CT creating visibility on existing UAE VAT fixed establishment risk and historic tax liability

With the pending introduction of Corporate Tax (‘CT’), UAE permanent establishment (‘PE’) risk is high on the agenda for foreign businesses with any degree of presence or activity in the UAE. However, establishment related tax risk is not new to the UAE due to the introduction of VAT on 1 January 2018, and the separate but related concept of a VAT FE. 

A fixed establishment (‘FE’) is a concept for tax purposes and is automatically assumed by tax authorities when the human and material resources of a business in another country is of a certain permanence.

As a result, whilst businesses conduct their reviews and consider whether they have a PE and future liability for CT, they also need to consider whether they also have an existing exposure and a historic liability for VAT as a result of a FE.

This existing risk may be elevated, as most businesses were required to take a position in respect of whether they had a FE prior to the publishing of the VAT rules in 2017, and later Federal Tax Authority (‘FTA’) guidance. It can often be challenging for multinationals to get true visibility of the extent of local activity and presence on the ground in the UAE.

CT will now bring this issue to the fore, as whilst the concept of FE and PE relate to different taxes and are separate concepts, there are some significant similarities. This means that through auditing PE risk, the FTA will become aware of whether there is a related VAT FE issue that they need to consider further.

Historic and current risk and impact of an unidentified UAE fixed establishment

The presence of a UAE FE can create significant risk and historic exposure in respect of supplies made, but can also mean, depending on the circumstances, that previously zero-rated purchases by non-resident establishments should have been standard rated.

A fixed establishment most closely related to supplies made

There is a risk that supplies made from overseas establishments (e.g., head office) could be treated as supplied through the UAE FE, requiring the business to register, and charge standard rated VAT (currently at 5%), rather than business customers applying the reverse charge mechanism.

The UAE VAT legislation requires businesses with multiple establishments to consider which one is ‘most closely related’ to the supply. Where the overseas establishment is most closely related, it is treated as supplier, meaning that supplies of services can be seen as cross border, and ordinarily subject to the reverse charge mechanism by VAT registered UAE residents, with no local registration requirement or requirement to charge UAE VAT. 

However, if the UAE FE is most closely connected then these supplies are effectively pulled onshore to the UAE, with a registration requirement, and liability to charge standard rated VAT to UAE resident businesses. This can mean significant amounts of under accounted VAT on sales, together with a large penalty exposure.

Whether the UAE FE is most closely related to the supply should be analyzed on a case-by-case basis.

Zero-rating of exported services

This concept also applies in respect of the purchase of services. The UAE allows for exported services to be zero-rated subject to certain conditions. One of those conditions is that the supply is not received by an establishment in the UAE. Where the UAE FE is considered most closely connected, then UAE purchases of services should be subject to standard rated VAT rather than being zero-rated.

What is a UAE fixed establishment and how can I tell if it is ‘most closely related’ to my supplies?

The VAT Federal Decree law defines a fixed establishment as ‘Any fixed place of business, other than the Place of Establishment, in which the Person conducts his business regularly or permanently and where sufficient human and technology resources exist to enable the Person to supply or acquire Goods or Services, including the Person’s branches’.

The definition of a FE shall be read together with the definition of a ‘Place of Establishment’ and definition of ‘Place of Residence’ in the UAE VAT Law and UAE VAT Executive Regulations. 

Place of Establishment is ‘the place where a Business is legally established in a country pursuant to its decision of establishment, in which significant management decisions are taken or central management functions are conducted’.

The Place of Residence of the supplier or recipient of services shall be the state in which the Person’s Place of Establishment is located or where he has a Fixed Establishment that is the most closely related to the supply if he has a Place of Establishment in more than one state or has Fixed Establishments in more than one state. Thus, when a business has a UAE FE it is considered resident in the UAE for the UAE VAT legislation.

This definition of a FE is similar to that used in other countries. However, in the UAE complications arise on how to interpret the FE definition. Given that VAT was recently introduced in the UAE, there is no indication on the tax authority’s position on this and no court cases. In the European Union VAT cases like Berkholz, DFDS, Welmory etc. clarify these gray areas of application.

Even then, the concept of FE and its scope is being continually refined, for example, in the case of Dong Yang, the CJEU recently determined that legal form is not critical in considering FE, instead it relies on the economic and commercial reality i.e., under certain circumstances a subsidiary could be a FE. In the recent case Berlin Chemie the CJEU further clarified that the human and technical resources of a subsidiary can be considered an FE of the parent company if the parent company has the right to dispose of those means in the same as if they were its own. However, the same resources cannot be used both to provide and receive the same services (e.g. the FE cannot provide services to the subsidiary that creates the FE). The FE concept is constantly evolving to adapt to new business structures.

In the UAE, we do not yet have precedent court cases, so we must rely on the FTA guidance, and experience from the practical application of the rules by the FTA during a tax audit.

Is there a requirement to register and account for VAT?

A resident business is required to register if it exceeds the mandatory VAT registration threshold of AED 375,00 of taxable turnover in a 12 months period. There may be cases where the human and technical resources in the UAE constitute an FE without the need to register or account for VAT. For example, when the FE only supports its head office the activities are without the scope of VAT because they take place within the same legal entity or when the FE is located in a Designated Zone. When the FE only makes supplies subject to the zero rate it may apply for an administrative exception to register for VAT.

What should you do?

Businesses should ensure they complete FE reviews, or revisit previous reviews undertaken. FE risk is an existing risk, so whilst the review can be undertaken alongside considerations of CT PE, the reviews can also be undertaken independently, with the FE review being completed earlier if required.

Key questions we recommend businesses to consider 

The risk for the business is that it may have an FE most closely related to supplies made/ received. In our experience the FTA can refer to a range of areas to consider the underlying reality, including the below amongst others.

Do you have an FE?

• Employees or persons you effectively control in the UAE;

• Fixed premises in the UAE either owned or controlled;

• Deploying assets in the course of provision of services;

• Any business function undertaken in to the UAE e.g. finance, administration, marketing, sales and HR;

• Extent of any temporary presence in the UAE;

Mostly closely related?

• Do they contract;

• Are the services provided necessary for the supply;

• Where is payment received and collected;

• Which establishment is actually benefiting from the supply;

• Which establishment will raise the invoice;

• Which establishment instructs the supplier for purchases.

Is there a requirement to register and account for VAT?

• Does the FE exceed the VAT registration threshold.

Who should consider VAT fixed establishment risk?

Non-resident companies with any degree of UAE presence (e.g., representative offices or people carrying out activities in the UAE) with sectors including but not limited to:

• Pharmaceutical and healthcare;

• Civil engineering and infrastructure;

• Defense;

• Professional services and consultancy;

• Construction related;

• Technology and e-commerce;

• Energy including oil and gas.