Avoiding Double Taxation in the UAE: Unilateral Relief and Treaty Based Relief Compared

Introduction

In an increasingly globalised economy, businesses often operate across borders, generating income in multiple jurisdictions. While this can expand opportunities, it also introduces a significant tax challenge: the same income can be taxed twice, once in the jurisdiction where it is earned and again in the jurisdiction where the business is resident. This problem, known as double taxation, can significantly erode profitability and deter cross border investment if not properly managed.

The UAE Corporate Tax regime recognises this challenge and provides mechanisms to alleviate or eliminate double taxation. Broadly, there are two ways this is achieved: through unilateral relief, where the domestic law allows a credit for foreign tax paid, and through treaty-based relief, where bilateral or multilateral Double Taxation Agreements allocate taxing rights and eliminate double taxation between countries. Each method operates differently and carries distinct strategic considerations for businesses with international operations.

The Legal Framework

The starting point is Article 47 of Federal Decree Law No. 47 of 2022 on the Taxation of Corporations and Businesses. This provision allows a Taxable Person to claim a Foreign Tax Credit for tax paid in another jurisdiction on income that is also taxable in the UAE. The relief is limited to the amount of UAE Corporate Tax due on the same income, ensuring that the UAE does not subsidise foreign tax beyond its own liability.

In addition, the UAE has an extensive and growing network of Double Taxation Agreements with other countries. Article 66 of the Corporate Tax Law stipulates that these treaties, negotiated on a bilateral basis, override domestic law where they apply. These are designed to prevent double taxation by allocating taxing rights, reducing withholding taxes, and providing mechanisms for credit or exemption.

Unilateral Relief: The Foreign Tax Credit

How It Works

Unilateral relief operates under domestic law without the need for a treaty. If a Taxable Person earns income abroad and pays Corporate Tax on that income in the source jurisdiction, it may claim a credit against its UAE Corporate Tax liability on the same income. The key principle is that the total tax paid on the income should not exceed the higher of the UAE Corporate Tax or the foreign tax due.

The amount of the Foreign Tax Credit is capped at the UAE Corporate Tax due on that income. For example, if a UAE company earns income in a foreign country and pays tax at a rate of 15 percent there, but the UAE Corporate Tax on the same income is 9 percent, the company can only claim a credit up to 9 percent. The excess 6 percent cannot be carried forward or refunded.

Key Conditions and Limitations

To claim the Foreign Tax Credit, the following conditions typically apply:

• The income must be taxable in the UAE under the Corporate Tax Law.
• The tax must have been paid in a foreign jurisdiction on the same income.
• Documentary evidence of the foreign tax paid must be provided to the Federal Tax Authority.
• The credit is applied on a per income item basis and cannot exceed the UAE tax due on that item.

\One important limitation is that Foreign Tax Credits cannot create a refund. If the foreign tax exceeds the UAE tax, the excess is simply lost. Similarly, the credit must be claimed in the same Tax Period; there is no carry forward of unused credits.

Advantages and Strategic Use

Unilateral relief is particularly useful where the UAE does not have a Double Taxation Agreement with the source country. It provides a straightforward mechanism for avoiding double taxation and ensures that UAE taxpayers are not taxed twice on the same income. It also applies automatically under domestic law, without the need to satisfy treaty eligibility requirements.

However, businesses should carefully model their foreign tax exposure, as the inability to carry forward unused credits can lead to inefficiencies. It may also be beneficial to explore restructuring options that align income streams with jurisdictions where treaty relief is available.

Treaty Based Relief: Double Taxation Agreements

How Treaties Work

Double taxation agreements are bilateral treaties that override domestic law and allocate taxing rights between the contracting states. They are designed to eliminate double taxation, reduce withholding taxes on cross border payments, and provide certainty about tax treatment.

Treaties typically operate in one of two ways:

• Exemption Method: The resident state exempts foreign sourced income from domestic taxation.
• Credit Method: The resident state taxes the income but allows a credit for foreign tax paid.

In practice, the UAE’s treaties most often use the credit method, although exemption clauses are sometimes included for specific types of income such as dividends from qualifying subsidiaries.

Allocation of Taxing Rights

Treaties allocate taxing rights based on the nature of the income. For example:

• Business profits are generally taxable only in the country of residence unless the enterprise has a permanent establishment in the source country.
• Dividends, interest and royalties are usually taxable in both countries but withholding tax rates are often reduced under the treaty.
• Capital gains are typically taxable in the country where the property is located.

This allocation prevents the same income from being taxed twice at full domestic rates in both jurisdictions.

Treaty Tie Breakers and Residency

Treaties also include tie breaker rules to resolve dual residency situations, where a company might be considered resident in two jurisdictions under domestic laws. These rules typically consider factors such as the place of effective management or the location of the company’s head office.

Comparing Unilateral and Treaty Based Relief

While both forms of relief aim to prevent double taxation, they operate differently and offer different advantages.

Strategic Considerations

1. Review Treaty Networks
   Businesses should map their income streams and assess where treaties are available. In some cases, restructuring supply chains or holding structures to take advantage of treaties can materially reduce tax costs.
   
   
2. Document Eligibility
   Accessing treaty benefits requires proof of residence, beneficial ownership, and sometimes substance. Failure to maintain appropriate documentation can result in denial of relief.
   
   
3. Plan for Non-Treaty Jurisdictions
   Where no treaty exists, unilateral relief becomes the default mechanism. Businesses should forecast the potential tax leakage and consider alternative structuring options where possible.
   
   
4. Monitor Permanent Establishment Risks
   The existence of a permanent establishment can shift taxing rights under a treaty. Businesses should regularly review their cross-border activities to manage exposure.

Conclusion

The UAE Corporate Tax regime provides a comprehensive framework for eliminating double taxation, whether through unilateral relief under domestic law or treaty-based relief under its extensive network of agreements. Both approaches serve the same fundamental goal but operate in different ways, and each carries its own practical and strategic implications.

Unilateral relief offers simplicity and broad availability but is limited in scope and effectiveness. Treaty based relief can significantly reduce withholding taxes, allocate taxing rights more favourably and provide greater planning opportunities, but it requires proactive compliance and careful structuring.

For businesses with cross border operations, double taxation relief should be a central part of their tax planning strategy. Understanding how each mechanism works, and when to rely on one over the other, is essential to optimising tax efficiency, reducing risk, and ensuring that profits generated internationally are not unduly eroded by tax in multiple jurisdictions.

Seek Legal Counsel

Our expertise in tax law and regulations allows us to provide clients with effective and accurate tax advice, taking into consideration their unique circumstances and needs.

Our tax and financial crimes team, led by our Head of Tax and Financial Crimes, Mohamed El Baghdady, has successfully advised and represented clients across various industries, including, but not limited to, consumer goods and retail, services, real estate, oil & gas and banking and finance, before the Government authorities, tax tribunals and courts. Our clients have been successful in multiple tax disputes before the committees and courts.

For further information, please contact, Mohamed El Baghdady, Partner, Head of Tax and Financial Crimes, on mohamed.elbaghdady@habibalmulla.com.

Disclaimer

The content provided in this article is intended for informational purposes only and does not constitute legal advice. While every effort has been made to ensure the accuracy and completeness of this information, the article does not offer a guarantee or warranty regarding its content. The matters discussed in this article are subject to interpretation, and legal outcomes may vary based on specific facts and circumstances. We recommend that readers seek individual legal counsel before making any decisions based on the information provided. If you require specific legal advice, please contact us directly.