Since UAE’s introduction of corporate tax, the concept of a ‘family foundation’ is frequently discussed, especially among business families. What it means is setting up a foundation or trust aimed to protect as well as manage the wealth of an individual or family engaged in running successful businesses.
It is often viewed as an alternative to wills when it comes for succession planning.
It is believed – and widely promoted - that family foundations could be used to save on corporate tax. The reason is apparent - a family foundation could apply to the Federal Tax Authority to be treated as a ‘pass-through’, i.e., an unincorporated partnership.
As ‘natural persons’ are generally not subject to corporate tax on their incomes unless conducting business, an impression is created that income of family foundation could be protected from corporate tax.
The tax laws make it abundantly clear family foundations are not a tax planning tool. FTA’s approval to a family foundation is conditional upon demonstrating that the principal purpose of such a foundation is not the avoidance of corporate tax.
Purpose of family foundation
A family foundation can be established for the benefit of identified or identifiable natural persons, or for the benefit of the public, or for both. The principal activity should be to receive, hold, invest, disburse, or otherwise manage assets or funds associated with savings or investment.
These are generally restricted to holding, investing and/or managing assets and funds. Such activities would not have constituted a business even if undertaken directly by natural persons.
Prohibition from conducting business
To seek the status of a ‘pass through’ for tax purposes, a family foundation should not conduct any activity that would have constituted a business if undertaken - or its assets held - directly by natural persons (i.e. the founder, settlor or any beneficiary). With that be the primary condition, any plan to explore family foundation as a tax saving tool should be revisited by business owners.
The subtle difference is critical to understand the tax implications. A family foundation could own the shares of a manufacturing company. But could a family foundation conduct manufacturing operations by owning individual manufacturing assets and be treated as a pass through? Could a family foundation conduct vacation rental business – otherwise taxable in the hands of individuals - without being subject to tax?
Reference in corporate tax laws
Family foundations (including certain trusts) are independent juridical persons with a separate legal personality. Any activity undertaken by a juridical person is automatically considered as a business/business activity for corporate tax purposes.
Similarly, any assets held by a juridical person is also deemed to be a business asset. The family foundations would therefore be subject to corporate tax in their own right.
To prevent unintended and adverse tax implications, family foundations have been allowed to seek FTA’s approval to be treated as ‘unincorporated partnerships’. This would result in the founder, settlor and/or beneficiaries to be considered as the respective owners of the assets and funds held by the foundation.
The Ministry of Finance has stated in its FAQs that other types of trusts (for example, trusts established in DIFC or ADGM) are a contractual relationship between two or more persons and do not have separate legal personality, and will by default be treated as transparent vehicles for corporate tax.
Implications on individual beneficiaries
They could be individually subject to corporate tax if they are conducting a business or business activity. Such individuals would be required to register for corporate tax, wherever applicable. If the beneficiaries of a family foundation are non-resident persons, the tax implications thereon needs analysis as per the nature of income and the tax code.
Stating the provisions of the tax code should not be mistakenly accepted as an explanation of the tax code. The family foundation planning needs a precise analysis to drive tax benefits.
