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June 14, 2021
2021-1170

Israel and United Arab Emirates sign tax treaty

Executive summary

Israel and the United Arab Emirates (the UAE) signed the first tax treaty between the two countries on 31 May 2021. If ratified during 2021, the tax treaty will be in force as of 1 January 2022.

Generally, the UAE does not impose taxes on companies (except on activities in the financial sectors and on activities related to oil and gas), and generally does not impose withholding tax. Therefore, the beneficiaries of the tax treaty are mainly residents of the UAE (and mainly governmental companies) who have investments or activities in Israel.

This Alert summarizes the main treaty benefits that apply to income in Israel (subject to the Limitation on Benefits (LOB) as detailed below).

Detailed discussion

Dividends

The tax treaty provides for the following withholding tax rates on dividends:

  • 0% withholding tax on dividends distributed by an Israeli company to the UAE Government, a qualified government entity or a pension plan, if the shareholding is less than 5%.
  • 5% withholding tax on dividends distributed by an Israeli company to the UAE Government, a qualified government entity or a pension plan, if the shareholding is 5% or more.
  • The withholding tax rate which is applicable to other UAE residents that hold at least 10% of the capital of the Israeli resident company is 5%; if the shareholding is less than 10%, the withholding tax rate is 15%.

Interest

  • 0% withholding tax on the payment of interest by an Israeli company to the UAE Government, a qualified government entity or a pension plan, if the shareholding in the capital of such company is less than 50%.
  • 5% withholding tax on the payment of interest by an Israeli company to the UAE Government, a qualified government entity or a pension plan, if the shareholding in the capital of such company is 50% or more.
  • In any other case, the withholding tax rate on interest payments is 10%.

Royalties

The withholding tax rate which is applicable to royalties shall not exceed 12%.

Permanent establishment

The treaty expands the definition of "dependent agent" to cases where a person plays the principal role leading to the conclusion of contracts that are routinely concluded without a material modification by the enterprise.

Capital gains

The treaty includes alternatives for the taxation of foreign residents on capital gains, even though the domestic laws in the UAE and in Israel provide capital gains tax exemptions with respect to the sale of shares by foreign residents.

It is noted that beyond the standard limitations on treaty shopping and abuse (the Principle Purpose Test), the treaty includes an LOB article (Article 28) which includes unique restrictions for the use of its main benefits:

  • Business profits (Article 7), international shipping and air transport (Article 8), dividends (Article 10), interest (Article 11), royalties (Article 12), capital gains (Article 13) and branch tax (Article 14) apply only to the Government of the UAE and/or qualified government entities of the UAE (closed list), on companies owned by the government (75%) while the remaining is held by UAE residents (the UAE Government and Qualified Government Entities), and pension plans.
  • UAE resident individuals and UAE resident corporations that are wholly owned by UAE residents or by the UAE Government and Qualified Government Entities, are also entitled to benefit from the international shipping and air transport Article (Article 8), dividends (Article 10) and capital gains (Article 13).
  • As a result, a UAE resident company, that does not meet the abovementioned conditions, that has activity in Israel will be subject to tax in Israel, even in the absence of a permanent establishment.

As the treaty is unique and complex, taxpayers should consider the application of the treaty articles, with careful attention to the parties to the transaction, whether they are Government or related entities, UAE residents or foreign residents, in order to determine whether treaty benefits can be granted.

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For additional information with respect to this Alert, please contact the following:

EY Israel, Tel Aviv

Ernst & Young LLP (United States), Israel Tax Desk, New York

 

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