Companies established in the United Arab Emirates (UAE) are highly attractive due to the favorable tax framework there. The UAE imposes no income or trade tax and a low corporate tax rate of 9%. This makes it an attractive location for international business and investments. For companies that are subject to unlimited tax liability in Germany and have relationships with companies in the UAE, the tax shielding effect is a significant aspect that requires special attention.
So, what is the tax shielding effect exactly? The tax shielding effect refers to the ability of a foreign company to retain its profits in a low-tax country without these profits being taxed in the home base of the parent company. This is particularly relevant when German companies maintain subsidiaries or branches in the UAE. The profits earned by UAE companies are subject to only a 9% tax rate in the UAE, and in some cases, only 0%. As a result, the profits could be transferred to Germany almost tax-free.
However, Germany has taken measures to combat the use of low-tax jurisdictions for tax avoidance purposes. The German Controlled Foreign Corporation (CFC) rules under §§ 7-14 of the Foreign Tax Act (AStG) are an instrument that can counteract the tax shielding effect. These rules aim to subject passive income of low-taxed foreign subsidiaries to German taxation, even if these profits are not distributed to the German parent company.
The CFC rules apply when certain conditions are met:
The foreign company is more than 50% owned by German taxpayers.
The foreign company predominantly earns passive income such as interest, royalties, or rental income.
The effective tax burden of the foreign company is below 25%.
However, there are ways to avoid or minimize CFC taxation. Active business operations of the UAE company that go beyond mere capital investment or asset management can result in the income being classified as active and thus not subject to CFC taxation.
For German companies that have business relationships or subsidiaries in the UAE, it is crucial to thoroughly understand and strategically plan for the tax implications. We are happy to assist you in minimizing your tax risks and maximizing tax efficiency.
