Case Study: Tax treaty application in Middle East

Tax treaty application in the Middle East is a high-stakes exercise for any international business operating through UAE or regional structures. The UAE has concluded over 140 double taxation agreements (DTAs), yet claiming treaty benefits remains procedurally demanding and legally complex. Misapplication of a DTA can expose a company to withholding tax, penalties, and reputational damage with counterpart tax authorities. This article walks through practical case scenarios, explains the legal framework, identifies the most common errors made by foreign investors, and outlines the procedural steps required to secure and defend treaty positions in the Middle East.

A double taxation agreement (DTA) is a bilateral treaty that allocates taxing rights between two states, typically following the OECD Model Tax Convention or the UN Model Convention. In the UAE, DTAs are incorporated into domestic law by federal decree and take precedence over conflicting domestic provisions under the general principle of lex specialis.

The UAE';s Federal Tax Authority (FTA) administers corporate tax under Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (the Corporate Tax Law). Article 3 of the Corporate Tax Law establishes the standard corporate tax rate, while Article 21 addresses the treatment of foreign-sourced income and the mechanism for granting foreign tax credits. Where a DTA applies, its provisions govern the allocation of taxing rights, and the FTA is bound to apply the treaty terms.

The UAE also operates within the Gulf Cooperation Council (GCC) framework, though the GCC does not yet have a unified multilateral DTA. Each GCC member state - Saudi Arabia, the UAE, Kuwait, Bahrain, Qatar, and Oman - maintains its own treaty network. Saudi Arabia, for example, applies the OECD Model Convention in most of its treaties, with modifications reflecting the Kingdom';s zakat-based fiscal system under the Income Tax Law (Royal Decree No. M/1 of 1950, as amended). Bahrain, which levies no corporate income tax on most activities, has a narrower treaty network but has concluded agreements with key trading partners.

The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI) is a critical overlay. The UAE signed the MLI and has applied it to a significant portion of its treaty network. Under the MLI, the principal purpose test (PPT) - a general anti-avoidance rule - has been inserted into covered treaties. This means that a treaty benefit may be denied if one of the principal purposes of an arrangement was to obtain that benefit, even if the arrangement is technically compliant with the treaty';s literal terms.

For businesses operating through the UAE, the practical consequence is that treaty access is no longer automatic. A company must demonstrate genuine economic substance, beneficial ownership of income, and a non-tax-driven rationale for its structure.

The starting point for any treaty claim is establishing tax residence. In the UAE, a Tax Residency Certificate (TRC) is issued by the FTA under Cabinet Decision No. 85 of 2022 on the Determination of Tax Residency. A UAE-incorporated entity qualifies for a TRC if it is registered in the UAE and has sufficient nexus to the UAE - including a registered office, management and control exercised from the UAE, and, following the Corporate Tax Law, a taxable presence.

A common mistake made by international clients is treating the TRC as a self-sufficient instrument that automatically unlocks treaty benefits in the counterpart state. In practice, the foreign tax authority - whether in India, Germany, France, or another treaty partner - will conduct its own analysis of whether the UAE entity is the beneficial owner of the income and whether the structure has economic substance. The TRC establishes UAE residence; it does not resolve the beneficial ownership question.

Beneficial ownership is a concept developed through OECD Commentary and incorporated into most modern DTAs. It requires that the recipient of income have the right to use and enjoy the income, unconstrained by a contractual or legal obligation to pass it on to another person. A UAE holding company that receives dividends from a foreign subsidiary but is contractually obliged to distribute them upward to an ultimate parent in a high-tax jurisdiction may be denied beneficial owner status by the foreign authority.

The UAE';s Economic Substance Regulations (ESR), introduced by Cabinet Resolution No. 57 of 2020 and subsequently amended, require entities in certain sectors - including holding businesses, finance and leasing, and intellectual property - to demonstrate adequate substance in the UAE. Failure to satisfy ESR requirements does not automatically invalidate a treaty claim, but it provides strong evidence that the UAE entity lacks genuine economic presence, which a foreign authority will use to challenge the treaty position.

In practice, it is important to consider that the FTA and foreign tax authorities increasingly exchange information under the Common Reporting Standard (CRS) and bilateral Tax Information Exchange Agreements (TIEAs). A UAE entity that appears on paper to be resident but has no employees, no decision-making activity, and no physical presence will be visible to foreign authorities through automatic information exchange.

To receive a checklist on establishing a defensible UAE tax residency position for treaty purposes, send a request to info@vlolawfirm.com.

Consider a structure where a UAE holding company owns 100% of an Indian operating subsidiary. The Indian subsidiary declares a dividend. Under India';s domestic law, dividends paid to a non-resident are subject to withholding tax. The India-UAE DTA, signed in 1993 and modified by the MLI, provides for a reduced withholding rate on dividends where the UAE recipient holds a specified percentage of the Indian company';s capital.

The Indian subsidiary';s finance team applies the reduced treaty rate and remits the net dividend. The Indian tax authority subsequently opens an inquiry. It requests documentation to verify that the UAE holding company is the beneficial owner of the dividend and that the structure was not established primarily to access the reduced treaty rate.

The UAE holding company must produce:

• The TRC issued by the FTA for the relevant financial year
• Board resolutions demonstrating that investment decisions are made in the UAE
• Evidence of UAE-based directors with relevant expertise
• Financial statements showing that the dividend income is retained or reinvested from the UAE, not automatically passed upstream
• ESR compliance notifications confirming that holding business substance requirements are met

If the UAE entity cannot produce this documentation, the Indian authority may apply the PPT under the MLI and deny the treaty benefit, assessing withholding tax at the domestic rate plus interest and penalties. The cost of this failure - measured in additional tax, professional fees for dispute resolution, and management time - can easily exceed the tax saving that the structure was designed to achieve.

A non-obvious risk is that even if the initial treaty claim succeeds, the Indian authority may revisit the position in subsequent years if the substance profile of the UAE entity deteriorates - for example, if a key director relocates or if the entity';s activity becomes purely passive.

A Saudi-based manufacturing company establishes a UAE free zone entity to manage its regional sales and distribution. The UAE entity employs a sales director who negotiates and concludes contracts on behalf of the Saudi parent. The UAE entity has its own trade licence and bank account, but the contracts are formally signed by the Saudi parent.

Under the Saudi-UAE DTA (if applicable) and the OECD Model Convention, a permanent establishment (PE) is created when an agent habitually exercises authority to conclude contracts in the name of the enterprise. Article 5 of the OECD Model Convention defines the PE threshold. The BEPS Action 7 modifications, incorporated into many post-2017 treaties and the MLI, expanded the PE definition to capture commissionnaire arrangements and similar structures where the agent plays the principal role in concluding contracts, even if formal signature authority is retained by the foreign entity.

If the UAE sales director';s activities create a PE of the Saudi parent in the UAE, the UAE has the right to tax the profits attributable to that PE under the Corporate Tax Law. The Saudi parent would then need to claim a foreign tax credit in Saudi Arabia for UAE corporate tax paid, subject to the terms of the applicable DTA.

The practical risk here is double taxation rather than treaty abuse. The Saudi parent may have structured the arrangement to avoid UAE corporate tax, not anticipating that the UAE';s adoption of the Corporate Tax Law in 2023 would change the analysis. Many businesses operating in the UAE free zones before 2023 did not consider PE exposure because the UAE had no corporate income tax. That assumption is no longer valid.

A common mistake is failing to review existing structures after the Corporate Tax Law came into force. Businesses that established UAE entities before 2023 under a pre-tax framework need to reassess whether their operational arrangements now create PE exposure, treaty conflicts, or double taxation risks.

A European technology company licenses its intellectual property to a UAE operating subsidiary. The UAE subsidiary pays royalties to the European parent. Under the UAE-EU member state DTA (for example, the UAE-Netherlands DTA or the UAE-France DTA), royalty payments may be subject to withholding tax in the UAE at a reduced treaty rate, or may be exempt depending on the specific treaty.

Under the Corporate Tax Law, Article 49 provides for withholding tax on certain payments made to non-residents, including royalties. The rate and applicability depend on the specific DTA in force. The UAE-Netherlands DTA, for example, provides for a zero or reduced withholding rate on royalties, subject to beneficial ownership conditions.

The European IP holding company must demonstrate that it is the beneficial owner of the royalties and that the IP holding structure has genuine substance in the Netherlands or France. Following the EU Anti-Tax Avoidance Directives (ATAD I and ATAD II) and the OECD';s BEPS framework, European tax authorities have become aggressive in challenging IP holding structures that lack substance.

A non-obvious risk in this scenario is the interaction between the UAE';s transfer pricing rules and the royalty rate. The Corporate Tax Law and the accompanying Ministerial Decision No. 97 of 2023 on Transfer Pricing require that transactions between related parties be conducted at arm';s length. If the royalty rate paid by the UAE subsidiary to the European parent is above market, the FTA may adjust the deductible royalty expense, increasing the UAE subsidiary';s taxable income. Simultaneously, the European authority may challenge the royalty income as excessive or as evidence of treaty shopping.

The business economics of this scenario are significant. A royalty rate dispute involving a mid-sized technology business can put millions of dollars of deductions at risk. Professional fees for transfer pricing documentation, treaty analysis, and dispute resolution typically start from the low tens of thousands of USD and can escalate substantially if litigation or arbitration is required.

To receive a checklist on defending royalty payment structures under UAE DTAs, send a request to info@vlolawfirm.com.

Claiming treaty benefits in the UAE follows a defined procedural path. The FTA administers corporate tax filings, and treaty claims are made within the annual corporate tax return. Where withholding tax is at issue - either on payments made by UAE entities to non-residents, or on payments received by UAE entities from abroad - the treaty claim must be supported by contemporaneous documentation.

For outbound payments (UAE entity paying a non-resident), the UAE payer must obtain a certificate of residence from the non-resident';s home jurisdiction, verify beneficial ownership, and apply the correct treaty rate. The FTA may request supporting documentation during an audit. Audit cycles under the Corporate Tax Law are not yet fully established, but the FTA has broad powers under Federal Decree-Law No. 28 of 2022 on Tax Procedures to request information, conduct inspections, and issue assessments within a five-year limitation period.

For inbound payments (UAE entity receiving income from abroad), the UAE entity must present its TRC to the foreign payer and, if challenged, engage with the foreign tax authority through the mutual agreement procedure (MAP). The MAP is a treaty-based mechanism under Article 25 of the OECD Model Convention that allows competent authorities of the two contracting states to resolve disputes about treaty interpretation or application. The UAE';s competent authority for MAP purposes is the Ministry of Finance.

MAP proceedings are slow - resolution typically takes 18 to 36 months - and are not always available for all types of disputes. Some UAE DTAs include arbitration clauses that allow unresolved MAP cases to proceed to binding arbitration, but this mechanism is not universally available and requires both states to have activated the relevant MLI provisions.

Where a UAE entity disagrees with an FTA assessment, it may file an objection with the FTA within 40 business days of receiving the assessment, under Article 27 of the Tax Procedures Law. If the objection is rejected, the entity may appeal to the Tax Disputes Resolution Committee (TDRC) and, subsequently, to the competent court. The TDRC process typically takes 40 to 60 business days for a decision. Court proceedings can extend the timeline by one to three years depending on complexity.

Loss caused by an incorrect treaty strategy can be substantial. A business that fails to claim treaty benefits in the first year of operations, or that claims them incorrectly and faces reassessment, may face a cumulative tax exposure covering multiple years, compounded by interest at rates specified under the Tax Procedures Law.

Not every cross-border structure benefits from treaty access. In some cases, the cost of establishing and maintaining sufficient substance to support a treaty claim exceeds the tax saving. In others, the treaty network of a particular jurisdiction offers no material advantage over the domestic withholding tax rate.

The decision to rely on a DTA versus restructuring the holding or financing arrangement requires a clear-eyed assessment of:

• The quantum of income flows subject to withholding tax
• The differential between the treaty rate and the domestic rate
• The cost of substance - directors, office, staff, compliance
• The risk profile of the structure under the PPT and beneficial ownership tests
• The treaty partner';s enforcement posture and information exchange capabilities

A UAE free zone entity, for example, may qualify for a 0% corporate tax rate under the Corporate Tax Law if it meets the conditions for a Qualifying Free Zone Person under Article 18. However, the interaction between free zone status and treaty access is not fully settled. A free zone entity that pays no UAE corporate tax may find that the treaty partner denies treaty benefits on the grounds that the entity is not subject to tax in the UAE - a condition that some DTAs require for treaty access (the so-called "subject to tax" clause).

Many underappreciate the importance of reviewing the specific DTA text rather than relying on general OECD principles. UAE DTAs vary significantly in their terms. Some follow the OECD Model closely; others, particularly older treaties concluded before 2000, contain provisions that differ materially from current OECD standards. The UAE-India DTA, for example, has been the subject of significant litigation and administrative guidance in India, and its terms differ in important respects from the OECD Model.

An alternative to treaty reliance is the use of UAE domestic exemptions. The Corporate Tax Law provides participation exemptions for dividends and capital gains received by UAE entities from qualifying shareholdings, subject to conditions in Article 23. Where the participation exemption applies, the UAE entity is not taxed on the income regardless of the treaty position, removing the need to engage with the treaty mechanism at all. However, the participation exemption does not address withholding tax levied by the source state - that remains a treaty issue.

We can help build a strategy for structuring cross-border income flows through the UAE in a manner that is defensible under both UAE law and the applicable DTA. Contact info@vlolawfirm.com to discuss your specific situation.

What is the most significant practical risk when claiming DTA benefits through a UAE entity?

The most significant risk is the beneficial ownership challenge. A UAE entity that receives income but lacks genuine decision-making authority, economic substance, and the practical ability to use and enjoy the income will be vulnerable to denial of treaty benefits by the foreign tax authority. This risk is heightened where the UAE entity is part of a multi-tier structure and where the MLI';s principal purpose test applies to the relevant treaty. Businesses should conduct a substance audit before making treaty claims and document the UAE entity';s decision-making processes contemporaneously.

How long does it take to resolve a treaty dispute through the mutual agreement procedure, and what does it cost?

MAP proceedings between the UAE Ministry of Finance and a foreign competent authority typically take between 18 and 36 months to reach a resolution, and some cases take longer. The process involves submission of a MAP request, exchange of positions between competent authorities, and negotiation. Professional fees for preparing and managing a MAP case typically start from the low tens of thousands of USD and increase with complexity. There is no guarantee of a favourable outcome, and MAP does not suspend the obligation to pay assessed tax in most jurisdictions, meaning the business may need to fund the disputed tax while the procedure runs.

When should a business consider restructuring rather than relying on an existing DTA?

Restructuring becomes preferable when the cost of maintaining treaty-compliant substance exceeds the tax benefit, when the structure faces a high risk of PPT challenge, or when the treaty partner has a history of aggressive treaty denial in similar cases. It is also worth considering restructuring when the underlying DTA is old and contains terms that are less favourable than current OECD standards, or when a newer treaty partner jurisdiction offers equivalent or better treaty terms with lower substance requirements. The decision should be based on a quantitative comparison of the tax saving against the compliance cost, substance investment, and litigation risk.

Tax treaty application in the Middle East demands more than a certificate of residence and a knowledge of withholding rates. It requires a documented, substance-backed position that can withstand scrutiny from both the UAE';s FTA and the counterpart foreign authority. The three scenarios examined - dividend flows from India, PE exposure in Saudi Arabia, and royalty structures involving European IP companies - illustrate that the risks are real, the costs of error are significant, and the procedural remedies available are time-consuming. Businesses that invest in proper treaty planning from the outset, and that review their structures as the legal landscape evolves, are best placed to protect their positions.

To receive a checklist on treaty compliance and dispute prevention for UAE-based structures, send a request to info@vlolawfirm.com.

Our law firm VLO Law Firms has experience supporting clients in the UAE on tax treaty application, corporate tax compliance, and cross-border dispute matters. We can assist with treaty position analysis, substance assessments, FTA objection filings, and MAP representation. To receive a consultation, contact: info@vlolawfirm.com.