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When is a company not a company? When is a trust not a trust? When it is a UAE foundation. Many trust, corporate and structural tax professionals have pondered over the form of entity that would suit their client’s needs best. Few could have done better than the UAE Foundation. After all, the DIFC and other interested parties sought the best structures and practices in many jurisdictions from around the world, and this was a crucial one. An effective orphan structure that has appearances of a company and a trust and can trade.
Setting up a foundation in the UAE has become one of the main ways to restructure wealth in the country. There may, however, be broader global benefits to structures involving such entities.
It is long known and accepted that foundations often play a similar role to trusts, especially when it comes to holding and protecting assets and legacy planning. But they have very different legal structures, akin to companies. This is a key difference that is beginning to be recognized by major banks and institutions and it is significant for that.
Most importantly, a foundation is an independent legal entity holding assets in its own right. The foundation meets its founder’s wealth protection needs but retains a corporate legal personality. This is where its advantage lies.
Local Use of a UAE Foundation
One of the key advantages of a Foundation over a Trust is its ability to hold and register assets in its own name. This appeals to many families in both the UAE, the wider GCC area and internationally as there is no need to transfer assets to unknown third-party trustees in foreign jurisdictions. This can have a wider appeal, particularly given the hybrid company and trust nature of the foundation.
One area where UAE Foundations have attracted particular initial attention is real estate. A significant benefit of UAE Foundations is that they are permitted to own real estate located in the UAE (as well as shares, bank accounts and investment portfolios). Unlike overseas Trusts, UAE Foundations are (with variances in the different Emirates) recognized by the Emirate level Land Departments , meaning they have become the succession vehicle of choice for local real estate.
There are an increasing number of structures where the UAE Foundation is used as an integral part of an international project. For example, a number of DIFC Foundations have been established to act as trustee of trusts established overseas. For many clients the private trustee foundation structure is more palatable than the additional layers typically involved with a private trust company structure. The decision of the DIFC is a central decision for Foundations.
Let us pause to look in detail at this judgement, involving as it did inter alia STEP. It is worthy of such consideration as it reveals the developmental judicial and legislative mind in the region towards both foundations and trusts. It may also assist those unfamiliar with judicial mechanisms operating in this region, so gives a little more context than would usually be the case in such reportage.
Background to the Decision of the Court
The Chief Legal Officer of the Dubai International Financial Centre Authority (“DIFCA”) of the Dubai International Financial Centre (“DIFC”) wrote to the Chief Justice of the DIFC Courts. He submitted to the Chief Justice an application asking that he request the Court of Appeal of the DIFC Courts to provide interpretations of provisions of two laws of the DIFC. They are the DIFC Trust Law , and the DIFC Foundations Law.
The Jurisdiction of the Court
The request was made pursuant to Article 5 of what is known as the Judicial Authority Law. Relevantly that Article provides :
“(B) The Court of Appeal:
(1) The Court of Appeal shall have exclusive jurisdiction to hear and determine:
………(b) request of interpretation by the Chief Justice of the Courts of any article of the DIFC Laws and DIFC Regulations upon an application submitted to him from any DIFC Body, DIFC Establishment or Licensed DIFC Establishment, such interpretation shall have the same authority as the interpreted legislation.”
This is the first time the Court had been called upon to exercise its jurisdiction under Article 5(B)(1)(b). It is an exceptional jurisdiction and, as the court stated pointedly, but to be expected with such a broad ranging authority, one to be approached with circumspection. It is a jurisdiction in which the Court is asked to respond to interpretive questions in a factual vacuum and without the focus that a real dispute between parties ordinarily provides to such questions. One should approach such matters with equal caution.
The background to the application by DIFCA was explained in the letter Chief Legal Officer of the DIFCA. One of the objectives of the DIFC from its inception has been to provide a platform, comparable to other financial international centres, from which family wealth can be administered, protected and transmitted. Family wealth was said to be a significant part of the United Arab Emirates (“UAE”) and Gulf economies. In 2016, His Excellency the Governor of the DIFC appointed a working group entitled the “Wealth Management Working Group” (the “Working Group”) to consider, among other things, the status of the wealth management industry in the DIFC and to propose strategy and policies relevant to the wealth management industry. The Working Group was established with a view to making the DIFC an attractive venue for local and regional families to structure their business and succession planning arrangements.
The Working Group considered the absence of any precedents from the DIFC Courts relating to the application and operation of the 2005 Trust Law. One of the options proposed by the Group to overcome that absence was an application to the Chief Justice to submit questions for interpretation of the Trust Law to the Court of Appeal.
The application letter from DIFCA also referred to the DIFC Foundations Law . DIFCA observed that, in addition to the problems arising from the absence of precedent decisions from the DIFC Courts relating to the Trust Law , there were problems arising from the absence of precedents in relation to the Foundations Law. DIFCA had therefore decided to expand the ambit of its application to cover the Foundations Law. That may be a matter of concern as an overreaching of the jurisdiction of the court given its circumspection over its jurisdiction, as will be seen in a moment.
The purpose of the Working Group’s recommendation in relation to the Trust Law was to obtain authoritative statements to give greater confidence to the DIFC community and its legal profession which, by the very nature of private wealth management and succession planning, is usually very conservative in its approach.
So it is important to note that the Court here was asked to act in an advisory jurisdiction, a reason for comfort perhaps.
DIFCA made some helpful submissions on advisory jurisdictions generally of importance to contextualise the judgment. As correctly pointed out, common law courts have traditionally preferred cases to be resolved by contested proceedings. In some jurisdictions the judicial power is confined, e.g. to “cases and controversies” or “matters”, so that the legislature cannot confer on courts jurisdiction to issue advisory opinions.
Where an advisory jurisdiction is validly conferred upon a court, it is, of course, the court’s duty to exercise it. Nevertheless, as Lord Haldane said of the advisory jurisdiction of the Supreme Court of Canada in Attorney-General of British Columbia v Attorney-General of Canada:
“… under this procedure, questions may be put off a kind which it is impossible to answer satisfactorily. Not only may the question of future litigants be prejudiced by the court laying down principles in an abstract form without any reference or relation to actual facts, but it may turn out to be practically impossible to define a principle adequately and safely without previous ascertainment of the exact facts to which it is to be applied. It has therefore happened that in cases of the present class their Lordships have occasionally found themselves unable to answer all the questions put to them and have found it advisable to limit and guard their replies.”
That passage was quoted with approval by the Privy Council in Attorney-General of Canada v Attorney-General of Ontario.
UAE Foundation Law Principles
It is worth a recap of the basics of DIFC Foundation Law as it is banal to seek to use a Foundation armed with little knowledge of its full force and effect. One will see that it is comprehensive and effective, but is a hybrid not only in terms of the introduction hereto, but in terms or types of foundations utilized mainly in continental Europe.
The scope of the Law is set out in Article 4 which provides:
“4. Scope of the Law
This Law applies to:
- any Foundation established in accordance with this Law;
- any Recognised Foreign Foundation to the extent stated in Article 62; or
- any Foreign Foundation which is established in another jurisdiction which has transferred its registration to the DIFC in accordance with this Law.”
The term ‘Foundation’ is necessarily but crucially explained in Article 10, which provides:
“10. Nature of a Foundation
- A Foundation is a body corporate with a legal personality separate from that of its Founder(s) and any other person.
- A Foundation has the capacity, rights and privileges of a natural person. The validity of an act done by a Foundation shall not be called into question on the ground of lack of capacity by reason of anything in its Charter or By-Laws.
- The property of a Foundation is not held by it upon trust for any other person.
- A Founder has such rights (if any) in respect of a Foundation as provided for in its By-laws.
- A person specified in the By-laws (other than a Founder, a member of the Council, the Registered Agent and any Guardian) has such rights (if any) in respect of a Foundation as provided for in its By-laws.
- Any rights a person may have in respect of a Foundation may be assigned to some other person, if its By-laws so provide.
- If rights are assigned under Article 10(6), the person assigning the rights must within a period of thirty (30) days provide a copy of the assignment to the Registered Agent or, if there is no Registered Agent, to the Registrar. A person who fails to comply with this requirement is liable to a fine, as set out in Schedule 3.”
Duration and Dissolution
Article 11 provides for the duration of a Foundation. In particular, Article 11(1):
“A Foundation may, but need not, be established for a fixed period or for a specified limited period, provided that it may be dissolved at an earlier time in accordance with the provisions of this Law.”
Article 11(2) requires that if a Foundation is to be wound up and dissolved upon the happening of some event or the expiry of a fixed period of time, the details must be specified in its By-laws. So too must the details of any right that a person has to wind up or dissolve a Foundation.
Objects of the Foundation
Article 12 sets out the objects and categories of Foundations. It provides:
“12. Objects and categories of Foundations
A Foundation’s objects:
- must be certain, reasonable and possible; and
- must not be unlawful or contrary to public policy in the DIFC.
A Foundation may be established for:
- objects which are exclusively charitable; or
- one or more of the following: objects which are not exclusively charitable; or objects to benefit persons by name, category or class.
……….(5) A Foundation may not carry out any commercial activities, except those necessary for, and ancillary or incidental to, its objects.
The Qualified Recipient Distinguished from a Beneficiary
Article 12(7) provides that absent an express power to amend objects in the Foundation’s Charter, an object may be amended by order of the Court on application made by or on behalf of a Founder, the Foundation or a Guardian. That is subject to Articles 12(1) and 12(2). The circumstances in which such an application may be made are set out in Article 12(7)(a) to (f). It is important to note that a beneficiary, called a Qualified Recipient in the law, is given no such right, the main distinction from the beneficiary of a trust.
An application to the Court pursuant to Article 12(7) may be brought by DIFCA or the Council of the Foundation or any other person with sufficient interest upon notice to the Founders (if still alive), the Guardian (if any), the Council and (if applicable) any other person with sufficient interest.
There appears to be a discrepancy here. Surely a Qualified Recipient is sufficiently interested. On that the court was silent or merely did not consider it further.
Ambit of Jurisdiction
Under Article 13(1), and subject to Article 13(2), all matters arising in regard to a Foundation or in regard to disposition of property to or by a Foundation are to be determined in accordance with the laws of the DIFC. They are to be determined without reference to the laws of any other jurisdictions with which the Foundation or its disposition may be connected.
Article 13(2) provides, among other things, that, subject to Articles 14, 15 and 16, Article 13(1) shall:
- “not validate any disposition of property which is neither owned by a Founder or Contributor, nor is the subject of a power vested in a Founder or Contributor;
- not validate any trust or disposition of immovable property situated in a jurisdiction other than DIFC in which such trust or disposition is invalid according to the laws of such jurisdiction
- not affect the recognition of Foreign Laws in determining whether a Founder or Contributor is or was the owner of any property transferred to the Foundation or is or was the holder of a power to dispose of such property;
- not affect the recognition of the laws of its place of incorporation in relation to the capacity of a corporation; and
- not affect the recognition of Foreign Laws prescribing generally, without reference to the existence or the establishment of the Foundation, the formalities for the disposition of property within the jurisdiction of those Foreign Laws.”
Article 14 limits the applications of Foreign Laws to invalidate the disposition of property to a Foundation which is valid under the laws of the DIFC. Articles 14(2) to 14(4) deal with the non-application of foreign statutes to avoid transfers of property to a Foundation where the Founder or Contributor is bankrupt or the Founder or Contributor is liquidated or there are claims made against the Founder or Contributor by any creditor. Under Article 14(3) the Court may declare a transfer of property void to the extent of a creditor’s claim.
Remaining Articles of Note
Part 3 of the Foundations Law provides for the establishment of the DIFC Foundations, for their creation under Article 17, their Constitution under Article 18, their Charter under Article 19, their By-laws under Article 20, a Default Recipient for the property of a Foundation under Article 21 and the Foundation Council under Article 22. Article 23 provides for a Foundation which has a charitable object, or a specified non-charitable object, to have a Guardian in relation to that object. The Foundation may have a Registered Agent under Article 24. Article 25 deals with the liability of Council Members and others and Article 26 with the reservation to the Founder of powers to amend, revoke, vary or terminate the Foundation.
Here one sees strong reflections of trust laws generally.
“27. Capital endowment
- The initial capital of a Foundation is the capital endowed upon the Foundation in order that the Foundation may be established.
- The initial capital may comprise any property and may be provided by way of gift or for valuable consideration.
- Following the endowment of the initial capital, further property may be endowed upon the Foundation by any person if the Charter so permits.
- A Founder does not have any interest in a Foundation by virtue only of endowing it with its initial capital or further property or otherwise by virtue of being a Founder thereof.
- No person has any interest in a Foundation, or is a Founder of a Foundation, by virtue only of endowing it with further property in accordance with Article 27(3).
Accumulations of Foundation Property
28. Financial Resources
The property of a Foundation shall consist of…………
- any further amount endowed upon the Foundation and accepted by its Council;
- the proceeds of investment of the capital of the Foundation; and
- any other property acquired by its Council in accordance with the Law and Regulations.
The Qualified Recipient
This is obviously a crucial element and is obviously ta foundation version of the beneficiary of a trust
29. Qualified Recipients
(1)A Foundation’s By-laws may provide for the distribution of property of the Foundation to Qualified Recipients.
(2) A Qualified Recipient shall be one or more of the following
- a person holding an entitlement specified in, or pursuant to, the By-laws to a fixed share of the property and income of the Foundation when the Foundation distributes it;
- a person holding a depository receipt;
- a person who is a prospective recipient of a fixed, or discretionary, share of the property of the Foundation upon the happening of a future event specified in the By-Laws;
- a person who is nominated pursuant to the By-laws to be a recipient of a fixed, or discretionary, share of the property and income of the Foundation at a time following the establishment of the Foundation;
- a charity; and
- a default recipient.
(3) A Qualified Recipient has no right to or interest in the property of the Foundation other than a right to payment of amounts which arises by virtue of the terms of the By-laws or pursuant to the By-laws, or a contract with the Foundation, including a contract in relation to a depository receipt.
- a Qualified Recipient becomes entitled to receive an amount from a Foundation in accordance with the Charter or the By-laws; and
- the amount is not provided,
the Qualified Recipient, or a person acting on behalf of the Qualified Recipient, may seek an order of the Court ordering the Foundation to pay the amount.
(5) Except as provided by Article 29(6), a Qualified Recipient must seek an order pursuant to Article 29(4) within the period of three (3) years from the time when the Qualified Recipient became aware of the entitlement to receive the amount.
(6) If the Qualified Recipient has not attained the age of 18 years when he or she became aware of his or her entitlement to receive the amount, the period referred to in Article 29(5) begins to run on the day on which the Qualified Recipient attains that age.”
Definition of Property
In the Schedule to the Foundations Law the term “property” is defined:
“any movable or immovable property, and includes rights and interests, whether present or future and whether vested or contingent and where it concerns the property of a Foundation, it shall include:
- any property (including money, investments and other property) contributed to the Foundation;
- any capitalised income added to the property so contributed; and
- the money, investments and property from time to time representing those assets and capitalised income.”
Recognized Foreign Foundations
“62. (1) A Foreign Foundation which wishes to conduct operations within the DIFC may apply for a License to be a Recognised Foreign Foundation in the DIFC for the purposes of this Law………
(3) A Recognised Foreign Foundation must appoint a Registered Agent, have a registered office in the DIFC and comply with the requirements of this Law and where applicable, Part 3 of the Operating Law, in respect to the conduct of its business in the DIFC.
(4) A Recognised Foreign Foundation may not carry out any commercial activities, except those necessary for, and ancillary or incidental to, its objects.
Judicial Observations on Foundations
The court also took the opportunity to make some general observations about the nature of Foundations, which are more than a useful reminder. As stated at the beginning of this article, they indicate the cosmopolitan emphasis of the court in its deliberations. They are worthy of repetition as they formed the backbone of the judicial analysis by the UAE court.
Regional Development of the Foundation in the UAE
As is well known to readers, the concept of the Foundation has traditionally been associated with Liechtenstein since 1926. It is a form of legal entity known in most continental European jurisdictions though in most cases limited to charitable purposes. In March 2018, the DIFC followed the Qatar Financial Centre (QFC) and the ADGM in enacting legislation for the establishment of Foundations, although their models are not identical. In 2020, the Ras Al Khaimah International Commercial Centre (RAKICC) also enacted Foundations Regulations which were largely based on the DIFC Foundations Law. The DIFC legislation and its RAKICC equivalent also drew upon European sources. In terms of governance arrangements there is little to distinguish between the alternative models. The role of the courts under the DIFC Foundations Law is more extensively defined in order to facilitate particular transactions such as mergers and divisions.
DIFCA drew particular attention to the following features of the Foundations Law which have no counterparts in either the QFC or the ADGM:
- the power of the courts to set aside transactions for mistake;
- the capacity to compulsorily settle intra-Foundation disputes by arbitration;
- re-domiciliation of Foundations, available also in the ADGM but not in the QFC;
- recognition of Foreign Foundations;
- conversion of DIFC private companies to Foundations available to any company whose domestic law permits its re-domiciliation to the DIFC as a preliminary step permitted by the DIFC Companies Law; and
- provision for depositary certificates modelled on the Netherlands STAK (Stichting Administratiekantoor).
The Influence of the STAK and Depository Certificates
The UAE court laid particular emphasis on the fact that STAK structures are generally set up in order to separate control over certain assets from the financial interest attributable to those assets.
That is done by transferring assets to the STAK in return for which the STAK issues depositary receipts in respect of those assets to the transferor. The STAK then becomes the legal owner of the assets but under a contractual relationship it will hold those assets for the risk and account of the holders of the depositary receipts rather than for its own risk and account. The depositary receipt holders will have the economic benefit of the assets through the depository receipts while, from a legal perspective, the STAK (as legal owner) will have full control over the assets. One can see this as a very valuable tool in international financial planning.
This separation of control and financial interests is used for purposes including private wealth planning, employer participation and privacy protection.
So, in its essence ownership of assets is not transferred to a trustee. Instead, the foundation is governed by rules set out in a charter and by-laws. These are overseen by a council, chosen by the founder as the above indicates in clear terms.
The Key Advantages of the UAE Foundation
So, armed with the law let us list some of the advantages.
- No interference of foreign laws and/or heirship rights conferred by foreign laws.
- No recognition/enforcement of foreign judgements.
- No statutory duration limits.
- Possibility for beneficiaries of transferring payment rights.
- Possibility to migrate foundation in and out of DIFC.
- Possibility to change a company into foundation.
- Possibility for a foreign foundation to apply for DIFC license.
- Access to private arbitration in case of disputes.
- Annual audited accounts can be filed with the Registered Agent.
- Mistakes and inadequate deliberations in relation to the disposition of the foundation’s property may be corrected by the DIFC court.
At the outset one needs to be clear. A trust is not a legal entity and information regarding the trust is not available to the public, whereas a foundation is an entity registered with the relevant authority. It could be argued that one of the most influential elements of a trust structure is privacy. If such is demanded then it seems a Foundation is not necessarily the optimal structure.
A foundation is constituted by by-laws and a foundation charter that governs the organisation, assets and the purpose of the foundation. As mentioned above, a foundation is incorporated as a registered legal entity and has its own legal personality, however, it also has characteristics of a trust insofar as it allows for the separation of legal and beneficial interests. It does not have shareholders. A foundation allows the continuance of the founder to exercise control over the foundation.
Foundations are exceptionally flexible and can be used for a variety of purposes, this is due to their hybrid structure and also their orphan nature. As a result, we are seeing that Foundations are becoming more widely utilized and in turn more important in the region and internationally. Most commonly Foundations are associated with purposes such as wealth management, family succession planning, inter-generational continuity, and asset protection. Very much the traditional home of trust structures.
However, Foundations can be utilised for a multitude of purposes a few of which we note below and are more reflective of the corporate element of the foundation’s nature:
- Holding of Investments: As noted above, a typical Foundation structure would be for a special purpose vehicle (“SPV”) to hold the investments and the SPV itself is held by the Foundation.
- Asset Protection: Foundations as a separate legal personality can hold assets in its own right on behalf of the designated beneficiaries. As an added benefit, the layer of separation of ownership between Founder and asset offers protection for the assets from creditors and government bodies.
- Charitable or Philanthropic Purposes: With the benefit of customisable By-Laws and Charters a Foundation offers a means of oversight and adherence to the vision of the Founder. A Foundation can therefore be effectively utilised for charitable and philanthropic purposes.
- Business Growth: From a business growth and inter-generational continuity perspective, a Foundation can provide a flexible means for a family business to hand over management of a business to a Foundation. The management of a family business is then governed by the vision of the Founder through the By-Laws and Charter and, in the event of passing or incapacity of the Founder, the management and business itself can continue from one generation to the next.
- Employee Share Schemes: Foundations can be used in the context of an employee share scheme whereby the shares of the employer company are held by the Foundation. In lieu of granting actual shares to an employee rights or units within an employment share scheme are granted instead. The payment right granted to the employee in line with the scheme is linked to the value of the employer’s shares however said shares remain secure and held by the Foundation.
Foundations benefit from a favourable tax environment in the UAE; there is 0 per cent personal income tax and access to a wide network of ‘Double Taxation’ treaties. Although a corporation tax of 9 per cent (or up to 15 per cent for large multinationals) will be introduced in the UAE from 2023 it is not expected to directly affect Foundations which are not trading and will generally receive passive income.
UAE foundation structuring is extremely flexible, but does not achieve all a trust can, particularly in terms of privacy, arguably a main motivator for such inter-generational wealth planning mechanisms. Nevertheless a foundation as a hybrid model is arguably a more useful tool than a trust in such circumstances and invites within its concepts and laws an innate flexibility for practical use in international commerce than the somewhat static trust.
There are still some teething problems with the exact status of the qualified recipient that the court did not sufficiently address. It may be that there will come a time when the DIFC courts are faced with a real dispute, as they described it, and will take the opportunity to address some of the albeit minor concerns addressed here.
Overall though it seems indeed that the UAE Foundation does indeed have the makings of the ultimate hybrid.
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The information provided by AGP Law | A.G. Paphitis & Co. LLC is for general informational purposes only and should not be construed as professional or formal legal advice. You should not act or refrain from acting based on any information provided above without obtaining legal or other professional advice.