Difference Between Mainland & Freezone Company Setup in the U.A.E.

Lawgical with LYLAW and Tim Elliot

17 September 2019

Tim Elliot:  Welcome to another episode of Lawgical.  It’s the Gulf Region’s first and still the only legal podcast.  My name’s Tim Elliot.  I’m here at the Jumeirah Lakes Towers offices of Yamalova & Plewka with the Managing Director, Ludmila Yamalova.  As always, Ludmila, really good to see you.

Ludmila Yamalova:  Tim, good to have you here again.  Thanks for coming to chat with us once again.

Tim Elliot:  In a recent edition of Lawgical, the last edition that we put online, we considered the topic of doing business in Dubai, actually more widely here in the U.A.E.  Now we talked in kind of broad terms about what’s required, the need to be present in the U.A.E. physically, the need to ensure appropriate licensing, etc.  We discussed financing, banking facilities, the evolution of the legal framework that surrounds and protects business setup, and we also discussed broadly about free zones, on shore, and a little bit about offshore operations.  Now in a country that’s taking the steps that we all agree about to encourage entrepreneurial activity is a topic that always spurs additional questions.  We have had lots of questions, so I wanted to do today was return to the topic and expand on offshore versus onshore business setup in the U.A.E.  But it’s a little bit more complicated than that so I thought we’d start with the difference in simple terms – and I am getting to the point here – between mainland, free zone, and offshore companies.  3-2-1-go.

Ludmila Yamalova:  I am glad that you summarized in the way that redefined the terms in your last sentence because in fact there are three different concepts.  They are (1) mainland, (2) onshore, and (3) offshore.  However, there is a popular misconception still to this day to call any freezones, for example, as being offshore.  But in technical terms or in legal terms, that is actually a separate legal concept, and it’s a different type of company to be located offshore, so to speak.

The accurate categorization of the types of companies you can set up, or businesses you can set up in the U.A.E., is mainland, onshore, and offshore.  Now in just very general terms, there are different types of companies that can be set up on the mainland, but the most common corporate vehicle is what is often referred to as an LLC, a limited liability company.  For that particular company, if you are setting up an LLC on the mainland, you’re required to have a 51% ownership by an emirate entity or an individual.

That’s probably the most significant difference between a company that is set up on the mainland versus a free zone, because in the free zone you are not required to have an emirate entity or an individual as a shareholder.  They entity can be 100% owned by an expatriate individual or a company.  But the onshore, or the free zone in this particular case, is still an onshore business.  In other words, a free zone company can do business in the U.A.E.  It is just set up under a different legal framework.

The final type of company is in fact a more traditional, more classical form, offshore.  The U.A.E. has at least two vehicles or two platforms under which you can set up more of a classical offshore entity that’s akin, for example, the Cayman Islands or the BVI, the better known offshores that have been used quite commonly by the world’s many different corporate entities over the last many years.  But not many know that the U.A.E. too has corporate structures that allow for a very similar type of corporate setup being an offshore company.  These kinds of companies in fact are truly offshore because they cannot do business in the U.A.E.

The free zone companies can do business with a few limitations, but offshore companies set up in the U.A.E. cannot do business in the U.A.E.  What they can do is they often serve more as a holding company.  They can own properties.  They can invest in businesses.  But they cannot directly do business in the U.A.E.  They can only be incorporated through an agent.  Again, this is more akin to a traditional BVI or Cayman Islands offshore company.

These are the three different types of companies.  They are really more delineated around the free zones or the geographic areas where they are set up.  The mainlands are everything except the free zone areas.  They are geographically defined.  There are two different offshores in the U.A.E.  One is in Dubai under Jebel Ali Free Zone Authority, or JAFZA offshore, and one in Ras Al Khaimah.  Those are the three business structures that businesses can set up under.

Tim Elliot:  Three very specific different ways of setting up.  We are going to come back and look at offshore companies in a future podcast.  I think what we need to do today is talk about mainland and free zone and the distinctions between the two if you want to do business in Dubai and the U.A.E.  Let’s put this into two parts, Ludmila.  First of all, consider the ways in which you can set up on the mainland.

Ludmila Yamalova:  Mainland companies are usually distinguished as those companies that require a local partner, a local partner being, generally speaking, a U.A.E. entity, be it an individual or a corporate.  There are different types of companies that absolutely require this kind of structure and that is any kind of limited liability company.  It is, however, possible to set up also on the mainland without having a local partner if you set it up as a different legal entity which is often called either a sole establishment or a sole proprietorship.  It is possible to set up on the mainland without a local partner, but it is a different legal entity that, in short, does not afford owners of the company limited liability, which means that in the event that there is any dispute or a claim against the company then the individual and the individual’s assets will be at risk because the company does not enjoy limited liability.  But most of the companies that are set up on the mainland are set up in the form a limited liability company that is required to have at least a 51% ownership by an emirate.  On top of that, there are certain restrictions in terms of licensing activities and industries which in fact require a larger percentage owned by emirates.  For example, if you want to do a real estate brokerage company, a company with that activity is required to have 100% ownership by a U.A.E. national.  Similarly, anything to do with an insurance business, for example, or HR or recruitment, also requires 100% by emirates.  There are also certain industries and certain sectors of the business that require to have a similar ownership structure, for example, oil and gas or any kind of security type company.  It’s not to say that all companies that are set up on the mainland only require a 51% ownership by a U.A.E. national.  There are many businesses which require a much larger percentage.  This is what a lot of businesses coming into the U.A.E. are not aware of because most of the time when mainland companies are introduced, they are always introduced in the context of a 51% ownership and only.  But generally speaking, the majority of the companies in the U.A.E., in particular that are in trading, they are set up on the mainland with a 51% ownership by a U.A.E. entity.

Now, there are a number of companies and businesses which do not have a choice of being anywhere other than the mainland.  For example, if you are in trading and you are moving physical goods, for many different reasons you need to be set up on the mainland.  You don’t even really have a choice of being set up anywhere else because of the activities that you are involved in.  At least historically before the free zones were introduced and before the free zones became more popular than they are today, a lot of foreign businesses and foreign individuals set up companies in the U.A.E. with that structure, where it’s 51% owned by an emirate and the remaining 49%, depending on who the foreign investors were.  However, in practice, those foreign companies or foreign investors wanted to, or at least believed that they owned a company 100%, so they would bring in a local partner as a silent partner.  Even though on the license it would show that 51% is owned by an emirate, there would be side agreements that without effectively change the legal structure of that particular corporation.  A lot of businesses are set up like that, even to this day where foreigners and foreign companies and businesses believe that the business is 100% under their management and their ownership, relying on these side agreements.  These side agreements, however, are not enforceable.  There is a tremendous misconception in the industry in the region, believing that these side agreements are actually enforceable and valid.  This is because ultimately the effect of these side agreements is that they change the law, and no legal instrument will ever be enforced in court if it contradicts the fundamental legal structure that is allowed by that country’s laws.  In this particular case, the side agreements are not valid because they effectively change the required legal structure of the company.  That realization has become more highlighted or more pronounced over the last several years and because of that the free zones have become a lot more popular and a lot more common as an option for businesses and individuals setting up their own businesses.

Tim Elliot:  That’s an interesting point because there is something like, at last count, I think 30 different free zones here in the emirates spread across seven emirates admittedly.  But it is a very popular way to go.  We will come to talk about free zone companies in more detail in a moment.  But if I can go back to LLCs for a second, how many shareholders are required for an LLC?

Ludmila Yamalova:  Minimum is one.  A limited liability company can be owned by one shareholder, and that would be 100%.  But it always has to have a U.A.E. national, or a GCC national.  There is an agreement for GCC countries that would allow a GCC national, as either an individual or a corporate, to actually own a company without the need to have a U.A.E. national as a shareholder.

Tim Elliot:  So, if I was a citizen of Saudi Arabia, it’s perfectly feasible for me to enter the U.A.E. market without the need for an emirate shareholder or an emirate sponsor?

Ludmila Yamalova:  Correct, with one qualification.  You, as a Saudi national, could not bring in a foreign investor into that equation.  You could own 100% of the company, but you could not have, for example, an American national own either 5% or 10%.  That is a limitation.  As a GCC national, you can own the company in the U.A.E. outright, without the need to bring in a U.A.E. national, but you cannot bring a different nationality into that equation.

Tim Elliot:  Let’s assume that I’m going to set up my mainland company, and I’m happy to do that.  Let’s talk about costs.  I’m not going to hold you down to exact numbers.  It’s clearly different for each business.  But you need to consider license costs.  You need to look at legal costs, and other costs, for example, costs for an office, costs associated with staffing.  What am I missing?

Ludmila Yamalova:  There are startup costs and there are ongoing costs.  The startup costs usually, as in any business, are quite high or higher than obviously the ongoing costs.  So, there is a startup costs to set up a license and that license cost usually is higher than the annual license costs.  In the mainland, it depends on the licensing activity.  It could be anywhere from 10,000 dirhams to 50,000 to 100,000, depending again on the licensing activity.  That’s just for the license.

Now, one of the requirements in the U.A.E. to have a business and to apply for a license is that you also have an office.  That’s part of a requirement to have the license issued.  It’s not that you get a license and then decide to either rent an office or not.  You’re obligated to have some type of a premise that’s attached to your license.  That’s obviously another cost.  There is also an insurance cost.  Whenever you take an office, there is an office insurance, liability insurance, and depending on the type of industry you may even require some specific insurance, like malpractice insurance and such.  If you are hiring employees then there are visa costs, and for every employee there are visa costs and there are deposits that are held with the government for the purposes of those visas.  Now, as of about two years ago, it has become standard across the U.A.E. that every visa is also attached to health insurance.  Before, at least other than Abu Dhabi, in all the other emirates it was optional to have health insurance provided to their employees.  Now it’s required, so you also need to factor in that cost.  If you have five employees, now you have to apply for five different visas, and you have to get health insurance for each one of them.  Without the insurance, you will not get the visa, so there is that cost.

There is a significant cost in terms of what’s called the share capital.  Companies have to decide what share capital they want to list as part of their starting up capital and for a lot of the mainland companies it’s about 50,000 dirhams and up.  Let’s say it is you and I, the shareholders, we would do 50,000 and 50,000 and that would be 100,000, but we could take it anywhere to 5 million, to 10 million, to 50 million.  It depends on the industry and the particular business in terms of what their share capital should be.  With regard to the share capital, that is the amounts that are required to be listed as part of the company startup, but once the company is open and running, that money does not need to be sitting in the account.  It’s actually open for the business to be used as part of their regular business practice.

In short, there are licensing fees, there are office fees, there are share capital fees or costs, there is insurance, residence visas, and obviously all the other operational expenses, such as utilities, electricity, air conditioning, phone companies, internet connection, and so on and so forth.  The expenses are sizable, and that’s why it’s so important for businesses to understand exactly what goes into the opening up a business in the U.A.E. before committing to doing business here because it can be quite costly.  This is what we see from our experience.  A lot of foreign individuals or businesses do not take the time to learn about what it really means to run a business in the U.A.E. and then find themselves disappointed at the various costs that they do not factor in into their equation.

Tim Elliot:  Let’s assume that I’ve put a tic next to every one of those on your list.  I’m functioning.  Let’s move a couple of years down the road, and my business is doing well.  I think to myself, alright, I’m going to expand.  I’m going to open a branch office.  I may think about franchising the operation in some way.  I know those are two huge questions to answer, but both are possible here in the emirates.

Ludmila Yamalova:  For sure.  Your original business can ultimately act as a parent company, for example.  There are different ways of structuring expansion.  One is to make that original company be the parent company and then from there on you open up either branches or subsidiaries or some sort of affiliated businesses.  A branch, for example, in general terms has to match to the licensing activity.  It has to match those of the parent company.  Subsidiaries, on the other hand, can have different types of activities.  Let’s say the parent company becomes a shareholder of another company and brings in another shareholder into the fold.  There are different types of expansions that are possible, and you can use the original setup as, sort of, your mothership, if you will, for further expansion.  As part your growth, you can set up these branches, subsidiaries, affiliates anywhere in the U.A.E., and by that same token, anywhere in the world.  For example, a Dubai company can now open up a branch in Fujairah or in Abu Dhabi.  Or it can set up another entity, let’s say, somewhere in France.  The company in France will now be owned 100% by a U.A.E. entity.  It’s a fairly flexible and commonly recognized legal platform that allows you to expand as is appropriate for your business.

Tim Elliot:  That is a mainland company.  Let’s move on to free zones because, as I mentioned, there are something like 30 free zones here.  Dubai, Media City, Internet City, DMCC, the Dubai Multi Commodity Center, under which your company is licensed.  There is the Dubai International Financial Center.  There are places such as Creative Zone, Virtual Zone that help you to set up in any number of free zones.  There are a lot to choose from.  Structurally, let’s start there.  If you decide to head to the free zone route, you decide that’s for you, what’s available in setup terms?

Ludmila Yamalova:  There are many options.  There are a lot of factors to consider in terms of deciding which options are appropriate for what business.  To highlight, not all businesses qualify to be based in free zones.  For example, trading businesses and any businesses that deal with the transport of particular physical goods, they have to be set up on the mainland.  They cannot be set up in free zones.  Also, apart from a few, sort of, limited free zones, if you want to have a business that also has a warehouse, most of the free zones do not have warehouses.  Your option may only be to set up on mainland.  Also, there are certain activities that require for you to be set up on the mainland.

So first of all, you need to identify what is the activity that you want to pursue.  If there are none of the activities that are limited to being set up in the free zones, now you start looking at which free zone is most appropriate for me.  The choices are wide, and they usually depend on a number of factors, cost being one.  There are some free zones that are perhaps a lot easier to operate because they’ve just been around a lot longer, for example, JAFZA.  JAFZA stands for Jebel Ali Free Zone Authority.  It’s the U.A.E. oldest free zone.  It’s the first and oldest free zone.  By virtue of that alone, it’s a free zone that’s a very well-oiled machine, if you will, because it’s been around for so long.  It’s quite developed and sophisticated platform to operate under, but the costs are fairly significant because it’s usually aimed for much larger companies, those who need to have access to the port because it’s attached to the port and it has customs and it has lots and lots of warehouses, large warehouses.  By its very nature, the JAFZA Free Zone, for example, is more tailored towards bigger companies, bigger businesses.  But if you are in one of those businesses that does logistics or transport, that could be the only free zone that is appropriate to you.

But if you don’t need to deal with either physical goods or transportation or warehouses, then you’re looking at all the other free zones that are scattered all over the U.A.E.  Some of the other free zones that are of note, financial, if you want to do any kind of financial activities, there is a Dubai International Financial Center, or the DIFC, and there is also in Abu Dhabi, ADGM, the Abu Dhabi Global Markets.  Those are the free zones that in particular are aiming at attracting finance companies and financial activities.  If that’s the activity you want to open, those would be the natural free zones to consider first.

This is actually a little bit of the history, that most of the free zones when they were first introduced, they were introduced to attract certain industries.  You have the TECOM free zone, you had the Internet City, you had the DMCC which is Dubai Multi Commodity Center, you have Silicon Oasis, you have Dubai Healthcare City, and so on and so forth.  Historically, the free zones were based more on the specific industry that they wanted to target.  But over time each one of these free zones have become a lot more flexible, so they now allow and, in fact, encourage set up of a much broader range of businesses and all sorts of consultancies including.  In each one of these free zones we still have the names, like the DMCC, the Dubai Multi Commodity Center, which is where we are based, our law firm, and you have TECOM and media city, but in fact you have a lot of IT consultancies, for example, that are set up in those free zones.

But if you are in a particular business and you still want to be surrounded perhaps by more businesses that are in the same industry, such as the diamond industry or media, then perhaps you’d want to choose one of these other free zones that are more specialized just so that you have access to more like-minded businesses and services.  But other than that, if you don’t really have a particular business that you belong to, for example, you’re in consultancy, and there are a lot of businesses here set up as such, as general consultancies and providing services on a number of levels, then there are many other free zones that are available to you.  At that point you may look at which ones that are most affordable, especially when you’re starting up.  Cost is a big factor, and there are free zones that are set up in other emirates which are more affordable than those, for example, that are available in Dubai.

Tim Elliot:  The point to make there is really that there is a choice.  There probably is a free zone for you.  If you want to come and start an internet startup is your thing, perhaps Internet City is the thing for you.  If you want to start a magazine, Media City is there for you, and there is expertise there within the free zone that could be well invaluable if you’re setting up a new business.

Ludmila Yamalova:  For sure, but those free zones, in particular, the older free zones, they also come at a price.  If you are a new business starting up and as much as you may want to be surrounded with the like-minded businesses and have the availability of those companies and perhaps clientele available to you, you may not be able to afford it and it may be that to start up with you want to be set up somewhere else that allows you to legally work in this country and operate, but yet, helps you manage your costs, at least at the start.

Tim Elliot:  The other thing with free zones, Ludmila, is the attraction, I guess, from a taxation point of view and the 100% ownership point of view.

Ludmila Yamalova:  Yes.  Historically, the free zones have always been advertised with those two main benefits: (1) the 100% ownership, and (2) 100% tax free.  While the 100% ownership still for the most part remains, but the 100% tax free perhaps is slightly now because in 2018 the U.A.E. has introduced a VAT tax or the value-added tax.  Unlike, I guess, popular belief, free zones are still subject to the VAT, so a lot of the businesses that are set up in free zones, with a few exceptions, the VAT applies to most of the free zones.  In that particular example, and in fact, there were many questions that were raised on this subject and that is:  Because it’s a free zone, does that mean it’s going to be exempt from VAT?  But the current stance is that no, even though they are free zones, VAT applies equally to all with very few exceptions of very specific free zones.

Tim Elliot:  I asked you this for the mainland company, but let’s talk about this in a free zone setup.  If you want to expand, you want to open another office to serve a different emirate, for example, or you want to perhaps franchise, one of the points, I guess, that is made very often is the number of staff visas possible depends on the space that you rent for your premises, and that’s strictly controlled for obvious reasons in a free zone.  Let’s say you open a branch office for your business in Dubai.  If you’re registered with a free zone in the Emirates of Ras Al Khaimah, for example, how would the intricacies work out in an example like that?

Ludmila Yamalova:  It’s fairly simple and, in effect, in many ways it’s easier because you already have a U.A.E. presence.  Various governments across the U.A.E. recognize corporate documents and corporate entities that are U.A.E. based a lot more and a lot better than, for example, a foreign entity.  Let’s take an example of a TECOM company who wants to now set up a branch in Ras Al Khaimah, and that becomes a branch off a TECOM company.  It’s possible and it’s easier to do than, for example, that same company is coming from, let’s say, Ireland and setting up in Ras Al Khaimah because if it were an Irish company setting up in Ras Al Khaimah there would be a lot of corporate documents, attestations, and legalizations that would have to be done to the original company and company documents with which you were trying to form a company.  It can take a lot longer and cost a lot more.  Whereas if it is a U.A.E. entity, even if it’s from a different emirate, setting up a branch and expansion elsewhere in the U.A.E. all the documents that are issued by U.A.E. governments are equally recognized by all the other licensing authorities across the U.A.E.  It’s a fairly simple process, but in terms of the formation and the requirements the list remains the same, and that is, once again, if you’re setting up a branch or a subsidiary you need to have a license in that emirate, you need to have an office in most cases, and if you want to hire employees then once again those employees would have to be licensed by that new entity and the same residential visa expenses and insurance costs apply to all those employees of a new branch.

Tim Elliot:  Let’s just round things off.  We’ve been talking about mainland or free zone setup here in the emirates.  Just, if you could, and if you can briefly – it’s tough – just final thoughts on the discussion we’ve had.

Ludmila Yamalova:  Final thoughts are that the U.A.E. is a very business friendly environment.  As time goes on, the options become even more diverse and more flexible.  There are discussions of even introducing new laws and new regulations to make it even easier for foreigners to come and invest in the U.A.E.  But for now, there are three main corporate setups that exist and that is (1) mainland, (2) the free zones, and (3) offshore.  Depending on the business and interests, the U.A.E. has all of those avenues available to practically any business or any investor from anywhere in the world, so come do business here.

Tim Elliot:  Offshore, we’re going to come back to in a future podcast.  As ever, Ludmila Yamalova, the Managing Partner of the Dubai-based law firm, Yamalova & Plewka.  Huge thank you for sharing your knowledge and expertise.

Ludmila Yamalova:  Thank you for your engaging discussion, as always.

Tim Elliot:  That’s it for another edition of Lawgical.  We’ll be back soon with more, specifically, offshore setup.  That’s coming soon.  If there’s a legal question, maybe a conundrum you need an answer to, or you need to get more details about something, you can find us at LYLawyers.com.  You can also search us out on social media, Facebook, Twitter, Instagram, LinkedIn, etc.  We’re easy to find.  We’re now podcasting on a variety of legal topics specific to the U.A.E. every week.  In fact, sometimes a few times a week on occasion, and we’d love to hear from you.  For a consultation to come meet with Ludmila and the team, the easiest way is to head to Lylawyers.com.  Just hit Contact.