Interpretation of DTAA with respect to Taxation of Cross-Border Transactions and Permanent Establishment (PE)

Earmarking another landmark step to further strengthen the country's position as a prominent center for businesses and investment, The United Arab Emirates (UAE) introduction and published Federal Decree-Law No. 47 of 2022 on Taxation of Corporations and Businesses. With implementation of Corporate Tax and with increasing number of international transactions entered into by the UAE companies, the tax authorities and the Companies in the UAE would often require in coming days to interpret the provisions of various tax treaties that the UAE has entered into with several countries.

A. Cross Border Transactions and Double Taxation

Cross border transactions encompass transfer of Goods, Services, Capital, and Technology and more than one country has a taxation claim on income from such transactions. As a consequence Same Income Taxed twice in different tax jurisdiction and Double Taxation Occurs.

I.???Double Taxation because of:

– Dual Residency Claim: Resident in both states and taxed on the same income or capital

– Dual Source Claim: Each state treating income from sources therein

– Competing Residence/Source Claims: Resident of one state derives income sourced in other state and both countries tax the same item of income

– Adjusting Profits Claims: Up-ward adjustment of profits by source state without the residence country making consequential compensatory adjustments

II.?? Methods for Elimination of Double Taxation (If covered under DTAA)

? Exemption Method

– Foreign Source Income is exempted in the country of residence

? Exemption with Progression

? Exemption without Progression

? Credit Method

– Credit for the foreign tax against the tax payable in Residence State but limited to the amount of tax payable therein.

? Deduction Method

– The amount of foreign tax is deducted from the total income

? Tax Sparing Credit Method

– The amount of foreign tax payable but exempted/reduced at source as part of its incentive program given credit against tax payable in Residence State but limited to the extent payable therein

B. Permanent Establishment (PE)

THE Legal Concept of PE is a compromise between “Source State Taxation” and “Residence State Taxation”. PE underlines that a state has a right to tax a non-resident if it has a PE in that state. For taxation, a company incorporated outside UAE and having its POEM outside UAE is considered as a non-resident. Under DTAA treaties, business profits are attributed to a Permanent Establishment (PE) as if it is a distinct and separate entity as per the provisions of Article 5 read with Article 7 of a DTAA. Such business profits can be taxed only if there exists a sate source income or a PE or a nexus in the UAE.

Introduction of concept of Place of Effective Management (POEM) (Clause 3(b) of Article 11) and Significant Economic Presence (SEP) (Clause 7 of Article 14) to reduce tax uncertainty and tax litigation (both) in the UAE.

The Legal Basis of PE can be one or more of the following alternatives:

– Basic Rule PE: Business activity performed through fixed place of business.

– Construction PE: Where Basic Rule PE does not exist but the business activity of the enterprise comprises performance of a construction or installation project at a building site for a prescribed period or more.

– Agency PE: Where Basic Rule PE and/or Construction PE does not exist but business is conducted through a person authorized to conclude contracts for or on behalf of a foreign enterprise under prescribed conditions.

Key considerations to address the tax concerns related to Permanent Establishment (PE) are as under:

1. Characterization of income i.e. Business income vs Other Passive Income.

2. Business Nexus for taxing right if a PE existence.

3. Business Income Allocation basis.

C. Interpretation of DTAA with respect to Cross Border Transactions & PE Taxability

Double Taxation Avoidance Agreement (DTAA) is an agreement signed between two countries/nations for resolving the issues of dual taxability of income. DTAAs objective is to restrict the right of a country to levy tax on income received by a non-resident entity from business activities pursued in that country and avoid the effect of double taxation on non–resident against income as liable to income tax in Country of Source as well as in Country of Residency (both) through allowing the Foreign Tax Credit (FTC) in country of residency. It provide Certainty of Tax Treatment to Investors and promote Exchange of Information’s.

Interpretation of tax treaties (DTAA) are crucial to the business as Article 66 of Decree Law 47 provides that “To the extent the terms of an international agreement that is in force in the State are inconsistent with the provisions of this Decree-Law, the terms of the international agreement shall prevail”.

As far as interpretation of tax treaties (DTAA) is concerned the Vienna Convention on the Law of Treaties (1986) and model conventions (OECD and UN) may be treated as the guiding path. International treaties, covenants and conventions although may not be a part of our corporate law, the same can be referred to and followed by the courts, having regard to the fact that UAE is a party to the said treaties.

Scope of Our DTAA, CBT & PE related services:

• Analysis of all Cross Border Transactions with the Related Parties ?& Connected Persons
• Implementation of favorable provisions under the DTAAs in comparison to the Corporate Tax Law
• Review of existing or proposed Business Structures and Transactions for possible PE exposure
• Advice on the different types PE’s as defined in the corporate Tax Law and DTAAs
• Advise on the issue of Place of Effective Management (POEM)
• Draft and Implement policies to mitigating PE exposure?

The information contained in this article is for general information purposes only. We make no representation or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the information provided therein.