Permanent Establishment (PE) is an important concept in tax rules, which is based on the OECD Model Tax Convention for a common standard for tax treaties between the UAE and other countries. A Qualifying Free Zone Person (QFZP) may have a domestic or foreign Permanent Establishment (PE) if it does business outside the free zone area, either within the UAE or in another country, through a fixed place or a dependent agent. It is important for the business to understand the difference between domestic and foreign permanent establishment in the UAE. This guide discusses the fundamentals of permanent establishments and their taxation under the UAE corporate tax system.
What is a Permanent Establishment?
Permanent establishment whether domestic or foreign means a fixed place of business or a tenancy which is situated outside the Free Zone. This can include:
- Having a permanent business address is one of the essential requirements in running a business.
- Carrying out business through a dependent agent
The income of a Qualifying Free Zone Person (QFZP) derived from a permanent establishment is subject to 9% corporate tax if the income is not otherwise exempted. Importantly, the revenue that produces this income is not taken into consideration when calculating the de minimis threshold to qualify as a Qualifying Free Zone Person (QFZP).
Domestic vs. Foreign Permanent Establishments
- Domestic Permanent Establishment: -It is a qualifying Free Zone Person (QFZP) with a fixed business place or other business activities in the UAE but not in the Free Zone. The income generated from such an establishment is taxed at 9% corporate tax rate if not exempted and is not covered under de minimis. A Qualifying Free Zone Person (QFZP) may have its head office in a Free Zone while its branch could be in another part of UAE, which can be regarded as a domestic PE. Likewise, a Qualifying Free Zone Person (QFZP) with its head office located in a country but having a branch in the Free Zone may have the head office treated as a permanent establishment in the country.
- Foreign Permanent Establishment: Foreign permanent establishment is a dependent agent or a fixed place of business in a country which is different from the UAE and is owned by a UAE tax resident as per Article 14 of the Corporate Tax Law. A resident person, including a Free Zone person, may elect to deduct from its taxable income any income and expenses relating to any permanent establishment which is situated in a foreign country subject to the following conditions. In the case of this election, all the qualifying foreign permanent establishments of the free zone person shall be entitled to be exempt from the corporate tax on income.
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The Exemption of Taxes for Permanent Establishments
Free Zone companies cannot be considered as branches of certain companies or their establishments in the Free Zone. The income or profits to be attributed to the Free Zone parent and its permanent establishment should also be in line with the arm’s length principle which requires that the profits of the Free Zone parent and the profits of its permanent establishment be based on the functions they perform, the assets they use and the risks they undertake. This means that the Free Zone parent company ensures that the appropriate levels of operating profits or losses are reported in accordance with the recognized profit splitting methods like the separate entity approach. If the goods belonging to Free Zone parent companies are utilized in the operation of the business of the permanent establishment, then the parent is deemed to have derived income from a non-Free Zone person. Under the beneficial owner principle, a permanent establishment is not considered to be a Free Zone entity.
Fixed or Permanent Place: - A QFZP is considered to have a permanent establishment in UAE if it has a fixed or permanent place of business outside the Free Zone. The premises must be accessible for a cumulative duration of no less than six months over any twelve months. Some examples of areas that may be exposed to high levels of noise include office spaces, factories, workshops, or construction sites. The following are some of the circumstances that may lead to the violation of the rule of a fixed or permanent place:
- Using real property for investment purposes for the sole purpose of being a landlord
- Doing ancillary activities
- Taking Auxiliary and Preparatory Activities
- Storing, displaying, or delivering goods
- Transferring goods through another person
Engaging in preliminary activities
These activities must be solely preliminary or ancillary to prevent the creation of a permanent establishment in the domestic country.
Activities Carried out outside the Free Zone
A Qualifying Free Zone Person may have a local permanent establishment in case a person generally exercises commercial activities outside a Free Zone with the same permanent establishment name.
Exception for Independent Agents: - In the normal course of its business, an independent agent does not constitute a permanent establishment in the domestic country since the income generated by the agent is not considered as part of the operations of the QFZP.
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FAQs
How are the Domestic and Foreign Permanent Establishments taxed in the UAE?
Domestic permanent establishments are subject to a 9% corporate tax rate unless otherwise excluded. Foreign permanent establishments may be exempt from corporate tax UAE if certain conditions are met and the resident person elects to exclude his income and expenses from the taxable income.
What Papers Are Needed in the Case of Permanent Establishments?
Documents such as legal documents, shareholders agreements, company articles and regulations, special agreements, and side letters are used to provide evidence of ownership and control in an effort to form a permanent establishment.
Is It Possible for a Business Entity to Have Domestic Permanent Establishment and a Foreign Permanent Establishment?
Yes, it is possible for a business to have both domestic and foreign permanent establishments if it meets the requirements of both kinds of establishments, such as ownership and control tests, and the nature of the business activities carried out.
Mostafa is a seasoned Tax Consultant with over 5 years years of experience gained in diverse taxations matters. He has vast expertise in settling tax disputes with the Federal Tax Authority and handling of tax procedures in compliance with tax laws. He is adept in investigating underlying tax intricacies and offering expert tax advisory. He is also well-versed in conducting tax analysis’s and negotiations with the Tax Regulators, upon tax preparation and filing. Mostafa specializes in the areas of Tax law, Auditing, Accounting and Banking law.
