A Special Purpose Vehicle (SPV) is a subsidiary established for a specific, narrow purpose, typically to isolate financial risk. By being legally distinct from their parent companies, SPVs offer a protective layer against financial and legal risks associated with the parent's operations. They are frequently used in structured finance, securitization, property investments, and project financing to manage and mitigate risk or for organizational purposes.
It is always recommended, when applicable, to use an SPV structure that relies on sophisticated common law jurisdictions (as is the case with ADGM and DIFC) to improve corporate governance and mitigate share transfer restrictions away from mainland civil law jurisdiction limitations. Furthermore, when trying to carve out assets as part of an asset acquisition, it improves substantially the ability to limit any liabilities that may be attached to a target company by moving those assets into a separate legal personality. In this article we will discuss the preferred jurisdictions to set up those SPVs and the benefits of their use.
Purpose of SPVs
SPVs are employed for several strategic reasons as pertaining to M&A deals:
- Risk Isolation: SPVs help shield the parent company from potential losses by isolating the financial risk of specific projects or assets.
- Securitization: SPVs are in some other times used to pool financial assets, such as loans or receivables, and issue securities backed by these assets, facilitating capital raising and risk management.
- Asset Ownership and Management: SPVs can own and manage assets, including real estate and intellectual property, separating these from the parent company's liabilities.
- Regulatory and Tax Efficiency: SPVs can be structured to leverage favorable regulations and tax treatments in specific jurisdictions, optimizing overall tax and regulatory outcomes.
Prevalent Jurisdictions for SPVs
Mainland UAE (Investment or Holding Company)
Mainland UAE allows SPVs to be set up as holding companies for owning shares or assets. This jurisdiction provides operational freedom and access to a wide range of investment opportunities. Mainland companies benefit from no restrictions on office locations and can own property in most parts of the UAE, which is advantageous for investment holding structures.
However, setting up a holding company in mainland UAE comes with challenges:
- Economic Substance Regulations:
Compliance with these regulations requires a substantial local presence, increasing administrative costs. As part of the UAE's initiatives to comply with the OECD Inclusive Framework the European Union Code of Conduct Group on Business Taxation, the UAE issued Economic Substance Regulations which requires annual monitoring requirements on companies deemed to have relevant activities which includes a "Holding Company Business."
By setting up a mainland company, founders and shareholders will be required to maintain an adequate economic presence. This includes the requirement to submit mandatory annual filings to the relevant authorities that show:
- The Company has the relevant activity to meet ESR requirements.
- The core income activities of the Company are being conducted in the UAE; and
- The Company has sufficient employees, a suitable premise and generates sufficient revenue
- Corporate Tax:
The introduction of corporate tax may affect the choice of the jurisdiction.
Corporate Tax was implemented in the UAE from January 1, 2024, at a tax rate of 9%. In some Free zones, companies may be subject to a tax rate of 0% if they meet the requirements of what is deemed a Qualifying Free Zone Person ("QFZP") and other conditions.
To be deemed a QFZP, the following criteria must be achieved and submitted to the competent authorities:
- Maintain adequate substance in the relevant freezone – derive its income from a specific set of activities as determined by the competent authorities, have adequate number of employees, adequate assets and adequate amount of operating expenditure; derive qualifying income;
- Satisfy the De-minimis requirement, which as of this date, the non-qualifying revenue in a tax period should not exceed the lower of:
- 5 million AED
- 5% of total revenue
- Comply with Transfer Pricing requirements; and
- Not elect to be subject to corporate tax
- Corporate Governance:
There are sometimes drawbacks in operating in the mainland which may be averted by utilizing other jurisdictions as set out below. Most notably, are shareholder restrictions when passing resolutions on various matters including share transfers. All shareholder resolutions require a visit to either a private or public notary registered and licensed in the applicable emirate in which the SPV is domiciled. Regardless of whether the valid quorum is present and the articles of association of a company allow for the passing of a resolution by either ordinary, special or custom resolution as determined by the aforementioned articles, the notary will require the attendance of the complete shareholders including those that are dissenting. Should a single shareholder fail to attend before the notary, the notary will require a court order to pass the resolution in adherence to the articles of association which from a corporate governance perspective can be unduly burdensome.
RAK International Corporate Centre (RAKICC)
RAKICC is favored for its flexibility and cost-effectiveness. It offers various corporate structures, including companies limited by shares or guarantee and segregated portfolio companies, which ring-fence assets from general liabilities of the company or of other segregated portfolios. The incorporation process is straightforward with minimal physical presence requirements and light annual compliance obligations. The absence of mandatory auditing and the ability to segregate liabilities makes it attractive for individuals or investors seeking a straightforward and uncomplicated setup.
Nevertheless, RAKICC has some limitations:
- Market Access: Entities cannot conduct business directly within the UAE mainland, limiting market opportunities.
- Banking Challenges: Offshore entities may face difficulties in opening and maintaining bank accounts due to stringent compliance requirements.
- Regulatory Framework: Unlike ADGM and DIFC, RAKICC lacks a dedicated regulatory framework for financial services, which may limit the scope of financial activities.
Jebel Ali Free Zone Authority (JAFZA)
JAFZA is a prominent free zone in Dubai known for its cost benefits and proximity to major logistics hubs. It offers lower formation and maintenance fees, and there are no minimum capital requirements, which adds flexibility to investment structuring.
However, JAFZA SPVs face some drawbacks:
- Memorandum of Association: Limited flexibility in customizing the Memorandum of Association compared to other jurisdictions.
- Legal Framework: Falls under UAE laws rather than common law, affecting certain legal aspects.
- Formation Process: Involves notarization and attestation, which can be time-consuming and costly.
- Banking and Regulatory Issues: Potential challenges with banking due to stringent KYC procedures and recent regulatory changes.
Abu Dhabi Global Market (ADGM)
ADGM is a leading international financial center with a robust legal framework based on English common law. It provides significant flexibility for structuring holding and investment entities, allowing for various classes of shares and diverse ownership structures, including foundations, trusts, and funds. ADGM SPVs can hold stakes in the UAE with minimal requirements for shareholders and directors.
Despite its advantages, ADGM may present challenges:
- Complex Compliance: Navigating compliance requirements can be complex without specialized advice.
- Ongoing Costs: While setup costs are relatively low, ongoing costs for services, legal compliance, and administration can be higher compared to some jurisdictions, particularly for smaller businesses.
Dubai International Financial Centre (DIFC)
DIFC is a prominent financial center with a legal system based on English common law, offering a well-regulated environment for SPVs involved in holding investments, structured finance transactions, and asset management. DIFC provides access to international capital markets and a comprehensive range of financial services.
However, DIFC has its own set of challenges:
- Costs: Higher setup and operational costs may be a consideration for smaller businesses or startups.
- Regulatory Complexity: The supportive regulatory environment can also be complex, requiring detailed compliance and potentially incurring additional legal and administrative expenses.
- Sector Focus: DIFC's ecosystem is geared towards financial services, which may not be as advantageous for SPVs engaged in non-financial sectors.
When considering jurisdictions for Special Purpose Vehicles (SPVs) in the UAE, ADGM and DIFC each offer unique advantages. ADGM stands out for its cost-effectiveness, flexible compliance requirements, and lack of minimum capital requirements, making it suitable for startups and smaller investors. Its legal framework, based on English common law, provides stability and operational efficiency.
On the other hand, DIFC is known for its robust financial services ecosystem and strategic location in Dubai. It supports complex financial transactions and global business activities with a well-established infrastructure and network of financial institutions. While it entails higher setup and operational costs, DIFC offers extensive support services and a strong regulatory environment.
Other jurisdictions like RAKICC or JAFZA may offer lower costs but come with limited services and higher operational constraints. Evaluating these factors can help align interested parties SPV's needs with the most suitable jurisdiction for achieving optimal investment and risk management objectives in the UAE.
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