Article:
ISSUE No. 11 July - August 2008

Guide to Tax Laws
Elimination of the Double Taxation Agreement (DBA) between Germany and the UAE by the End of 2008

By Dominik F. Weiss, Attorney and Legal Consultant, Dubai

The United Arab Emirates has become an interesting sales and production location for thousands of foreign investors. Among these are many German companies. Until now the double taxation agreement has been an added investment-incentive which offered a multitude of tax breaks to German firms. Since the year 2006, when the German financial authorities suddenly announced that the agreement will only be extended through August of 2008, all entities affected by this change have been eagerly awaiting new developments.

Actual Situation

The Double Taxation Agreement between Germany and the UAE, enacted in 1996, expires officially on August 10th 2008. Financial authorities from Germany and the Emirates have been striving for almost two years to find new agreeable solutions – no headway is being made according to the ministries involved. This leaves investors and business owners, who are already economically established in the region, to focus on the question of how the legal treaty situation will develop in the coming years.

There are two possible scenarios:

1st Alternative: Discontinuation of the Double Taxation Agreement – No New Agreement

A concrete timeframe for finalizing a new agreement is not yet foreseeable. A complete failure of negotiations is possible. To be noted here is the fact that the UAE Ministery of Finance is in active and frequent negotiations with foreign representatives about the enactment of a Free Trade and Double Taxation Agreement (i.e. with the US and Australia). A quick conclusion to negotiations for a new Double Taxation Agreement with Germany is not imminent.

Due to the virtual freedom from taxation in the UAE, German negotiators will lobby for diverse changes to the current agreement, especially in view of the proposed capping or abolishment of many current tax advantages.

Although the current regulations expire in August of 2008, the DBA regulations are effective for all of 2008 (until December 31st). After that deadline – unless a quick and amicable arrangement is reached soon – even the bilateral relations of the two countries will not be able to avoid double taxation of income and assets. All income earned in the UAE will then only be taxed according to the national German tax laws.

The following describes several considerable consequences. We want to point out that a concrete fiscal assessment can only be done on an individual basis.

Income from renting or leasing properties in the Emirates will be totally taxable for the owner/landlord in Germany after the abolition of the DBA. Until now, only the country of domicile (here the UAE) had a right of taxation (Article 6 DBA-UAE). The country of residence of the property owner (here Germany) considered the income only for exemption with progression purposes. The situation is similar to the property funds in Germany which increase the taxpayer’s liability because they are deemed commercial income. The loss of the DBA will lead to tax liabilities in Germany, equal to the profit from the property funds, as long as the property owner has a legal residence in Germany.

Employees who maintain a residence in Germany, but temporarily work in the Emirates (double-residency) were able to profit from the regulations of Article 15 DBA-UAE (the so-called 183-day rule). With the loss of the DBA, salaries are completely taxable in Germany (World Income Principle).

There are hardly any changes for businesses that have a subsidiary in the Emirates, maybe in the form of a Limited Liability Company (LLC), equal to a German GMBH. The LLC would remain on the same level as an Emirati corporation (taxable branch) with basic tax exemption. The German treasury only has a claim to money earned by a corporation when dividends are being disbursed to private persons in Germany (half dividend system). When money is disbursed to domestic corporations, five percent of the dividends continue to be considered as non-taxable business expenses.

Without the DBA additional tax burdens will occur for German firms that have branches in the UAE. The income of said branch will, after the discontinuation of Article 7 DBA-UAE, be completely taxable through the German corporation. The possibility of tax credits per Article 34 EStG is nil in the UAE – with the exception of companies who work in the areas of extraction and processing of oil, gas and petrochemical products, as well as banks – since the UAE does not tax income or corporate enterprises.

2nd  Alternative: a new agreement is signed in 2009 (or later) –  retroactive to January 1st 2009

Agreement to a compromise is more likely than the complete dismissal of the DBA, although concrete contents of a future agreement are not foreseeable at this time. Most probably there will be deductions for many revenues, now tax free, from renting or leasing real estate that is located in the Emirates, as well as for other commercial income that is also tax free now (i.e. real estate investment funds).

Since the DBA is a two-party agreement, it remains to be seen how the Emirates’ side will react to the correction requests of the German finance administration. It is possible that in 2009 or 2010 the two negotiating parties will implement an agreement and make it retro-active to January 1st 2009. This would follow common practice. This would assure that for any given time period, there is a legally binding rule to avoid double taxation.

Conclusion

According to information from the German Federal Ministry of Finance, all 143 double-taxation agreements which Germany has with other countries regarding income-tax, corporate tax and inheritance tax, are being scrutinized with the plan to re-negotiate all that is not beneficial to the German treasury. The DBA with the United Arab Emirates will basically set an example for all future bilateral agreements.

Businesses and private persons, who are working in the Emirates or plan to do so in the near future, should check the legal situation as of January 1st 2009 and watch for further developments in the signing of a new agreement.

Independent from the Germany – UAE agreement status, there are possibilities for alternative arrangements, in isolated cases, through inclusion of the DBA which was negotiated in recent years with the neighboring countries of Austria and Luxembourg.