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The role of tax treaties in transforming corporate tax landscape in UAE

By utilising beneficial provisions, companies can gain a competitive edge

In an era marked by the digital economy’s rise and enhanced global connectivity, one frequently find themselves residents of one country while earning income sourced from another. This scenario often triggers double taxation, where two nations levy taxes on the same income based on the rule of residence and rule of source.

While the primary purpose of double taxation avoidance agreements (DTAAs) was to eliminate instances of double taxation, multinational corporations (MNCs) frequently utilise jurisdictions with favorable tax treaties as conduits for routing funds, loans, and investments, thereby minimising taxes on repatriation of profits and capital gains in the source country and accordingly, also limiting the taxes withheld, and other levies that could erode returns. By strategically routing transactions through jurisdictions and utilising beneficial provisions either by way of reduced rate of taxes or restricted scope of taxation, as compared to the domestic tax laws, companies can enhance their after-tax returns and gain a competitive edge in the global marketplace.

For instance, assuming a company resident in India provides services to an entity located in UAE, then the Indian entity would be subject to taxation on its global income in India (as per residence rule). Simultaneously, under UAE CT Law, the same income would be taxed in UAE being the state sourced income because it is derived from a resident person i.e. the UAE entity (as per source rule). Consequently, in absence of DTAA between countries or in a case where DTAA benefit cannot be taken, the Indian entity is obligated to pay taxes in both countries on the same profits. Conversely, the existence of a DTAA between India and UAE alleviates the issue of double taxation since the DTAA includes a concept of taxing business profits in a foreign jurisdiction only if a permanent establishment is created in the foreign jurisdiction. Further, the income to be taxed is also restricted to the income attributable to the permanent establishment. This reduces the scope of taxation for companies who do not have presence in the foreign jurisdiction.

The withholding tax rates in a cross border transaction, for a UAE sourced income, in case of transactions with Singapore and India range from five per cent up to 12.5 per cent, as per the DTAAs with these countries. For transactions with Mauritius, as per the UAE-Mauritius DTAA, the UAE has foregone the rights for taxing state sourced dividends and interest. While, DTAAs do generally provide for a beneficial tax regime by providing for a reduced scope or restricted scope of taxation, the domestic law typically provides that the provisions of DTAA would apply only to the extent they are more beneficial. On account of this provision, interestingly, the UAE CT regime which currently provides for a zero per cent withholding tax rate on UAE-sourced income of non-resident is more beneficial than the provisions of DTAAs with the counterparts. Implicitly, a non-resident earning UAE state-sourced income, although liable to tax, on account of zero per cent withholding, currently, no mechanism prevails to collects the taxes.

While routing such transactions from more beneficial tax regimes, called as tax havens, and embracing treaty shopping has been a common practice, the government of few jurisdictions together with the Organisation for Economic Co-operation and Development (OECD) have been actively taking measures for not only amending the tax treaties which provide a preferential tax treatment, but also retrospectively amending the DTAAs to prevent treaty shopping.

The recent proposed amendments in India-Mauritius DTAA requiring the transactions to satisfy the principle purpose test i.e. demonstrating that the principle purpose of the transaction was not to obtain the tax benefit clearly reflects the intention as well as action to introduce stringent anti-abuse provisions and filling the gaps. In conclusion, where borders blur and markets transcend national boundaries, the strategic utilisation of DTAAs has emerged as a potent tool for MNCs aiming to gain a competitive advantage. These agreements, designed to prevent the double taxation of income earned in multiple jurisdictions, are increasingly being leveraged not only to eliminate tax burdens but also to sculpt tax-efficient structures that propel businesses ahead in the global arena. There is a consistent effort both by government authorities as well as OECD for filling the gaps, and ensuring a more transparent tax environment.

The writer is Partner, MICS International