(Bloomberg) -- Few nations have been as successful as the United Arab Emirates in building a vibrant, low-tax economy to lure the world's biggest companies and wealthiest individuals. The government has been doing everything else to get them to stay -- building gleaming infrastructure, international schools, museums and industrial zones. It even broke ranks with the rest of the region in adopting a working week aligned with global markets. With major economies now waging war on tax havens and money laundering, the Middle East commercial hub is dismantling parts of its low-tax regime. The change may test the UAE's appeal to foreign nationals, who make up around 80% of the population. Any slip-up could hand an advantage to Saudi Arabia, which is trying to develop its own free-wheeling international economic zones to steal a march on its smaller neighbor.
1. What's behind the UAE's economic miracle?
Established in 1972, the UAE built its reputation as a global trade hub by levering its location between east and west. OPEC's third-biggest producer, it presents itself as a haven for business and tourism in a volatile region. Known for executing mega-projects, it's home to one of the world's largest man-made islands, the tallest skyscraper and one of the busiest airports for passenger traffic. Unlike in other parts of the Middle East, foreigners can own real estate -- everything from million-dollar waterfront villas to tiny studios. Since the onset of the pandemic, it's offered long-term residency, citizenships and low business fees to retain foreign companies and talent.
2. What are the downsides?
Blue-collar workers, who make up the majority of the UAE's expatriate population, sometimes suffer dire living situations and risky working conditions. Then there's sponsorship. The government requires all foreign workers to be sponsored by their employers before they can start work. Expatriate men can thereafter sponsor their families but only if they earn a minimum of 4,000 dirhams ($1,089) a month or 3,000 dirhams including company accommodation. Expatriate women can in some cases sponsor their spouses and children but generally under stricter rules than for men. Education is expensive, with private schools charging as much as 60,000 dirhams a year, as is medical care. And although the country has made it theoretically possible to acquire citizenship or long-term residence visas, the rules are vague, with only a few people said to have done so. Retirees are expected to leave the country unless they can show a steady income. Another downside is the UAE summer, when temperatures can reach 120 degrees Fahrenheit (49 degrees Celsius). Most worryingly of all, the UAE is still fighting a war in neighboring Yemen, recently suffering several missile and drone attacks launched by Yemen's Houthis and prompting the U.S. to issue a travel warning.
3. What's it doing to retain skilled foreigners?
This year, it switched to a Saturday-Sunday weekend to put it in better sync with the global economy. In 2020, the government abolished a rule that required companies to have Emirati shareholders, and last year it unveiled plans to offer citizenship to select foreigners. The government also announced it would decriminalize “actions that don't harm others,” potentially ending punishments for alcohol consumption or unmarried cohabiting couples. Though prosecutions have been rare, some cases involving drunkenness and sex out of wedlock became well-publicized, denting the Gulf country's allure for skilled foreign workers.
4. How is it dealing with the pressure on tax havens?
The UAE is planning to tax corporate earnings for the first time, applying a 9% rate from June 2023. The change reflects how the country is seeking to align itself with new international standards, particularly the move toward a global minimum tax on multinational corporations that was endorsed by the Group of 20 nations last year. The UAE is at risk of being added to the Paris-based Financial Action Task Force's so-called “gray list,” people with knowledge of the matter have said, effectively labeling it as a country that's not doing enough to combat money laundering and terrorist financing. Officials have been working to head off the designation, which could adversely affect investment. As far as other levies are concerned, a 5% value-added tax was introduced in 2018 and the government later imposed a 5% customs duty on imports. It also taxes the profits of banks and insurance companies operating outside of the country's network of free zones at 20%.
5. So it won't be a tax haven any more?
Yes and no. While corporate tax is new to the UAE, the 9% rate is still lower than regional peers and most global financial centers. And personal income from employment, real estate and other investments will remain untaxed. Importantly, incentives will remain for companies that operate in the free zones -- where firms operate under a different set of regulations to the rest of the country -- though with some exceptions.
6. What else will have to change?
The UAE is under huge pressure from the Financial Action Task Force to fulfill an agreement to combat money laundering and terrorism financing. In response, the country has created central bank task forces and established money-laundering courts. Should the FATF put the UAE on its “gray-list,” it would be a major blow to a country that has carved out a position as the Middle East's leading financial hub.
7. What does it mean for the UAE's regional clout?
The UAE is locked in a struggle with Saudi Arabia, its bigger neighbor, to hold on to its status as the region's business hub. As part of Saudi Crown Prince Mohammed bin Salman's efforts to wean the kingdom off oil revenue, it has given international firms until 2023 to move their headquarters to Riyadh or risk losing government contracts. It's hard to say what effect this has had so far but the increased cost of doing business in the UAE could make a difference.
The Reference Shelf
- QuickTake explainers on efforts to tax global corporations and the UAE's conflict with Yemen's Houthis.
- The UAE government details the next stage in its economic growth plan
- Bloomberg Opinion's Bobby Ghosh on the UAE's economic rivalry with Saudi Arabia
- The Brookings Institution explains why Gulf states must shift their economies away from oil
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