Navigating UAE Regulatory and Tax Updates: Ensuring Compliance and Maximising Opportunities

Matthew: Hello, everyone. Welcome to our webinar today in navigating UAE regulatory and tax updates to ensure compliance and maximizing opportunities. We’ll try and keep today’s 35 minutes and cover some topical items. I could see that we’ve had a few questions submitted ahead of the webinar, and we’ll try and answer them if time permits. To introduce myself, my name’s Matthew Brown, and I’m part of the investor solutions team here in the Middle East for Waystone Compliance Solutions. I’m also joined by Nigel Pasea, Managing Director of Waystone Compliance Solutions Middle East, and Thomas Vanhee, Founding Partner at Aurifer. Thank you both for joining us today. Without further ado, let’s move into some questions. Nigel, maybe starting with yourself, what changes have been introduced onshore in relation to fund distribution?

Offshore fund distribution changes

Nigel: Thanks, Matthew. Yes, it’s very topical, because there have been a number of changes at a time when were seeing a great number of hedge funds and fund managers from around the world coming into the UAE. But, last year, January 2023, there were some changes onshore whereby the onshore regulator, SCA, or the Securities and Commodities Authority, removed the heather to exemption enabling foreign fund managers to promote their funds to institutional investors. After that date, basically those fund managers looking to access institutional investors were required to firstly register the funds with SCA, and then secondly, have it distributed through a local promoter.

The other change that came in last year was that it became impossible to promote foreign funds to retail investors. That was prohibited. And going forward, to promote retail funds to retail investors, that would need to be done by a domestic fund manager through a domestic fund structure. There are some exemptions to this requirement, but there’s only two. Basically, it is possible still to promote funds to government agencies and sovereign wealth funds, and it is possible to promote on a reverse solicitation basis but note that the regulators are very wary of this route being used as a device to circumvent the regulations.

Circumvention or non-compliance obviously exposes the firm to regulatory and reputation risk, but it’s probably equally, if not more important, to note that firms operating in the UAE without a license are exposed to significant commercial risk. In particular, operating on an unlicensed basis provides the opportunity to investors in your funds to argue that the contract is voidable at their instance, and in effect gives them a put option should the fund not be performing well. So, bear that in mind when deciding your regulatory risk appetite.

Accessing the onshore UAE local fund market

Matthew: Nigel, you covered onshore entities. What about the DFSA and FSRA firms in the financial free zones? How can they access the onshore UAE local fund market for retail?

Nigel: Good question. Yes, they can. They would need to set up a fund within those financial free zones of DIFC or ADGM. And having done so, you can then apply for passporting of that fund into the onshore market. Now, to set up a fund in the free zones, you either need to set up a fund manager, typically a Category 3C fund manager. That’s not cheap. That would require capital, probably more than $500,000, would require certain mandatory personnel such as a CEO, a compliance officer, a money laundering officer, and will have ongoing additional expenses in terms of real estate and utility costs.

So, as an alternative, there are within the DIFC and ADGM, certain what we call third-party management companies or fund platforms, which assume these infrastructure costs now, therefore, thereby obviating the need for the foreign fund manager to set them up themselves and provide access to that foreign fund manager who basically just then creates a sell, which they provide the portfolio selection over. A wider caution though, on using those free zone managed companies is that SCA’s recently declared that they have some concerns that, what they call letterbox companies, that are being created in the free zones with a sole intention to use the passport to access the retail market. And they have said they’re monitoring that situation. They may actually call into question whether the passport is available for that type of structure, so just be aware of that potential risk.

Prospects of GCC fund passport

Matthew: Finally, Nigel, there’s long been rumors that we will one day see a GCC fund passport enabling funds in one GCC country to market and be sold in other GCC countries. Is that day getting closer?

Nigel: I think it’s been getting closer, but it has been touted for a very long time. But it does really seem imminent now. Again, pronouncements out of the Securities and Commodities Authority in the UAE are such that we expect it to be released in mid to late 2024. Specific dates have not yet been released by the GCC Council of Ministers, but we understand that the text of the passporting arrangement has already been approved and now it’s just at the signing stage, which is expected to be at the next meeting of the GCC Council of Ministers. Once that comes into place, it does mean that a fund, which is domiciled in say, UAE, would be able to be marketed in, for example, the kingdom of Saudi Arabia or Kuwait, subject to compliance with whatever distribution requirements exist in those countries. Note though that if and when it comes in, it will be limited to onshore regulated funds, i.e. those regulated by SCA, and as per my current understanding, it won’t be available to funds which are domiciled in the financial free zones of DIFC and ADGM.

Considerations for corporate tax and regulatory variances between mainland and free zone

Matthew: Thank you, Nigel. Let’s see if it happens. Certainly a lot of buzz around the market for that. Thomas, moving to yourself, Nigel had touched on the access of free zone firms to onshore markets, but one of the most recent developments in tax has been the implementation of corporate tax in the UAE. What are the highlights for corporate tax that our attendees should be considering, and secondly, what are the important regulatory differences in mainland versus free zone relating to that corporate tax? And finally, how do those differences translate into the application of 0%?

Thomas: Thanks, Matt, for those questions, and thanks really for the earlier intro as well. And I picked up a thing or two from Nigel as well in terms of the regulatory framework, so it’s quite interesting to be able to tie those two aspects together. You were referring to a buzz before, I think at least in a tax world, the introduction of corporate income tax in the UAE has created a buzz. And that buzz started exactly on the 31st of January 2022, when the UAE Ministry of Finance announced the introduction of UAE corporate income tax. Probably good to know that the UAE is not doing this for revenue purposes. It is doing so to align its framework internationally, and that mainly means perhaps evolving a bit from the situation where no corporate income tax used to apply in the UAE and evolving more into a jurisdiction where it does apply and where there’s more regulation, which is really something that we’ve seen evolving in the last couple of years in the UAE.

Now, I’d highlight a couple of things that are important in terms of the application of corporate income tax. First off, it’s applicable, or it’s effective in terms of its liability since the 1st of June of 2023, but if you’re working on a calendar year, it’s as from the 1st of January 2024. We have a rate of 9%, which is really not that high, in combination with a nil bracket of 375,000 dirhams or $100,000, which means that the first $100,000 of profits are subject to a 0%. Tied to that as well, quite important, we were talking about the regulatory differences between mainland and free zone, and we’ll get back to that in a bit, is that under certain circumstances, free zone entities will be paying just 0% on their profits as well. But it comes with a lot of ifs and buts, and I’ll explain those momentarily.

I think another very important aspect of the UAE framework from a CIT point of view is that there’s a 0% withholding tax due, and that means, really that for any foreign investors investing into the UAE, whether it’s into a fund or private equity and whatnot, the distribution of those profits can happen at no withholding taxes. So, it makes it a very efficient regime, very attractive for foreign investors. We’ll talk in a bit probably also about how investment funds tie into that. But one more very important feature as well of the UAE tax framework is the participation exemption, which is going to exempt the receiving of dividends and capital gains in the hands of a UAE company, again, under certain circumstances and conditions, but the application is fairly wide, which again, makes it quite an attractive regime.

Now, you’re referring to, you know, mainland versus free zone, and from a financial point of view, obviously Nigel’s already referring to it before mainly looking at ADGM and DIFC really from a financial point of view. First off, it’s important that we don’t have an out-of-scope regime anymore, meaning that we do have free zone entities irrespective of whether they’re subject to 0% or 9%. They are subject to registration requirements and filing requirements more overall, so they need to have audited financial statements. So, you’re very much in scope, but subject to a different rate.

The main difference being between the two is mainland you’re subject to 9% corporate tax with that nil bracket up to 375,000 dirhams or $100,000, and in the free zone, we need to look at whether you can be considered as a qualifying free zone person. A qualifying free zone person is an entity that has substance in the free zone, derives a type of qualifying income and I’ll explain a couple of examples in a bit, which are relevant for the financial services sector. It would be an entity that has not opted into paying 9%, which it can. Meets the minimum requirements, has audited financial statements, and there could be future conditions imposed by the ministry as well. If you don’t meet those conditions, for example, you don’t have enough substance, then you’d be disqualified for a period of five tax periods of the benefit of the 0%.

And I think what is probably important to explain and the distinction is quite important, but complicated, when we look at the free zone person earning income, we need to identify where that income is coming from, whether from another free zone person or from a non-free zone person. The non-free zone person being mainland or third country. When it is from another free zone person, the income cannot be coming from an excluded activity. And two activities which are important from a financial point of view are banking and insurance. Those two types of activities are excluded, which means subject to 9%.

When it then comes to earning income from mainland or from third countries, the only situation in which I can claim 0% applicable is when they, those activities are on the list of qualifying activities. And a couple of relevant ones are the holding of shares, for example, is a qualifying activity, reinsurance services, whereas insurance services are excluded. Fund management services is quite important, and wealth and investment management services. So, it’s not a simple regime. There’s a lot of elements to it to take into account, really.

Tax implications for investment funds managed by fund & wealth managers

Matthew: That’s really helpful, Thomas. You mentioned fund management and wealth management activities there, and the application of the corporate tax regime. How does this tax framework apply to the investment funds being managed by fund managers and wealth managers?

Thomas: It’s a very good question, and obviously it’s a very important question given that there’s sizeable investment funds in the UAE. So, there are a number of possible qualifications for those investment funds, but I’ll take the two most straightforward ones. Number one is that an investment fund qualifies as a qualifying investment fund, which means that it doesn’t suffer any taxation at the level of the investment fund. So, for all, from a financial point of view, it is essentially transparent. Money goes in without being taxed additionally, which is really what you see in line with other regimes as well. The conditions associated with that, for example, is that the units in the fund are tradable, that the fund is regulated as well, that the fund is not private, that it’s sufficiently marketed and floated. I think those are a couple of the important ones. Perhaps good to know as well is that real estate investment trusts also can claim the capacity of a qualifying investment fund.

Now, what I’ve just explained applies to a limited company, but obviously there’s also structures sometimes referred to as GPLP structures. And for those GPLP structures, we need to look at the legal status of the limited partnership. If that limited partnership has legal personality, then the only option there is to be a qualifying investment fund. Or if non-qualifying, qualifying free zone person. But if it does not have legal personality, like for example, in ADGM where this is a possibility, then it will be considered as tax transparent, which also means no taxation at the level of the limited partnership, but at least from an international tax point of view that’s a very different qualification, and also from the reporting point of view it is as well.

Regulatory focus areas in 2024

Matthew: That’s really helpful for a lot of our colleagues, I think. Thank you, Thomas. Nigel, moving back to yourself, you touched on the distribution of funds, but what are some of the other key areas that the regulators are focusing on in 2024?

Nigel: I see that as a combination of traditional topics and newer ones. In terms of traditional topics which are on the business plan of the regulators for 2024, we obviously continue to see AML and financial crime as being a prime focus. Also, client onboarding, sanction screening as a result, client classification, which is a concept within the free zones, but to distinguish between retail and professional investors, because the regulatory requirements for dealing with each of those are very different. Protection of client money, client assets, is always going to be a feature for a regulator. And not forgetting things such as making sure that the employees and staff of the regulated firm are appropriately trained and educated as to the regulatory responsibilities, and indeed, and so the ability to advise and manage on behalf of clients.

And in terms of some of the newer ones we see becoming much more prominent in ’23 and ’24, environmental social governance, ESG, has become a topic of greater interest, particularly with UAE hosting COP 28 back end of last year. Cyber resilience, cyber risk, definitely becomes a prime focus with more that we go online in terms of delivering client services and managing our businesses. And the last one I’d mention would be market abuse. We’re definitely seeing regulators looking at firms expecting them to have in place much more robust systems to prevent and detect market abuse.

Integrating wealth and fund management exemptions with economic substance

Matthew: Thank you, Nigel, and we’ll pick up on a couple of these topics later on, I think. Thomas, we spoke about wealth management and fund management exemption from corporate income tax, but how does that tie in with economic substance and other requirements?

Thomas: Yeah. So, the economic substance requirements predates the UAE’s introduction of corporate income tax, because they date back to 2019, and they’re sometimes a bit overlooked these requirements, right? They apply to nine types of relevant activities, of which there’s a number which are relevant for the financial services sector, for example, lease finance, but equally so they apply to investment funds as well. Those requirements also entail that the entity needs to meet a certain substance threshold, which is commensurate to the activity that it is developing.

What is probably interesting in terms of the economic substance regulations regime is that given that it predates the introduction of UAE corporate income tax, it may potentially be destined to disappear. The reason why we had it had a tax origin, and the origin for that is that the UAE was considered a no or only nominal tax jurisdiction, and we’ve moved away in part from this. One other requirement to move away from this is a transparency requirement as well, but which the UAE is meeting more and more. So, this might be destined to no longer be there, and I think a lot of people will be quite happy about that. This being said, free zone entities, I’ll remind you that want to be considered as a qualifying free zone person also need to meet substance requirements. So, we’re essentially shifting the separate ESR reporting into the corporate income tax reporting.

We were referring to investment managers as well before, and probably good to know as well that the UAE has aligned its regime with other international financial centers, where you’ll often find a so-called investment manager exemption. Now, the term might be a bit misleading, because it doesn’t mean that the investment manager doesn’t pay any taxes, but it’s an exemption from the investment manager constituting a permanent establishment on behalf of the non-resident for whom they are executing transactions. So, it’s a very different thing than simply a tax exemption.

Now, perhaps to close off that bracket on miscellaneous topics, let’s say, we have also had to discuss quite a bit with clients in recent times the place of effective management criteria. Under the UAE corporate income tax legislation, an entity which is incorporated outside of the UAE, but which is effectively managed from the UAE, where these strategic and managerial decisions are taken in the UAE is considered a UAE tax residence. And I think it’s a very important point there, because it’s a governance point really around some of those structures which require additional attention. Back to you, Matt.

Cybersecurity expectations and priorities

Matthew: Thanks, Thomas. I think I’ve got my head around that, but I might come back to with a couple of questions. Nigel, you mentioned one of the key areas that the regulator’s focused on is cybersecurity, and a priority this year. What are the regulators expecting in that regard?

Nigel: Thanks, Matt. Yes. This is not new. Apologies if I made it sound like a new thing for the regulators. It’s just increasing in terms of depth of scrutiny and vigilance. This year, if you look at the DFSA first, they’ve announced that they’re going to do an updated thematic review into firms’ compliance with the new cyber risk management rules, which came into force on the 1st of January 2024. And that thematic review will aim to assess the maturity of the cyber risk management frameworks in not just the regulated firms, but also authorized market institutions and registered auditors. And firms will be evaluated based on their developments since the last thematic review DFSA conducted in this area in 2022, so a two-year timescale. And I think, you know, DFSA’s expectations is that in those two years, there would and should have been a tremendous investment into improvement and robustness of cyber risk management systems.

Similarly, in ADGM, the FSRA is to issue risk management guidance covering four main areas concerning IT risk, and the overall governance controls for IT risk is firstly number one. Second, managing an IT environment infrastructure, systems lifecycle, and resilience. Thirdly, the way in which firms manage access to their key systems. And fourthly, how authorized firms that use specific technologies consider and address the IT risks associated with those technologies. So, cyber risk is definitely going to be something that you’ll see more and more of from the regulators, particularly when they come and do their inspection visits, so you may need to have on hand your IT cyber risk experts, which may be based in other locations, but on hand to explain how your firm’s systems are protected from attack. Back to you, Matt.

Tax integration within ESG framework

Matthew: That makes sense. Certainly, a topical issue, and good to understand the developments in the UAE. Thomas, Nigel had mentioned ESG as one of the areas of a focus for the regulators. How does tax fit into the ESG now that the UAE has become a normal tax jurisdiction?

Thomas: Oh, yeah. Obviously, the T is not in the acronym of ESG, but somewhere implicitly included in it. I think when we talk about ESG, there’s a number of elements which come into play from a tax point of view. One is transparency, which is something that the OECD and the European Union have been working on quite a bit for quite some time now. What that translates into from a UAE point of view, for example, is that if an entity negotiates a tax ruling abroad, and that tax ruling has ramifications in the UAE, then that tax ruling is going to be exchanged with the UAE. People tend to forget that sometimes you negotiate a ruling with the tax authority in Switzerland, for example, and if it has an impact on the UAE, then the UAE will get a copy of that ruling.

So, you have the government-driven mandatory disclosures of which we know FATCA and CRS is also one. But ESG tries to suggest also to businesses to spontaneously disclose their information. And when you translate that into the tax environment, it could be, for example, to state how much your effective tax rate is per country. Is that, you know, 5%, is it 25%? Especially since the 2008/2009 financial crisis, then the COVID epidemic which followed it, there’s a lot more focus on, you know, pay your taxes where they are due, and pay your fair share. So, I think that those are a couple of bits on the ESG side.

I think when stating, you know, the UAE has evolved into a normal tax jurisdiction, I think it’s probably good to know that 9% corporate income tax is still very low. It’s still a very attractive regime. It still preserves a lot of the advantages that the UAE has as a regional headquarters jurisdiction as a platform to the rest of the region, as a more and more sophisticated jurisdiction, really. I think the things of it that we need to see now that we’ll have to follow is the development of expertise at the level of the federal tax authority as well, to have due audits, to have a good ruling practice, good transfer pricing audits and whatnot. So, I think we’re very much in a situation where things are moving almost on a daily basis with additional guidance issued. So, I think it’s a good thing for the UAE to move away from these types of blacklists or grey lists that other countries might put the UAE on, and so additional legislation, at least from a tax point of view is good for that purpose.

Benefits of corporate tax income in the UAE

Matthew: Yeah, it was going to be a question of mine, Thomas, generally higher, you know, implementing taxes or raising taxes is generally not seen as a positive for a country, but do you think the implementation of corporate income tax in the UAE will be a net benefit?

Thomas: It’s one of those things where I think you’ll see the economic issue of the country evolve, right? If you have 0% or no corporate income tax, then there’s a number of situations that can arise, which perhaps as a country you don’t necessarily want, which don’t necessarily produce a lot of value for your country. It’s good to have a bit of a, “cleaned up,” to have a normal functioning economy. Also don’t underestimate the amount of data information that the federal tax authority is going to be collecting with this, which it can crosscheck, which helps also towards broader planning for the country. I probably need to stress again that the corporate income tax, the introduction of it is not an exercise to get more revenue. That there’s no need at a federal level to get more revenue. The books are very much balanced if not in a surplus. But I do think in the same way as perhaps in the regulatory space where you’ve seen, you know, more attention towards regulatory compliance, and anti-money laundering and whatnot, but this will also have a positive effect, really.

Factors contributing to the UAE’s removal from the FATF grey list

Matthew: Thanks, Thomas. I think we’ve got time for one more question. Nigel, back in February the UAE was removed from the FATF grey list. What were the factors that contributed towards that significant event, and do you think they’ll… What do you think the impact will be on growth as a result of that event?

Nigel: Yes, indeed. The announcement back in February was very well received. It was a source of some embarrassment to be on the grey list in the first place, but I think the authorities here embraced the observations from FATF for enhancements in the robustness of the underlying procedures. And the regulators certainly did do a lot of work, onshore free zone regulators all. We certainly, you know, as a consultant to many regulated firms, we certainly saw greater scrutiny and diligence exercised by the regulators in setting what their expectations were in terms of the systems and procedures that firms should operate. We obviously only see a small sample of those growing across the whole industry. So, but I imagine that was replicated on a very broad basis leading to a much more robust set of AML procedures operating at firms and operating across the country.

We certainly, from our side, saw the DFSA and the FSRA focus very much on the business AML risk assessment, and demanding of firms to consider things like targeted financial sanctions, proliferation financing, and also to link the findings in the firm’s business risk assessment to the findings of the national risk assessment, which is being conducted by the authorities, and to bring into their assessment relevant factors that have been observed more broadly. And certainly, we’ve seen much more in the way of follow up visits, regulatory visits, thematic reviews, all of which I think contributed to FATF’s reassessment of the UAE, and its ultimate removal in February from the grey list. And in terms of the impact on the UAE, well, I can only see it being positive. I think in this sort of 18-month period that they were on the grey list, I think there were some concerns expressed by international firms about whether, you know, it was right to establish in a country which was on the grey list, and so that particular consideration has been removed. And in terms of firms coming to the UAE, there’s definitely been an uptake since the February announcement.

Concluding remarks

Matthew: So, I think we can take away two key takeaways here of a net positive for the country in the removal from the FATF grey list and the implementation of corporate income tax, I think that’s fair to say. We’re quickly coming to the end of our allotted time. I think we’ve covered a lot of ground in both regulatory developments and the introduction of corporate income tax for the region. I want to thank you all for your time and hope that the attendees have found this useful. We very much appreciate you taking the time out of your day to join us. I think I can say from all of us that if you had any questions on the topics covered today, then please don’t hesitate to get in touch with Thomas, Nigel or I for more information, and we’d look forward to arranging another informative session in the not too distant future. So, Nigel, Thomas, thank you very much, and look forward to seeing you again soon.

Nigel: Thank you.

Thomas: Thank you.