Agreement between Cyprus and the UAE on the avoidance of double taxation became legally effective on the 1st of January 2012. For the most part, the agreement corresponds to the model convention of the Organization for Economic Cooperation and Development (OECD) on the matter of tax treaties. The double taxation agreement can only be applied to the residents of the two countries. The document was adopted in order to avoid double taxation and to make international tax planning more predictable.
UAE agreements often define the notion of a resident in a slightly different way than it is usually described in details in the OECD model convention or regulatory documents of other jurisdictions. This happens mainly due to the fact that countries that conclude treaties with the UAE do not want to grant too many rights with respect to taxation since income in the UAE itself is not taxed.
Therefore, some agreements limit the benefits and facilities, making them available only to citizens of the UAE or government institutions. Determining which individual or legal entity is a resident of a particular country is very important, as it allows determining who can benefit from the double tax treaty.
In the agreement between Cyprus and the United Arab Emirates, an individual is considered to be a resident of the United Arab Emirates if a person is a resident in accordance with the law of the United Arab Emirates. In Cyprus, however, an individual is considered as a resident if a person is obliged to pay taxes due to residence in the country’s territory. As you see, while Cyprus criteria correspond to the OECD model, the UAE criteria don’t correspond to it. And this is very convenient, since under this contract an expatriate in the UAE with a resident visa can be considered being a resident for the purposes of the contract. The same question is often unclear and lacks clarity in agreements with the UAE because if they include a tax payment requirement, the question arises whether there can be an obligation for someone to pay tax in the UAE if there are no taxes in the country. If on the basis of these criteria an individual is considered to be a resident of both states, then the contract determines that the person is considered to be a resident of the country where he has got a permanent place of the residence.
The verification of residency for companies for the purposes under this agreement is as follows: The UAE considers a legal entity as a resident if it is formed in accordance with the legislation of the UAE. Cyprus considers a company as a resident if its actual management is located in Cyprus. If the company is considered to be a resident of both countries, then the actual location of the management will be the decisive factor. Therefore, if the UAE tax residency is important for a company and there may be questions about whether the company’s actual management is in Cyprus or not, then it is better to use a company located in the UAE than, for example, in the British Virgin Islands, because only the listed options are subject to the protection agreement
This might become a problem when, for example, a company owned by a resident of Cyprus owns real estate in the UAE. In accordance with the Cyprus legislation, if the actual management of the company is in Cyprus, then the income from the property will be subject to 10% income tax in Cyprus. However, if an UAE company is used to own the property, then it is not only subject to the domestic law of Cyprus, but the company's residence must be determined in accordance with the agreement. Consequently, it will be more difficult to assert that the company is a resident of Cyprus and a 10% tax applies to it.
In the absence of the agreement, Cyprus charges a 10% tax, also known as the “special defense contribution,” on royalties paid to non-residents if the incomes are derived from the intellectual property rights which are used in Cyprus. For instance, a lumpsum payment paid by the franchise company in Cyprus will involve a 10% defense fee if the lumpsum payment which is paid for benefit of an offshore company in the British Virgin Islands. But if it is paid to a company in the UAE which is a resident of the UAE it will not be taxed. The new agreement prevents Cyprus from collecting this tax when it comes to paying a resident of the UAE. Cyprus does not charge tax and dividends on individuals or non-resident companies. If payments are made to people who are residents of Cyprus, then a special contribution to the defense is around 15% and 17% accordingly.
But what happens when payments are made for the benefit of the offshore company, which, in turn, belongs to a Cyprus resident? Currently, while dealing with cases like this, there is a practice not to charge taxes as well, but from the point of view of the law, the question is not clarified, as it is unclear, which leaves room for the bringing in taxes in the future. This perspective is quite real, taking into account the budgetary problems and issues that Cyprus had been experiencing. What this may have to do with tax planning for a Cyprus resident is perhaps best illustrated with the following. For instance, a Cypriot company owner can hire himself in his own company, set himself a low salary, and pay the balance in the form of dividends, from which he pays a 17% tax.
Instead, he could hold shares in the offshore company and pay zero percent on dividends paid to the offshore company. Currently, this scheme works, yet there are doubts whether it will remain acceptable in the future. However, now there is a simple solution of how to prevent this ambiguity. The way out of it is to hold shares in a company registered in one of the free economic zones of the UAE. As in the case of royalties, the agreement provides that Cyprus is not entitled to charge taxes on dividends and incomes paid to a company that, in accordance with the terms of the agreement, is considered as a resident of the UAE. As a rule, tax agreements also include a note that the recipient company must also be a “beneficiary” of dividends (income / royalties), but there are situations when the company itself is not considered as the actual beneficiary.
For example, in the case when the company has no legal right to manage the funds and is obliged to transfer them further to the beneficiary.
However, this critical condition, meaning the need to be a beneficiary, is not very sustainable. In some countries there is a very broad definition of who is considered as the beneficiary. The agreement between the UAE and Cyprus does not have a beneficiary requirement for dividend payments, incomes and royalties. Therefore, if the law is applicable, it is only necessary to confirm that the company is a tax resident in the UAE. This can be easily achieved by registering a company in a free economic zone, appointing a resident as the director of the company. Obviously, this will convince the international tax planning authorities more than planning without this agreement or with another agreement that does not include beneficiary requirements.
