Facts
An Emirati company has entered into a profit-sharing agreement (PSA) with foreign partners. The agreement relates to a trading activity in which the goods do not cross UAE borders. Profits and losses are to be shared equally between the partners.
The agreement outlines the specific functions and contributions of each partner to the trading activity. All on-the-ground functions in the UAE are carried out by the UAE partner. The foreign partner has no physical presence in the UAE (no office, staff, or assets) and performs no direct functions within the UAE.
Profits are allocated between the partners without any geographic segmentation.
Question
Could the foreign partner be regarded as having a UAE Permanent Establishment (PE) solely by virtue of being a partner in the business, despite having no physical presence in the UAE?
Summary
Following the analysis below, we have reached the following conclusions:
- However, we recommend you evaluate risks for the lender of being treated as permanent establishment in the UAE. The foreign partner of Unincorporated Partnership is likely to be treated as having a permanent establishment in the UAE, which might eventually lead to the 9% Corporate Tax imposed on the foreign partner.
- However, there are potential structuring options for the partnership agreement that could either avoid creating a permanent establishment for the foreign partner in the UAE or reduce the income attributable to such an establishment to zero.
- As with all scenarios where there is no clear-cut guidance in the law, regulations, public clarifications, or authorized guides, there is a risk of disagreement with the FTA. Therefore, it is advisable to seek verification of the above position through a private clarification with the FTA. When doing so, the taxpayer must present a favorable tax position, propose alternatives (where applicable), and provide a detailed analysis of these positions. A relevant tax opinion should also be submitted. The arguments outlined below can support a favorable interpretation, but additional arguments tailored to the specific facts of each case should be thoroughly developed and included in the technical position.
Analysis
In essence, a foreign partner will be taxable in the UAE if it carries on business in the UAE through a permanent establishment. If a PE exists, the UAE will tax the profits attributable to that PE at the 9% corporate tax rate (with the first AED 375,000 of profits at 0%).
Conversely, if a foreign company has no PE and only earns UAE-sourced income passively (with no significant presence), it might fall outside the UAE Corporate Tax scope or only be subject to withholding tax (which in the UAE is 0% on most payments under the current law).
For the foreign partner in the current scenario, the critical question is: do the partnership’s activities in the UAE create a “fixed place of business” PE or an “agent” PE for the foreign partner, even though the foreign partner itself has no office or employees in the UAE? We address this below.
Section 5.1.2.2 of the Corporate Tax Guide on Taxation of Partnerships No. CTGPTN1 states that a juridical person that is a Non-Resident Person will be subject to Corporate Tax on its distributive share in the fiscally transparent Unincorporated Partnership if the Unincorporated Partnership constitutes a Permanent Establishment in the UAE or nexus in the UAE. If not, the distributive share of that partner in the Unincorporated Partnership will be treated as State Sourced Income, i.e., currently will not be taxed.
Although this instruction doesn’t provide guidance on how to determine whether the PE is established for a foreign partner, it admits scenarios when foreign partners don’t have a PE in the UAE. Furthermore, it indicate that the attributes of the PE for Unincorporated Partnership rather than for its foreign partner are relevant. Therefore, the activity of a partnership as a whole should be considered to resolve the case.
Although this instruction does not provide specific guidance on how to determine whether a PE exists for a foreign partner, it does acknowledge that there are scenarios where foreign partners may not have a PE in the UAE. Additionally, it indicates that the relevant attributes are those of the PE of the unincorporated partnership itself, rather than those of the foreign partner. Therefore, the partnership's overall activity should be considered when assessing the case.
Neither Article 14 of the Corporate Tax Law nor by-laws and FTA’s guides provide clear guidance on whether the activity of a foreign partner should be regarded as carried out in the UAE by virtue of the local partner performing the activity in the UAE on behalf of all partners, both local and foreign.
International practice shows that even without physical presence, a partner in a transparent partnership can be regarded as carrying on business in the location where the partnership operates. Tax authorities generally view a partnership not as a separate taxpayer (when it’s fiscally transparent) but as an extension of the partners.
Para 43 of the OECD’s Model Convention Comments to Article 5 clarifies that ‘in the case of an enterprise that takes the form of a fiscally transparent partnership, the enterprise is carried on by each partner and, as regards the partners’ respective shares of the profits, is therefore an enterprise of each Contracting State of which a partner is a resident. If such a partnership has a permanent establishment in a Contracting State, each partner’s share of the profits attributable to the permanent establishment will therefore constitute, for the purposes of Article 7, profits derived by an enterprise of the Contracting State of which that partner is a resident’.
In para 56 of the Comments to this Article, ‘in the case of fiscally transparent partnerships, the twelve-month test is applied at the level of the partnership as concerns its own activities. If the period of time spent on the site by the partners and the employees of the partnership exceeds twelve months, the enterprise carried on through the partnership will therefore be considered to have a permanent establishment. Each partner will thus be considered to have a permanent establishment for purposes of the taxation of his share of the business profits derived by the partnership regardless of the time spent by himself on the site’.
Para 86 sets forth that ‘a person is acting in a Contracting State on behalf of an enterprise when that person involves the enterprise to a particular extent in business activities in the State concerned. This will be the case, for example, where an agent acts for a principal, where a partner acts for a partnership, where a director acts for a company or where an employee acts for an employer’.[1]
Commenting Article 10, the OECD informs in para 2 that ‘many States consider that the profits of a business carried on by a partnership are the partners’ profits derived from their own exertions; for them they are business profits. So these States treat the partnership as fiscally transparent and the partners are ordinarily taxed personally on their share of the partnership capital and partnership profits.’[2]
Comment 6.2 to Article 15 addresses employment issues related to a fiscally transparent partnerships: ‘it should therefore be considered that, in the case of fiscally transparent entities or arrangements such as partnerships, … subparagraph [b] applies at the level of the partners or members. Thus, the concepts of “employer” and “resident”, as found in subparagraph b), are applied at the level of the partners or members rather than at the level of a fiscally transparent entity or arrangement. This approach is consistent with the approach under paragraph 2 of Article 1 under which the benefit of other provisions of tax conventions must be granted with respect to income that is taxed at the partners’ or members’ level rather than at the level of an entity or arrangement that is treated as fiscally transparent…’.[3] The FTA can use it to contend that employees of an Emirati partner should be not only treated as extension of this partner but also as a personal of each of the partners. For non-resident partners, this personal activity can be treated as a foreign partners personal activity in the UAE.
Example 12 in the OECD 1999 Report on the Application of the OECD Model Tax Convention to Partnerships[4] considers a case where partnership P, which has been established in State P, has a fixed base in State R [UAE in the current scenario]. Partner A is a resident of State P and partner B is a resident of State R [UAE]. They have agreed to divide the profits of the partnership equally. P earns 1,500,000 during the taxable period. 1,000,000 of that amount is attributable to the services performed by B [UAE Co.] from the State R [UAE] fixed base. The remaining 500,000 is attributable to services [functions performed by the foreign partner] performed by A [foreign partner] in State P [Outside the UAE]. Both States treat partnerships as transparent entities.
The Committee agreed that ‘under Article 14, P’s fixed base in State R [UAE] should be considered to be a fixed base of both A and B and that the same is true for a permanent establishment under Article 7’.
Two views were expressed:
- Under the first view, ‘the reference to "his activities" in paragraph 1 of Article 14 refer to the personal activities of each partner and the partnership’s activities cannot be flowed-through to the partners. According to that view, Article 14 would not allow State R to tax partner A on his share of the income attributable to the fixed base (500,000) since the fixed base was not regularly available to A for the purposes of his own personal activities.’
- The majority, however, agreed with the different view that ‘the activities of the partnership should be allocated to the partners to the same extent that the fixed base of the partnership is attributed to each of them. Applying this approach to the above example, State R [UAE] would be allowed, as a source State, to tax partners A and partner B on their respective share of the income attributable to the fixed base located therein. State R will also be allowed, as the residence State, to tax partner B’s share of any other partnership income. Similarly, State P will be allowed, as a source State, to tax all the partnership’s income attributable to the fixed base of the partnership that is located in that State’.
Notably that ‘the Committee realised, however, that cases in the real world are rarely as simple as this example. The partnership agreement may specifically allocate the income from various States to particular partners...’.
This raises questions about how the above example should be treated if the parties agree that:
- Partner B (foreign partner) performs all of its functions outside the UAE, while Partner A (UAE Co) conducts its partnership role exclusively from within the UAE;
- The share in distributable profit represents the arm’s length consideration for the functions independently performed by each partner in their respective country of residence, with risks separately managed and resources secured by each partner through their own efforts carried out in their respective jurisdictions;
- The entire activity of the partnership consists of trading in goods that are both purchased and sold outside the UAE.
In our view, under this scenario, both the existence of a permanent establishment and the attribution of the foreign partner’s income to the UAE should be called into question.
[1] C(5)-36.
[2] C(10)-1.
[3] C(15)-11.
[4] https://www.oecd.org/en/publications/1999/08/the-application-of-the-oecd-model-tax-convention-to-partnerships_g1ghgc82.html
The disclaimer
Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.
The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law. See the full press release here.
You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have the status of the author’s opinion only. Furthermore, it is not legal or tax advice. Like any human job, it may contain inaccuracies and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.
