Avoid Permanent Establishment in EU

[European]

Hi all,
Consider the following setup.

FZC in UAE with two shareholders:
- 51% for SH1, who lives and is a legal tax resident in UAE
- 49% for SH2, tax resident in a EU country

SH1 is the appointed director and manages the company. He is the effective decision maker since he owns the majority. If necessary, he could receive a (small) salary from the company but best if this can be avoided. That is the only director appointment SH1 has (max perhaps another one).
Some shared/flexi office space could be set up for the company in UAE if necessary. Another option would be for SH1 to set up a space in his home as office.

Dividends would be paid out from the company to UAE and EU shareholders at the end of the year.

Would such a company be at risk of being considered a tax resident in the EU country?
Are UAE's ESR (Economic Substance Requirements applicable to the FZC?

Thanks

 

[Mike Forman]

Any income from UAE in EU will be reported by banks and probably also on your tax filing.

It seems your company has no substance, what is the company doing as business?

For sure you will have tax authorities asking question and the assumption will be tax evasion, it will be up to you to proof contrary. An empty shell office and a director paid a low salary won't do it, they aren't that foolish.

If you are not an EU resident there is no problem,otherwise better don't move anything from UAE to EU

 

[European]

What the banks do is not really relevant as SH2 in the EU will be reporting the dividends to the tax office and paying the tax due. No hiding.
The company would offer mostly consulting services in technology/software across the world.
SH1 would be doing most of the work. SH2 would help technically from time to time but mostly with contacts to get work.
Some temp contractors might be hired outside the UAE as needed, although not necessarily.
Does SH1 really have to have a salary? He is the majority shareholder and is working for his company, what is wrong with that? In fact the expected amount from his dividends will be higher than if he was employed as a director with no equity.

 

[Sols]

Would such a company be at risk of being considered a tax resident in the EU country?

Risk? Yes. How great of a risk depends on where SH2 is resident. Especially now that UAE is on both the FATF watch list and on the EU blacklist. Expect EU to be less forgiving and more aggressive when UAE is involved.

If SH2 is a bona fide passive shareholder, though, the structure may hold and no (partial) tax residence or PE being created in EU established.

Does SH1 really have to have a salary? He is the majority shareholder and is working for his company, what is wrong with that? In fact the expected amount from his dividends will be higher than if he was employed as a director with no equity.

SH1 is largely irrelevant here. What matters is SH2 and their role in the company.

 

[European]

Risk? Yes. How great of a risk depends on where SH2 is resident. Especially now that UAE is on both the FATF watch list and on the EU blacklist. Expect EU to be less forgiving and more aggressive when UAE is involved.

If SH2 is a bona fide passive shareholder, though, the structure may hold and no (partial) tax residence or PE being created in EU established.


SH1 is largely irrelevant here. What matters is SH2 and their role in the company.

Thanks
A. Regarding SH2 fiscal residency:
Option 1: Slovakia
Option 2: Greece

B. Can the company be considered a partial tax resident in the EU? How would that work?
Most tax treaties in the EU consider the place of effective management as the tie breaker.
You mention SH1 is largely irrelevant but if SH1 has has effective control of the company through his 51%, is that not enough to prove the place of effective management is in UAE? How could the opposite be true unless another person is officially appointed as director (which will not be the case)?

 

[Sols]

B. Can the company be considered a partial tax resident in the EU? How would that work?
Most tax treaties in the EU consider the place of effective management as the tie breaker.
You mention SH1 is largely irrelevant but if SH1 has has effective control of the company through his 51%, is that not enough to prove the place of effective management is in UAE? How could the opposite be true unless another person is officially appointed as director (which will not be the case)?

A company can have PE and/or tax residence in multiple jurisdictions simultaneously. Unlike natural persons which are bound by the laws of physics thanks to their corporeal nature, juridical persons such as companies have no such limitations and can be in multiple places at the same time.

Let's say the company makes a profit of one million EUR and SH2 gets a dividend of 490,000 EUR. This raises questions in the tax office and they start investigating. If the investigation finds that SH2 has been doing work for the company (i.e. not just being a bona fide passive shareholder), they can make a claim that 49% of the company's revenue took place on their territory and is taxable.

I'm not aware of Greece or Slovakia doing that, but I have seen others successfully make that claim.

 

[European]

How would the company or the tax office prove who did the work in any case? Would contracts with clients for instance have to specify that SH1 (or temp contractors) is doing the work? Contracts that I've had with clients on my past EU-based companies for instance do not typically go into that detail, they specify the deliverables but nor really who will do the work.

Out of curiosity what jurisdictions have you seen make that claim?

 

[bigdaddyleon]

How would the company or the tax office prove who did the work in any case?

most tax offices do not have to prove it, suspicion is enough.
Of course, you can try to convince the administrator out of court, but if they remain stubborn, you would have to file a lawsuit.

 

[Sols]

How would the company or the tax office prove who did the work in any case?

It's not a court of law. The tax authority doesn't to prove of anything other than strong, reasonable suspicion (sometimes not even that). Then they send you an invoice, which you can either pay or fight in court. That's when you have a chance to prove your innocence.

Would contracts with clients for instance have to specify that SH1 (or temp contractors) is doing the work? Contracts that I've had with clients on my past EU-based companies for instance do not typically go into that detail, they specify the deliverables but nor really who will do the work.

If SH2 was a bona fide passive shareholder, I don't think you would be bringing up SH1 so much. I take that to mean SH2 isn't a bona fide passive shareholder. As such, there is a non-negligible risk of partial tax residence, PE, or through some other method having income attributable to SH2's place of residence.

If — and I can't comment on how likely this is — Greek or Slovak tax authority comes after SH2, they aren't going to care one iota what SH1 does. However, what SH1 does may become important if the matter goes to court. Tax authorities lose court cases left and right. They are betting on winning enough cases and on enough people not fighting.

Out of curiosity what jurisdictions have you seen make that claim?

Of the top of my head, Finland, Spain, and Germany.

 

[European]

It's not a court of law. The tax authority doesn't to prove of anything other than strong, reasonable suspicion (sometimes not even that). Then they send you an invoice, which you can either pay or fight in court. That's when you have a chance to prove your innocence.


If SH2 was a bona fide passive shareholder, I don't think you would be bringing up SH1 so much. I take that to mean SH2 isn't a bona fide passive shareholder. As such, there is a non-negligible risk of partial tax residence, PE, or through some other method having income attributable to SH2's place of residence.

If — and I can't comment on how likely this is — Greek or Slovak tax authority comes after SH2, they aren't going to care one iota what SH1 does. However, what SH1 does may become important if the matter goes to court. Tax authorities lose court cases left and right. They are betting on winning enough cases and on enough people not fighting.


Of the top of my head, Finland, Spain, and Germany.

If there are only two shareholders and one is passive, the work has to be done by the other shareholder (or employees/contractors), so I am guessing you would have to prove that is the case. That is why I bring up SH1.
I am thinking of the possibility of truly having a bona fide passive SH2 but not being able to prove it. It is unclear to me, and worrying, how you would prove it in a completely legitimate scenario.
If for instance SH2 brings in the contacts and facilitates getting contracts that then are executed mostly by SH1, would SH2 be considered a passive shareholder or active? If the former, how would you go about proving that? Again, assuming for the sake of the discussion that this is true.

Something else. If the company had several employees in UAE and office space there, if SH2 is working actively for the company in the EU, could the company still be considered a partial resident in the EU?

 

[Sols]

I am thinking of the possibility of truly having a bona fide passive SH2 but not being able to prove it. It is unclear to me, and worrying, how you would prove it in a completely legitimate scenario.

If SH2 isn't doing any work for the company and instead is just a majority shareholder, there is generally nothing to worry about. Speak with a Greek or Slovak tax adviser for certainty and for specific aspects of the structure to consider.

If for instance SH2 brings in the contacts and facilitates getting contracts that then are executed mostly by SH1, would SH2 be considered a passive shareholder or active? If the former, how would you go about proving that? Again, assuming for the sake of the discussion that this is true.

This is very hard to answer. A shareholder occasionally making introductions to a business they are invested in is usually not a problem. There is leniency and understanding that shareholders may take certain actions at times to help their business, especially smaller or startup businesses. On the other hand, I am aware of cases where a shareholder has been too active in promoting the business, to the point where the promotion itself created a taxable nexus in the eyes of the tax authority.

But if you're saying SH2 also executes the contracts (meaning signing the agreements and/or doing the work), it'd be very hard to make a convincing case that SH2 is passive.

Something else. If the company had several employees in UAE and office space there, if SH2 is working actively for the company in the EU, could the company still be considered a partial resident in the EU?

The problem is if SH2 works for the company. Shareholders don't work for companies. At least in their capacity as shareholders. Shareholders invest in companies, usually in the hope that the shares will increase in value. You don't buy a couple of Apple shares on Tuesday afternoon and walk into the Cupertino office on Wednesday, asking for a key card and name badge.

 

[European]

Of the top of my head, Finland, Spain, and Germany.

How high was the company's (taxable) profit in those cases?

 

[Mike Forman]

The only way to be safe and sure is to either consult an international tax lawyer/consultant, don't live in the EU or don't receive any income on any local or account abroad with an EU residential address.

Any other path might work (for some time) or might not. Tax authorities are very aggressive once they smell something and as indicated by someone else, they don't need to proof anything, high will have to proof. You have to proof this is a company with substance (employees and office) and that you are 100pct passive shareholder.

This means no email communication done by you, no access to a foreign bank account, no confirmation of transactions, nothing. And you will have to proof that, not them. They can send you any tax bill on any suspicion and only a good tax lawyer and court will get you out of this (if you can proof all). From your communication you already indicate you are not passive, for tax authorities you are guilty until proven not guilty.

Save up your dividends and pay them out once you change your residence outside EU to an account outside EU. Receiving them regularly on an EU account might be considered as a taxable salary

 

[European]

Save up your dividends and pay them out once you change your residence outside EU to an account outside EU. Receiving them regularly on an EU account might be considered as a taxable salary

But that would not work either, would it? If the tax office considers the company is a local resident, it would tax that profit regardless of whether it stays in the company or it is disbursed. Am I wrong?

 

[walako]

Hi al!
If somebody can clarify this or tell whether it is possible to find on the internet. What are the other implications of the PE.

• The existence of a PE is not always a bad thing. For example, according to tax laws in some countries, the existence of a PE will eliminate the need to file taxes in the country of headquarters (‘residence country’). If the target country has a lower corporate tax rate, this could be to the enterprise’s advantage.

If the company, which was incorporated in the UK, then deemed to have a PE in the EU country, how the sale of shares should look like? I understand that the EU country will charge local corporate tax, although which tax would imply on dividend and capital gains?