Understanding Permanent Establishment Status in the UAE and the Small Business Relief Mechanism

Entities with permanent establishment (PE) status of foreign companies in the UAE are ineligible for Small Business Relief (SBR) benefits as they are not considered resident persons under UAE Corporate Tax Law. Thus, foreign branches and representative offices in the UAE must fully comply with corporate tax regulations without claiming SBR relief.

By Melissa Cyrill and Jacob T. Thomas

As the United Arab Emirates (UAE) continues to attract foreign businesses and investors, it has also aligned its corporate tax framework with global standards. One of the key components of this framework is the concept of Permanent Establishment (PE), which plays a crucial role in determining the tax obligations of foreign enterprises operating in the country. Additionally, the UAE has introduced a Small Business Relief (SBR) mechanism to support small and medium-sized enterprises (SMEs), easing the compliance burden on qualifying entities. This article explores the intricacies of PE status, its implications under UAE corporate tax law, and how the SBR mechanism interacts with PE considerations.

What is permanent establishment?

A permanent establishment (PE) generally refers to a fixed place of business through which the activities of an enterprise are partly or wholly conducted. The UAE Corporate Tax Law’s definition of a PE aligns closely with international guidelines, particularly those set by the Organisation for Economic Co-operation and Development (OECD). The existence of a PE is pivotal because it triggers tax liabilities for foreign entities, requiring them to pay taxes on income generated within the UAE.

Types of permanent establishments in the UAE

There are three primary types of PEs recognized under the UAE Corporate Tax Law:

1. Fixed place PE: A fixed place PE exists when a foreign business operates through a physical location in the UAE. Common examples of fixed places of business include:
   • Offices
   • Branches
   • Factories
   • Workshops
   • Construction sites that operate for more than six months

For a fixed place of business to be classified as a PE, it must be used consistently for business activities rather than for auxiliary or preparatory functions.

1. Agency PE: An Agency PE is formed when a person or entity in the UAE acts on behalf of a foreign enterprise, and this agent has the authority to conclude contracts on behalf of the foreign company. This situation typically arises when the agent regularly exercises this authority, effectively binding the foreign enterprise to commercial transactions in the UAE.
2. Service PE: A Service PE is created when employees or personnel of a foreign enterprise provide services in the UAE for an extended duration, typically exceeding 183 days within a 12-month period. This form of PE is particularly relevant for industries where service delivery is a core function, such as consultancy, IT services, or professional advisory firms.

Key factors for determining PE status in the UAE

Several factors influence whether a foreign enterprise is considered to have a PE in the UAE:

1. Place of business: For PE status to be triggered, the entity must have a fixed, physical location in the UAE where its business activities are conducted. A mere temporary presence or a location used only for auxiliary functions does not generally qualify as a PE. Examples of auxiliary activities include activities such as data collection or market research that are not directly linked to the core revenue-generating functions of the enterprise.
2. Management: The concept of management plays a critical role in determining PE status. If senior management or key decision-makers of a foreign enterprise reside in the UAE and make important commercial decisions there, this can trigger PE status. Even if the enterprise does not have a formal office in the UAE, the presence of top management personnel making significant decisions locally may suffice to classify the entity as having a PE in the UAE.
3. Duration of activities: The time span over which activities are carried out is another crucial factor. Continuous or substantial activity in the UAE increases the likelihood of a PE classification. Generally, activities extending over six months are considered sustained. However, short-term, preparatory, or auxiliary activities usually do not result in a PE.
4. Authority to conclude contracts: If employees, agents, or representatives of a foreign enterprise in the UAE have the authority to negotiate and conclude contracts, this can result in the creation of an Agency PE. The regular exercise of this authority on behalf of the foreign entity is sufficient to trigger tax obligations in the UAE.

Implications of having a PE in the UAE

When a foreign enterprise is classified as having a PE in the UAE, it faces several important tax and compliance obligations.

1. Taxation: The income attributable to the PE is subject to UAE corporate tax. As of now, the corporate tax rate is set at 9 percent on profits exceeding AED 375,000. Below this threshold, the income is taxed at 0 percent. This is a significant development, as the UAE previously did not have a federal corporate tax regime. The introduction of corporate tax now aligns the country with international practices, ensuring that foreign enterprises with PEs contribute their fair share to the economy.
2. Compliance requirements: Entities with a PE in the UAE must register for corporate tax, file tax returns, and maintain proper documentation related to their business activities. Compliance extends to adhering to transfer pricing regulations, which govern transactions between different parts of the same enterprise (such as between the PE and its headquarters). Transfer pricing rules ensure that intra-company transactions are conducted at arm’s length, preventing tax avoidance through mispriced transactions.
3. Transfer pricing rules: The UAE has introduced transfer pricing regulations that require businesses to document transactions between the PE and other parts of the same entity. This ensures that prices for goods, services, or financial transactions reflect market conditions, preventing profit shifting or tax evasion.

Small Business Relief mechanism in the UAE

To support the growth and sustainability of small and medium-sized enterprises (SMEs), the UAE introduced the Small Business Relief (SBR) mechanism under the corporate tax framework. The SBR aims to reduce the tax burden and compliance requirements for qualifying SMEs, which form the backbone of the UAE economy.

Key features of small business relief

1. Eligibility criteria:
   • Revenue threshold: Businesses are eligible for SBR if their revenue does not exceed AED 3 million during the relevant tax period and all prior tax periods ending before or on December 31, 2026. Once the revenue exceeds this threshold, the business becomes ineligible for SBR, even if revenue falls below the limit in later periods.
   • Resident status: Only businesses considered tax residents in the UAE can claim SBR. This includes both natural persons conducting taxable activities and juridical persons incorporated in the UAE. However, branches of foreign companies, which are classified as PEs, are not eligible for SBR, as they do not qualify as resident persons under the UAE Corporate Tax Law.
2. Benefits of SBR:
   • Tax exemption: Eligible businesses can elect to be treated as having no taxable income, effectively eliminating their corporate tax liabilities for the relevant period.
   • Reduced compliance requirements: SMEs benefiting from SBR are not required to calculate taxable income or adhere to the full transfer pricing documentation requirements, resulting in reduced administrative burdens.
3. Duration and applicability:
   • The SBR applies to tax periods commencing on or after June 1, 2023, and ending on or before December 31, 2026. During this period, eligible businesses can benefit from the relief, provided they meet the revenue and resident status criteria.

Interaction between permanent establishment and Small Business Relief

The interaction between PE status and SBR is straightforward but significant. PEs of foreign companies, including branches and representative offices, are not eligible for SBR. This exclusion arises because PEs are not considered resident persons under the UAE Corporate Tax Law. Therefore, foreign companies with a PE in the UAE must comply fully with corporate tax obligations, without the tax relief benefits provided to qualifying SMEs under the SBR mechanism.

Tax obligations for permanent establishments in the UAE

PEs are subject to UAE corporate tax at the same rates as other taxable entities: 0 percent on income up to AED 375,000 and 9 percent on income exceeding this amount.

Despite their ineligibility for SBR, PEs must adhere to all local tax regulations, including registering for corporate tax, filing tax returns, maintaining accurate financial records, and complying with transfer pricing rules.

Conclusion

Understanding the classification of a Permanent Establishment and its tax implications under the UAE’s Corporate Tax Law is essential for foreign businesses operating in the country. While the UAE offers Small Business Relief to ease the burden on resident SMEs, PEs of foreign companies are excluded from this mechanism. Foreign enterprises must carefully assess their presence and activities in the UAE to determine their PE status and ensure compliance with corporate tax regulations. By doing so, they can manage their tax obligations effectively while contributing to the UAE’s dynamic business environment.

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