This article began a new series in Offshore Investment and was published in the February 2006 issue
Don’t most OECD countries avoid signing treaties with OFCs or tax havens?
Generally yes, but there are some interesting exceptions, including a recent tax treaty between Austria and the United Arab Emirates (UAE) that took effect in 2005. Under it, all dividends, interest and other passive income paid from Austria to an individual or company resident in the UAE are exempt from tax in both countries.
What is the significance of an Austrian treaty with an OFC?
An individual or company resident outside the EU but having investments in the EU wants to receive investment income at the lowest possible overall tax cost. EU directives make it relatively easy to transfer the ownership of investments from one EU country to another. It is harder to reduce withholding taxes when the investment income leaves the EU. Using an Austrian company (owned by an OFC resident company or individual) that pays treaty-reduced withholding taxes and little or no tax where it is based may help to achieve the desired result.
But, doesn’t the treaty with the UAE deny benefits to those who don’t pay taxes?
It does for Austrian persons but not for UAE individuals or companies. An Austrian individual or company is resident for treaty purposes based on domicile, residence or place of management, unless he is liable to tax only on Austrian-source income. In the UAE, however, a resident means any individual who is considered a UAE resident under UAE laws by reason of his domicile, residence or any other similar criterion. There is no mention of tax and no exclusion for nontaxpayers. A company or other entity incorporated or created in the UAE is similarly resident for treaty purposes based on its residence, domicile, place of management or any other similar criteria. Once again, there is no mention of tax and no exclusion.
Does Austrian law restrict treaty shopping?
There are apparently no statutory restrictions but Austrian courts have denied treaty benefits in abusive cases. One case involved the payment of dividends to a Swiss holding company that was beneficially owned by residents of Monaco. Another case involved an Austrian corporation that tried to avoid tax on interest income it derived from an Austrian bank by interposing Irish subsidiaries and using an Irish bank as an intermediary. The Austrian authorities are less likely to attack more normal planning involving an entity that is clearly resident under the treaty and the other country’s law.
How does Austria tax passive income paid by Austrians to the UAE?
Under the treaty, all dividends paid by an Austrian company to a UAE resident are taxable only in the UAE. Interest paid from Austria to a UAE resident who beneficially owns the interest is taxable only in the UAE. Royalties from Austria beneficially owned by a UAE resident are taxable only in the UAE. Gains from the sale of Austrian shares and bonds (or any property other than real property, business property, ships or aircraft) are taxable only where the seller is resident. Private pensions for past employment are also taxable only in the residence country. If not for the treaty, Austria would withhold 25% tax on the dividends and interest and 20% tax on the royalties.
So, how does the UAE tax passive income received by a UAE resident?
It doesn’t; the UAE does not impose any income tax on either individuals or companies. Although the UAE has never been attacked by the OECD for allegedly harmful tax practices, its tax system is essentially the same as that of the Bahamas and the Cayman Islands. Unlike those jurisdictions, however, it has over 40 income tax treaties in force, at least 15 of which are with OECD countries. Developed countries like Austria readily sign tax treaties with the UAE because of its great private wealth much of which is invested only in countries with which the UAE has favorable tax treaties.
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