Countries follow either source-based taxation or residence-based taxation. In source-based taxation, the incidence of tax arises with respect to the country where the income is generated, whereas in residence-based taxation, the incidence of tax arises irrespective of the country in which the income is generated if the residency requirements are satisfied.
Since countries are free to choose their desired system of taxation, issues of double taxation arise where individuals/companies end up paying tax for the same income in more than one jurisdiction. To obviate this problem, double taxation avoidance agreements (DTAA) are signed by countries.
The UAE’s Ministry of Finance is working on expanding its DTAAs and Bilateral Investments Treaties (BITs) network. It has so far concluded 193 DTAAs and BITs, for the purpose of exempting or reducing taxes on investment and profits from direct and indirect taxes.
It is to be noted that a DTAA is not a taxing statute, although it is an agreement on how taxes are to be imposed. Recently, Indonesia ratified a tax treaty - which was signed on July 24, 2019 - with the UAE. The treaty officially came into effect through the issuance of Presidential Regulation (Perpres) No.34/2021 on the agreement between Indonesia and the UAE on avoiding double taxation and preventing tax evasion.
Take over from 1995 treaty
The new treaty will replace the 1995 tax treaty between the two countries. Here, we would be analysing the interplay of the recently introduced corporate tax regime in UAE vis-à-vis the DTAA with Indonesia by focusing on business profits, associated enterprises and credit methodology.
Article 7 of the DTAA between UAE and Indonesia, which deals with business profits, has direct linkage with the corporate tax introduction. A plain reading of clause 1 of Article 7 clearly shows that if an enterprise has a presence only in UAE, then it shall be taxable only by the UAE.
On the contrary, if an enterprise has a presence in UAE and through a permanent establishment (which includes a branch office, factory or workshop as defined in Article 5 of the DTAA) and also has a presence in Indonesia, then the profits of the enterprise are taxed by both UAE and Indonesia on the basis of proportional apportionment of income.
Affixing 'associate enterprise' status
The second aspect of the DTAA of direct import to corporate tax is the concept of ‘Associated Enterprise’. In layman’s language, associated enterprises are generally used in the context of multinational conglomerates that have fused and inter-mixed ownership structures. The logical question which arises is how does one tax such corporate structures equitably.
Clause 2 of Article 9 incorporates the concept of ‘arms-length principle’ to ensure the taxation rights of both states are maintained equitably and does not lead to base erosion.
Finally, the third aspect which has implications for corporate tax is the credit methodology. Simply put, it refers to the aspect as to whether taxes paid in one jurisdiction can be set-off with respect to taxes due in the other jurisdiction, subject to fulfilment of certain conditions.
As per the DTAA between UAE and Indonesia, this credit methodology is laid down in Article 23. Supposing an entity based out of UAE derives income from Indonesia, then the amount of tax levied by Indonesian tax authorities can be credited against the tax imposed by UAE.
Therefore, the introduction of corporate tax in UAE will create new challenges with respect to the implementation of the UAE-Indonesia DTAA provisions. But the challenges are not insurmountable.
It would require entities based out of UAE to carefully account their business profits and take into account arms-length principles when dealing with associated enterprises and subsidiary companies.