Kuwait ratifies tax treaty with the UAE

Executive summary

On 13 July 2024, the Kuwait government ratified the tax treaty (Treaty) between Kuwait and the United Arab Emirates (UAE), according to press reports. The Treaty is aimed at avoiding double taxation on transactions and investments between both jurisdictions, as well as preventing tax evasion and avoidance. Both countries have completed their internal ratification processes as per their domestic law. Therefore, in accordance with Article 31 (Entry into Force), the Treaty would enter into force starting from 1 January of the year following the year of ratification (i.e., 2025).

The Treaty provisions are generally aligned with the standards of the United Nations (UN) and the Organisation for Economic Co-operation and Development (OECD), as well as the OECD's Base Erosion and Profit Shifting (BEPS) Action Plans.

The Treaty is a welcome addition to the tax treaty network of both the jurisdictions. It is the first tax treaty ratified between Kuwait and another Gulf Cooperation Council (GCC) Member State.

Detailed discussion
 

Taxes covered

Article 2 of the Treaty covers the following taxes of both jurisdictions:

• Kuwait's National Labor Support Tax (Law No. 19 of 2000), applicable to companies listed on the Kuwait Stock Exchange

• Kuwait's Income Tax Law concerning the Designated Region (Law No. 23 of 1961) and Income Tax Decree No. 3 of 1955 amended by Law No. 2 of 2008, concerning corporate bodies

• The UAE's income tax and corporate tax

Kuwait's Zakat Law No. 2 of 2008 and contribution to the Kuwait Foundation for the Advancement of Sciences are not mentioned as taxes covered under Article 2 of the Treaty.

Other identical or substantially similar taxes that are imposed after the signing of the Treaty would also qualify as "covered taxes" within the meaning of Article 2 of the Treaty. Therefore, the proposed business profit tax (BPT) Law in Kuwait would likely be covered under Article 2 of the Treaty.

Residence

Under Article 4 of the Treaty, from Kuwait's perspective, the term "resident" shall include individuals who are domiciled in Kuwait and are Kuwaiti nationals. The term also includes corporations incorporated in Kuwait.

From the UAE's perspective, the term "resident" shall include a corporation incorporated in the UAE, individuals who are UAE nationals or individuals who are considered to be resident as per UAE domestic law or those who have their habitual abode or vital interests in the UAE.

If an individual taxpayer has dual residence, taxation will be determined through a few factors, including permanent home, place of vital interests, habitual abode and nationality.

If a taxpayer other than an individual has dual residence, taxation will be determined based on the place of effective management.

Permanent establishment (PE) and business profits

Article 5 of the Treaty defines the concept of permanent establishment, the purpose of which is to determine the right of a Contracting State (source state) to tax the profits of an enterprise of the other Contracting State (residence state). Article 5 broadly follows the structure and content of the equivalent article in the UN Model Tax Convention.

Under Article 5(3) of the Treaty, a building site or a construction, assembly or installation project in the source state constitutes a PE if the projects/site or activities continue for more than six months.

The provision of services, including consultancy or administrative services, creates a PE in the source state if the services are rendered for more than three months within any 12-month period under Article 5(4) of the Treaty. Additionally, the Treaty provides in Article 5(5) that a PE will be established if substantial equipment is used or installed in the source state for a period exceeding three months within any 12-month period.

Only profits attributable to a PE situated in the source state would be subject to tax in the source state.

Taxation of passive income and fees for technical services

The Treaty includes reduced tax rates for certain items of income, as follows:

1. The definition of technical services under this Article includes payments for technical assistance, consulting and management services, but excludes payments made (1) to employees of the person making the payment, (2) for teaching in or by an educational institution or (3) by an individual for services of personal use.
2. The provisions of this Article shall not apply in the case of technical agreements concluded between the two contracting states or one of their relevant institutions.

Historically, tax treaties concluded by Kuwait did not specifically contain a separate article dealing with taxation of fees for technical services. In Kuwait, fees for technical services were treated as business profits and, therefore, governed by the provisions of Article 7. Article 12(a) of the Treaty is expected to provide more certainty on the taxation of fees for technical services in both jurisdictions.

Capital gains (sale of shares or participations)

Article 13 of the Treaty provides further guidance on the alienation of shares along with the general guidelines used in other treaties, wherein capital gains generated from the alienation of shares may be taxed exclusively in the residence state.

However, the alienation of shares of a land-rich company may be subject to tax in the source state, if at any time during the 365-day period preceding the transfer of ownership, the company acquired (directly or indirectly) more than 50% of its value from immovable property situated in the source state. This treatment does not apply to capital gains resulting from the transfer of ownership of shares of companies that are listed on a stock market recognized in either state.

Government investments

Under Article 21 of the Treaty, a more favorable tax treatment is applied to profits from government investments in which no source taxation would apply on dividends, interest, royalties, fees for technical services or capital gains, excluding income from immovable property.

Anti-abuse rules

The Preamble of the Treaty states that its purpose is to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax avoidance or evasion, including through treaty-shopping arrangements.

Article 29 (Entitlement to Benefits) of the Treaty provides that the benefits of the Treaty shall not be granted if obtaining such benefits is one of the principal purposes of the arrangement/transaction.

Implications

GCC Member States, including Kuwait and the UAE are signing tax treaties to further facilitate the mutual flow of trade and investments, and further strengthen the economic ties between them. Businesses should review their operating structures from a tax perspective, in light of the new tax treaty.