Globalisation and rapid technological developments have resulted in increased international trade and the creation of huge multinational companies.
In this evolving global economy, national tax laws have been slow to adapt to the way that these organisations conduct business internationally, resulting in gaps and mismatches in national tax laws and double tax agreements (DTAs), allowing some companies to exploit these differences to minimise their overall tax burden.
DTAs were initially agreed for the purposes of avoiding double taxation on the same taxpayer, on the same tax base. However, they have been used by some multinational organisations to avoid tax in a way that undermines the integrity and purpose of the treaties.
In order to counteract this, the OECD, as part of its Base Erosion and Profit Shifting (BEPS) project, developed the Multilateral Instrument (MLI), which enables signing jurisdictions to implement agreed minimum standards within applicable DTAs – referred to as ‘covered tax agreements’ – to counter treaty abuse in an efficient and consistent manner.
Explaining the treaties & regulations
The UAE signed the Multilateral Instrument (MLI) on June 27, 2018, and this was ratified on May 29, 2019. The UAE and the UK have both ratified the MLI, bringing it into force on September 1, this year. As such, the UAE-UK DTA is modified, to include the minimum standards contained within the MLI.
On October 21, 2019, the UK HM Revenue and Customs published the synthesized text of the UAE-UK DTA, which includes modifications as follows:
Additional wording to emphasise that the DTA is not to be used for the avoidance of taxes;
Inclusion of a Principal Purpose Test (PPT) whereby tax benefits would be denied if it is found that the main purpose, or one of the main purposes, of any transaction or arrangement is to obtain a tax benefit; and
Additional wording regarding the ‘Mutual Agreement Procedures’, to improve the dispute resolution process between the tax authorities of each country.
So what’s changed?
The key change to the UAE-UK DTA is the PPT, which aims to make sure that DTA benefits will not be granted where the ‘main purpose, or one of the main purposes’, of the arrangement or transaction is to access the benefits of the DTA.
The purpose of the PPT is to prevent treaty benefits from being granted in unintended circumstances, and all UAE Covered Tax Agreements will be required to implement this minimum standard.
So, UAE companies transacting with the UK and benefiting from the DTA will now have to analyse the aims and objectives of any arrangement or transaction with the UK to determine whether it’s reasonable to conclude that one of the principal purposes of that transaction was not to obtain a tax benefit, such as a reduction in tax or profit shifting, for example.
This analysis would involve identifying the tax and non-tax reasons for undertaking the transaction, and critically evaluating these reasons to determine whether the arrangement or transaction is principally tax-driven.
Where this is the case, the DTA benefits should be denied, which may result, amongst other things, in an increase in cash taxes or the creation of a permanent establishment.
How the new UAE economic substance rules can also come into play
If obtaining the DTA benefit could be considered a principal purpose of the transaction, but the granting of the DTA benefit is in accordance with the DTA’s objectives, then companies may have to show that there is economic substance in the jurisdiction obtaining the benefit.
On this basis, it would be necessary to consider the UAE’s economic substance regulations issued April 30, 2019, and the supporting guidance notes.
Overall, with the introduction of the MLI standards, as illustrated by the synthesised tax treaty with the UK, the UAE is striving to counter harmful tax practices and comply with international tax standards, which will help strengthen the UAE’s reputation globally.
Consequently, these changes require businesses operating in the UAE to consider their global operating models and analyse transactions with treaty jurisdictions adopting the MLI.
Mark Schofield, PwC Middle East’s Tax & Legal Services Leader
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