he Gulf is built on a trading history, and the UAE has always been at its centre. Before oil there were pearls, before pearls there was everything else. Before the current rise of South-South trade there was North-South.
The United Arab Emirates (UAE) has many advantages meant for a modern age. Although it is sparsely populated and covered in desert, its longitudinal position makes it a natural central point for liaising with financial markets in America, Europe and Asia in a time of increasing economic globalisation. Its position also makes it an ideal hub point for an age of jet travel. And, of course, it has significant oil deposits.
But because of those deposits and sparse population, the UAE lacks a diverse economy that can take advantage of its strategic position. In order to counter-act this, the UAE government started to create free zones – geographically defined areas inside of which companies are exempt from certain duties and taxes.
Starting with the creation of the Jebel Ali free zone in 1985, UAE free zones have reflected the reasons for their creation. They were made to diversify the economy by bringing in businesses and foreign expertise from a wide range of sectors.
As a result they are more than simple tax havens. They have been created to be hubs of collaboration, learning and expertise. UAE free zones are largely sector-specific, meaning they bring businesses in similar industries – such as aviation – together. By offering well developed infrastructure, logistics and independent administration capable of catering to each sector’s specific needs, free zones have attempted to create an environment that can pass expertise and diversity into the UAE economy.
Thus far, the free zones have been successful. There are already around 40 free zones in operation throughout the UAE, with another 10 in planning or implementation. (See the sidebar for a list of some of the most important zones.)
Free zones do have limitations with companies who operate in them unable to trade directly with the home UAE market unless they establish an ‘onshore’ operation. The Dubai Government has recently announced its intention to crack down on those companies flaunting their position within free zones by trading directly onshore.
“It is true that Free Zones offer companies a ‘tax haven’, but this is only for a 50-year period,” says Stuart Curtis, Group Managing Director of The Links Group. “Certainly a Free Zone entity is preferable to companies who do not want to sell their products directly to the end users in the UAE. However, if you are one of those free zone companies in the ‘grey area’ that does business onshore here and there, it is time to get your ducks in a row and apply for an onshore license.
“This is particularly true of companies that are thinking long term. If any sort of tax regime is introduced to the UAE, which has been mooted, free zone companies will be seriously restricted with respect to trade partners. Having an onshore presence is the best way to grow your business in the ever-expanding market of the UAE,” says Curtis.
Sweeping Changes in the Offing
Since 2006, there have been discussions on changes to the UAE commercial companies laws that could affect the competitive edge free zones enjoy over business developments in the rest of the UAE.
According to Andy Nunn, a partner at the international law firm and consultancy Eversheds, this new law may be implemented finally at some point in 2013.
The bill is meant to be a complete rebuild of the UAE’s financial regulations.
It will cover a myriad of issues ranging from accounting practices to directors’ duties to compliance, according to international law firm Latham and Watkins. Clauses in the law that change the rules surrounding foreign ownership of companies could have a significant effect on international investors.
Currently in order to do business, a foreign company has to open a local subsidiary that is majority owned by a UAE national, says Nunn. “There are other options that allow foreign contro,l but these limit the commercial activity that can be undertaken and are shop windows for all intents and purposes,” he adds. Free zones are exempt from this rule. Businesses setting up inside free zone boundaries can be 100-percent foreign owned – enabling businesses to take advantage of UAE benefits, such as no corporation tax, without surrendering control of their business.
But when the new law comes into effect, the rule preventing foreign ownership outside a free zone is likely to be relaxed. It is still unclear to what extent this will happen. Lobbying by local businesses means that foreign ownership is almost certainly to be restricted in some way, says Mark Gilligan, a former associate at UAE law firm, Habib Al Mulla and Co.
Emirati majority ownership requirement restrictions would likely be loosened only in sectors that the government has identified as in need of foreign expertise. Whether or not foreign nationals would be able to operate 100-percent owned businesses or whether they would still have to have minority UAE partners to operate in the country is also unclear, he adds.
No matter what, the modification of the foreign ownership laws will result in a competitive disadvantage for free zones, where a main selling point has been the option of 100-percent ownership. In order to counteract this, the law is likely to include a clause enabling free zone-based businesses to more easily do business with UAE entities outside their free zone, says Nunn.
Currently a company inside a free zone must either have a non-free zone entity or branch, hire a representative UAE agent to or have a direct order placed in order to do UAE business outside its free zone, says Nunn. However, enforcing this rule has proven difficult, especially with regards to companies offering services. Enforcement tends to work on a case-by-case basis but is frequently ignored. This is most apparent in dealings with the UAE government itself. “The government might turn around and say, ‘Yes we’re happy to buy from your Jebel Ali free zone company,’ ” he says. “Or they might say, ‘No we’d like you to open up and show commitment here.’ ”
Overall there seems to be an appetite to put into law what is already happening in practice by allowing certain services to be provided without a presence outside a free zone, Nunn adds. By doing so, UAE will restore the competitive advantage that free zones enjoy.
Due to their purpose-built nature, free zones often offer better office space and infrastructure than commercial property found in other areas, says Nunn. Speaking at the World Freezone Conference in London in December, James Bernard, director of business development at the Jumeirah Lake Towers (JLT) and Dubai Multi Commodities Centre (DMCC) agreed, stating that this can include basic necessities such as telecommunications and power infrastructure but also stretch to sector-specific items, such as gem sorting and precious metal smelting for businesses involved in jewellery.
Meanwhile, independent administration means that it is often easier to set up a business inside a free zone compared to the rest of the UAE, says Gavin Maude, chief executive officer at Pemberton Partners, a consultancy that helps to find staff for companies setting up in the UAE. “The UAE can be bureaucratic. They like paperwork over there. When you first get over there, there’s a lot of, ‘Go over there and talk to them and they’ll sort you out, now go over there and so on.’ ”
But central free zone administration simplifies things by putting everything in one location. “For example,” adds Nunn, “Jebel Ali works as a one-stop-shop for setting up a company, rather than running around to a number of ministries such as the immigration, economy and labour departments.”
Free zones have also been able use independent administration to offer unique services to businesses. These can partially act as unique selling points when two free zones overlap on sector, says Nunn.
For example, JLT offers businesses freehold property, whereas other free zones usually only offer leaseholds and foreign nationals are generally prohibited from owning property in non-free zone areas. It also offers businesses just starting in Dubai, or not in need of continual office space, the ability to register a desk at its business centre, says Bernard. (In order to start work a business needs a physical address to register with the UAE government.)
Currently the economic downturn has hampered growth throughout the Middle East, says Nunn. It is one of the reasons why the UAE wants to push its new law through. A reformed and more transparent regulatory environment should encourage further growth, he adds. If it can be done quickly, the UAE can also increase its competitive edge over its rival Bahrain. “The UAE can showcase itself as one of the more stable, liberal countries in the region,” says Nunn.
If it does, expect free zones such as JLT to continue to expand. As of 2012, JLT contained about 5,500 companies. It expects to continue to grow, increasing its average registration of 100 new companies per month and reaching 7,500 operating businesses by the end of this year, says Bernard.
Although meeting this target relies somewhat on the global economic situation and whether the new law is passed, it may be unwise to bet against it happening.
Rob Denman is editor in chief and CEO of London-based Pathfinder Business. He is a regular contributor to Site Selection International and Site Selection Magazine.