this federal corporate tax law, because you can imagine, if free zones were completely exempt from corporate tax, you would probably have very few mainland businesses, especially now that you are not required to have a local partner anymore, you can basically move to a freeze very easily. This was a way to straddle that potential conflict or discrepancy in the law. What the authorities have ultimately decided, and for the time being this perhaps will continue to evolve in other ways, but if you are inside of a free zone as a business, it is not that you don’t need to pay, you are not exempt, you are subject to a different tax rate, and the tax rate is 0%, but on certain kinds of income only. If you a business inside of a free zone, anything you generate within the free zone is taxed at 0%. You are not exempt, but it is a 0% tax rate.
Let’s say if I’m a business inside the free zone. We can call it the DMCC, which is where we are, and all of my income is from my clients here. Let’s say I’m a restaurant in the DMCC or TECOM, since I am inside the free zone, then all of my income that is generated within the free zone is taxed at 0%. Whatever income is generated within my free zone is taxed at 0%. Whatever income is generated from outside of the U.A.E. is taxed at 0%, and whatever income is generated from other free zones is also taxed at 0%. Let’s say I am sitting in the DMCC and I do work with TECOM, with Silicon Oasis, DIFC, Jafza, so any kind of income between the free zones is also taxed at 0%.
Tim Elliot: Let me just simplify this for my non legal brain for a second. You’re a restaurant and you’re in the DMCC free zone. Any revenue generated in your restaurant when people come there and pay their bill, that is taxed at 0%. If you do outside catering to another free zone, that is taxed at 0%. If you do outside catering in another country, taxed at 0%. However, am I to understand that if I were to do outside catering in Dubai outside of a free zone on the mainland, income is no longer taxed at 0%.
Ludmila Yamalova: A great example. That is an example and it’s a great demonstration. Because you think even a business that is not professional services, because professional services is much more fluid in terms of where the income is generated, but a stationary business like a restaurant, you would think all of the income should be taxed at 0% if they are in a free zone. But as you rightfully said, in the U.A.E. in particular, deliveries are very common for all restaurants.
Tim Elliot: That’s a really interesting point because that’s another aspect, isn’t it? As soon as you deliver outside of the free zone, all of sudden, yeah. Okay.
Ludmila Yamalova: Exactly. I will tell you, there is even more. That is just for businesses that actually deal with material or tangible goods, such as restaurants. What about professional services? For example, let’s take a law firm, like us. For us, let’s say you are my client. You are my client and you have a company based in Jafza. Any kind of income that we do for you and for your business in Jafza is taxed at 0%. However, same client, and you have a property that you own on the Palm. Any of my services related to that property, to that interest of yours that is outside of a free zone, that is on the mainland, will be subject to the 9%.
Tim Elliot: Even if the client is in theory located inside a free zone, the asset outside of the free zone?
Ludmila Yamalova: Exactly. It’s not just the location of the client. It’s basically where the revenue stream comes from, the source of the revenue streams. Because in that case, you are paying me for the services that relate to your asset outside the free zone on the mainland, and that is subject to 9%.
Tim Elliot: Keeping track of that is going to be – that’s – essentially your audited reports are now set to be really, really scrutinized. You have got to be really on top of this.
Ludmila Yamalova: Absolutely. You can imagine what this will do to a lot of businesses in terms of just administration, operations, and compliance costs, but also, I guess what it will do to the accounting and the auditing industry. I would expect more schools to open and more accountants and bookkeepers to flood into the U.A.E. because certainly businesses will need this help. As you just identified, there are so many different layers. As a business you could have the same client, and that same client could be in different free zones. The services you would be providing to different free zones, it could be outside of the U.A.E., it could be on the mainland, so just keeping all of that documented and monitored, it’s not going to be simple.
Tim Elliot: And the thing with this is in the free zones there are many major global corporations. To many of them, a new procedure isn’t such a big deal. But by the same token, there are lots and lots of small to medium enterprises operating from these free zones here in the U.A.E., and for them, this will be a big deal.
Ludmila Yamalova: Absolutely. We have seen that with the introduction of VAT. That’s why, as I mentioned earlier, I think that was a very gentle way perhaps to ease businesses in the U.A.E. into the new corporate world of tax. Because until VAT was introduced, most businesses, a lot of the small mom and pop businesses, boutiques, grocery stores, cafes, and restaurants, all of the accounting was done by hand because if you don’t have to pay taxes, you don’t have to disclose or make reports to any specific authority. How you keep your books is completely your business. That is why a lot of businesses just literally did it by hand. A lot of receipts, I remember, I’m not that old, but I remember the majority of my time here receipts were handwritten. Then when VAT was introduced, that was one of the requirements under the VAT law was that all of the invoices and all the receipts had to be in a specific format and ultimately electronically generated. Hopefully by now the businesses have had a little bit of time to ease into it and adopt some bookkeeping and accounting practices that will make it easier for them to embrace the new reality and the new level of reporting requirements, but it is going to be complex, for sure.
Tim Elliot: There is something else as well. Two of the U.A.E.’s free zones, the DIFC, the Dubai International Financial Centre, and the Abu Dhabi General Market, the ADGM, are in many ways independent legal jurisdictions. That’s historically the legacy, I think it’s fair to say. They have their own laws, their own courts. For the purposes of U.A.E. corporate tax, the DIFC and the ADGM are subject to federal law, just like the other free zones now.
Ludmila Yamalova: Exactly. That’s another big point in this, less something that we have learned, but clarified and solidified in our minds recently. Before I jump into that, I did want to also make one comment, because there are a lot of free zones. As we mentioned earlier, the U.A.E. has many free zones, and every emirate has its own free zones. Dubai has the greatest number of free zones. In addition to the general free zones, we have the specific free zones like DIFC and the ADGM, and we will come back to them shortly. But in terms of the regular free zones, a lot of foreign interests, companies, businesses, and individuals, have set up free zone companies around the U.A.E. for their global operations, which basically means they have a base here, a legal base. Let’s call it a Jafza company or a Silicon Oasis company, a DWC company, or a DMCC company, any one of these free zone companies. They have the company, but all of their income is generated outside of the U.A.E.
Therefore, by law, by at least perhaps the speculation or implication would be that they are within the free zone and all of their income is generated from outside of the U.A.E. and therefore they will be taxed at 0%. However, this is where a number of laws come into play together. There is an additional set of laws, and we have talked about it in a previous podcast, called the ESR, which the economic substance requirement. In order to benefit, and this is where this particular aspect of the corporate tax comes in with the economic substance requirement, and that is, in order for those kinds of businesses or for businesses to benefit from the 0% rate, there is an additional requirement.
These are only free zone businesses which meet the following requirements that can benefit from the 0% tax rate. Otherwise, they will be taxed at 9%. Those requirements are (1) the business has to be derived from the qualifying income, the qualifying income being, for example, either from free zones or from outside of the U.A.E. That is called the qualifying income. But (2) second of all, the free zone company or persons must maintain what is called adequate substance in the U.A.E. and conduct their main core income-generating activities and maintain their assets and employees and expenditures in this free zone company.
Tim Elliot: Right. But what’s adequate substance?
Ludmila Yamalova: It’s a fairly complicated area of law, but basically the managers of the company have to be based in the U.A.E., have X number of board meetings and quarterly meetings have to take place in the U.A.E., the decision making has to take place in the U.A.E., the senior management have to be in the U.A.E. Depending on the type of businesses, they have to have X number of employees and these employees have to be under the company’s residence, and they have to be based in the U.A.E. In other words, shell companies, which previously was one of the prolific industries for a lot of the free zones, they were companies set up in all of the free zones and being used for purposes of their own tax optimization or tax reporting in their respective countries to minimizing and optimizing tax, and they would use the business in the free zone for that purpose.
Now that option is no longer. For those businesses who have these purely shell companies for just that reason alone, that is no longer going to work. They will have to still pay 9%, and if they don’t want to pay the 9%, then they need to make sure that the business is a substantive business. In other words, if I have a company in the Netherlands and I just have a free zone entity here, I can no longer just run all my income through the DMCC company for purposes of being taxed at 0%. I will actually have to have employees here. I’d have to have an office here. One of the requirements will be just a physical office because a lot of these shell companies don’t necessarily have a physical office. It is a flex desk option. This is where I am saying the ESR, the economic substance requirements that we have done a podcast on, has a very specific list of the requirements, depending on the business, how many employees, how many meetings, management, decision making, how much of that substance has to take place in the U.A.E.
That is where the two merge together, the corporate law and the economic substance law and then basically if a business is based in a free zone in the U.A.E. and wants to benefit from the 0% tax rate, it must have its substance here in the U.A.E. and not just use this as a shell entity for purposes of tax optimization.
Tim Elliot: Okay. So adequate substance is kind of proportionally linked to operational activity, I suppose.
Ludmila Yamalova: Exactly. Yes.
Tim Elliot: Would be one way of putting it.
Ludmila Yamalova: Right.
Tim Elliot: Sorry. Let go back to the DIFC and the ADGM.
Ludmila Yamalova: Yes, but there are a few other things for these free zone companies.
Tim Elliot: I had the feeling there was going to be more.
Ludmila Yamalova: Yes, yes, yes. Yes. Also, some free zone companies and some businesses actually may want to opt for 9%, even if they have businesses elsewhere. They may actually be inside the free zone, and they may otherwise have qualifying income that would be subject to 0% tax rate, but they can opt in for 9%. They can opt in to pay 9%. Why? Because it may be that in another country where they have a business the tax rate is much higher. If there is an agreement between the two countries for double taxation, they would prefer to pay a lower tax here in the U.A.E. than a higher tax, let’s say in Europe. In other words, businesses even who have qualifying income that otherwise would qualify for a 0% tax rate, they can actually opt in to pay 9% so that they can opt for the 9% and not the higher rate that they would be subject to in a different jurisdiction.
Tim Elliot: Let me just boil this down once again for my very simple non legal brain. You effectively through introducing tax, you – not chase, that’s the wrong word – but you discourage the businesses that you don’t want and other businesses may opt in and you encourage the businesses that you do want.
Ludmila Yamalova: And this is perhaps the evolution of every economy. The U.A.E. has over the years become a lot of an evolved, stable, and sustainable economy, and it’s by virtue of these new regulations and the businesses that are being set up here are becoming more of real businesses, sustainable businesses, and that is, to your point, ultimately these are the businesses that will benefit the economy in the long run, the economy and society, because they are the ones that generate businesses, they are the ones that generate employment, they are the ones that rent spaces and hire people and so on and so forth. These are the kinds of businesses the country actually benefits from more in the long run. As part of the evolution of these legislative reforms, this is what is happening. The businesses that are being set up here or that still remain are actual, real businesses.
Tim Elliot: So, it is starting to fall into place.
Ludmila Yamalova: Yes. There is one more comment and this is also important just to make sure there is compliance for tax optimization. Any kind of multinational companies that want to potentially benefit from a 0% tax rate, they need to make sure they adhere to what are called the arm’s lengths principles and maintain adequate transfer pricing standards and documentation, meaning if you have a big company and you have multiple entities, what you can do is set up different free zone entities and say, oh, yeah, this free zone basically is a 0% tax rate and that one is a 0% tax rate because they are a separate legal entity. But in order to benefit from the 0% tax rate, their transactions themselves have to be conducted at arm’s length in order to benefit from these potential exemptions in the law. Again, you cannot use this, abuse it, or misuse it, as was in the case before and in many other countries where companies or businesses always seek out the more beneficial jurisdictions to set up in order to basically either avoid paying tax or trying to optimize their tax obligations.
To wrap this up in terms of the legal foundation, these clarifications of the free zones in particular were issued by virtue of Cabinet Decision #55 of 2023 regarding the qualifying income of qualifying free zone entities and in particular Articles 3 and 7 and obviously that is in addition to the Federal Decree Law #47 of 2022 which is the corporate tax law and the specific Articles there, like 1834 and 55 that deal with or set the foundation of the base for what’s to come next. On the back of that substantive law, these new Cabinet Decisions that came out recently, just this year, and that’s basically where these nuances that we have just discussed are embedded in and further detailed.
Tim Elliot: I think that pretty much sums it up, but I’ve got a feeling this is a topic we’re going to come back to.
Ludmila Yamalova: As far as the free zones are concerned, the regular, the ordinary free zones, but we still have the DIFC and ADGM free zones to cover.
Tim Elliot: Oh, okay. So, we do.
Ludmila Yamalova: Yes.
Tim Elliot: A few words on that, I think, are necessary.
Ludmila Yamalova: Yes. So, ADGM and DIFC, these are the two very special free zones in the U.A.E. DIFC stands for the Dubai International Financial Centre free zone, and the ADGM stands for Abu Dhabi Global Market. Two separate free zones in two different emirates, one in Dubai and one in Abu Dhabi. These free zones are not just your typical free zones. They are also independent judicial zones, and they have their own laws. Interestingly enough, they are independent jurisdictions and they have their own, not just laws, but their own courts. For example, the DIFC has its own common law jurisdiction versus civil law in the rest of the U.A.E. The same with ADGM. Their laws are based on English laws and on English legal practice. The same with ADGM. Even all the practice and all the laws are drafted in English and the main language is English, not Arabic, as is the case in the rest of the U.A.E., including other free zones, and they have their own courts. Their courts are, for the most part, represented by very senior judges that are English, trained judges, and it is an all English-speaking court.
These two free zones are not just your typical free zones, but they are also completely independent jurisdictions. For the most part, they are the law in themselves, and the federal laws don’t necessarily apply to these free zones apart from a few laws, like the criminal law. That’s why we have had a few questions recently from clients that want to go get set up in the DIFC or the ADGM, move our business either from the mainland or from a free zone to one of these because we don’t want to have to pay tax, or we just want to maybe optimize our tax obligations, and we are thinking of moving to the DIFC or the ADGM, thinking that because the DIFC and the ADGM have their own laws that this corporate tax law will not apply there. For the most part, with regard to most other laws, that is the case. For example, the DIFC and the ADGM have their own employment laws, they have their own corporate laws, their own contract laws, and so on and so forth, but as far as the U.A.E. corporate tax law, the corporate tax law applies to the entire country and to all of the companies in all of the free zones, irrespective of what type of free zones they are.
In other words, this particular corporate tax law applies equally to ADGM and the DIFC. In that case, ADGM and DIFC will be treated the same way as any other free zones for purposes of the corporate tax law and the 0% tax rate on income, as we discussed earlier. In other words, whether you are based in the DIFC, the DMCC, TECOM or ADGM, your reporting tax obligations will be the same. Certainly, you will still have to register with the authority, with the FTA. You will have to submit your income. Some of your income could be taxed at 0% if it is qualifying income, but the other income that deals with the mainland of the U.A.E. or sourced from the mainland of U.A.E., you will still be subject to the 9% tax rate.
Tim Elliot: There’s a lot more to talk about here. I think we’ll come back to U.A.E. corporate tax law, no doubt, and over the course of the next few days, weeks, months, I have a feeling. That is another edition of Lawgical, corporate tax Law, an update. As ever, thank you for watching, listening, or both, and thanks to our legal expert, the Managing Partner here at Yamalova & Plewka, Ludmila Yamalova. I feel it’s a lot clearer.
Ludmila Yamalova: Ah, yes. You look a lot more enlightened. (Laughing).
Tim Elliot: Thank you. I appreciate you sharing your knowledge again. Find us at LYLAW on social media, Facebook, Instagram, TikTok, LinkedIn. All the podcasts that we do are free at LYLawyers.com and at most other podcast platforms. If you’d like a legal question answered in an episode of Lawgical or you want to talk to a qualified U.A.E. experienced legal professional, click Contact at LYLawyers.com.