Interplay of a well-structured estate & succession plan with UAE Corporate Tax

Today, the UAE maintains its status as one of the most competitive and highly advanced economies in the world, leveraging on innovative strategies to boost economic growth and diversification. It sits at the heart of a strategic, geographic crossroads where trade, commerce and diverse cultures have co-existed and flourished over the years. Whilst the global economy is witnessing a radical volatility, UAE remains the preferred destination in the region for global business and investment, especially with a very robust thriving start-up ecosystem.

Wealth is a function of growth in business and investment and therefore we are witnessing a significant growth in the number of Ultra-High-Net-Worth Individuals and Families (Ultra-HNIs) in the UAE. However, the augmented wealth also necessitates a plan for succession of the accumulated wealth, especially when the geopolitical scenario is not very encouraging. This is especially on account of the fact that each individual has a different perspective on wealth which is shaped by their values, experience as well as what they want to pass on to the next generation to build on the same.

Succession planning is the means to enable the above in an organised manner. A conscious succession plan can aid seamless and amicable transfer of wealth and help protecting assets and mitigating financial losses, in case of unforeseen circumstances and absence of one can trigger internal disputes, expose assets to unwarranted risks and taxes, etc.

One of the simplest and conventional ways of succession planning is by way of a will, wherein family business and assets are passed on to the family members / successors on demise of the individual, as per the wishes of the individual. However, succession through Will is suitable in situations where the asset and the family structure are straightforward. Also, one key aspect to factor is that the executor of the will, would typically be required obtain a Probate order from the Court to validate the Will and execute the same as per the manner prescribed therein.

In case of Ultra-HNIs and Families where the asset portfolio is diverse and significant, intertwined with a large family where the possibility of disputes is higher, execution of a Will more likely than not does not suffice. To effectively develop a succession plan in such situations, two primary structures are commonly used i.e. trusts or family foundations. These structures, though frequently misunderstood or used interchangeably, are fundamentally different in both their purpose and operation. It is crucial to understand these distinctions, as they form the backbone of effective succession planning.

A Trust is a legal arrangement in which one party (the Settlor), transfers assets to another party (the Trustee), to be managed for the benefit of one or more third parties (the Beneficiaries). A trust deed needs to be executed for creation of a trust, which would lay down the modus operandi of the trust and trust’s assets, the management and distribution of trust’s assets to the beneficiaries, etc. In the UAE, a trust can either be established under Federal Decree Law No. 19 of 2020 i.e. Trust Law (on-shore trusts) or under separate laws of Financial Free Zones like DIFC / ADGM - both provide a separate framework for governance of trusts.

On-shore trusts have a separate legal identity and the assets are held under the name of trust, whereas trusts established under DIFC / ADGM do not have a separate legal identity and the trust’s assets have to be held in the name of the trustee, for the benefit of the beneficiaries. However, the regime for on-shore trusts is still evolving and therefore DIFC / ADGM trusts are typically preferred by settlors. Given the distinct legal status, the corporate tax implications for both these categories also differ, which have been discussed towards the latter end of the article.

A foundation is constituted by virtue of its charter and bye-laws which govern its modus operandi as well the distribution of assets. The Foundation has separate and distinct legal personality from that of its Founder and is considered a juridical person. Given its separate legal identity, it can hold assets in its own name, which are ring fenced from the Founder. Also, a Founder can be sole beneficiary or one of the beneficiaries of the Foundation.

Foundations can be established only under the regulations stipulated by DIFC, ADGM and RAK ICC. Based on our practical experience, DIFC / ADGM Foundations are preferred jurisdictions vis-à-vis on-shore Trusts. The regulations of all the three Financial Free Zones are unique and the decision of the jurisdiction would more often than not be governed by the objectives of the Foundation.

A key element in a succession plan is taxes. Especially, with Corporate Tax applicable to juridical persons incorporated in UAE for financial years starting on or after 1 June 2023, the impact of the same on the assets held by Trusts / Foundation has to be factored in while devising a succession plan. Trusts established under DIFC / ADGM laws are treated as transparent vehicles from the perspective of UAE CT Law. Foundations, being juridical persons, may be exposed to UAE Corporate Tax, unless a specific approval is obtained from the Federal Tax Authority – the approval is subject to certain conditions. Where the approval is obtained, the foundation can be treated as fiscally transparent. Once the Trust / Foundation becomes transparent, the taxability flows to the beneficiaries.

To quote the words of Benjamin Franklin - “If you fail to plan, you are planning to fail!”. The same holds good especially, when a succession plan is in mind but not on paper i.e. not formally executed as we often tend to procrastinate the same. There are plethora of case studies where family’s wealth has been eroded on account of absence of a succession plan or due to lack of a sound one, leading to internal family disputes, ambiguity, etc. Given the same, it is pivotal that due attention is paid to devising a well-structured succession plan, having regard to the aspirations of the Testator, Settlor or the Founder.