Spotlight: key transactional issues in tech M&A in United Arab Emirates

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Key transactional issues

i Company structures

Technology companies in the UAE will typically be structured as private companies limited by shares. In the UAE there are multiple free zones (over 40 currently), a number of which are technology-focused. The Dubai Technology and Media Free Zone incorporates a number of areas including the Dubai Internet City, which houses many of Dubai’s local and multinational technology companies. For companies looking to do business with onshore UAE companies, it is preferable to establish a company, which will typically be a limited liability company.

One key point to note is that, to carry on business in the UAE, a company needs to be licensed by the relevant authority to carry out its specific business activities (which are prescribed by the relevant authority). The relevant authority will be the relevant free zone authority if in a free zone or the Department of Economic Development in the relevant emirate. As an example, there are specific e-commerce-licensed activities available in most free zones. It is, however, important that the entity has the correct licensed activities attaching to the company’s regulatory licence for the business that it is wishing to carry out.

From an M&A perspective, one point to be aware of when acquiring a UAE limited liability company, is that typically you will have a master purchase agreement with a separate local agreement to effect the transfer of shares with the relevant regulatory authority. This local agreement needs to be signed by all shareholders, and there are no provisions in the Companies Law that provide for the compulsory acquisition of minority shareholders in private transactions.

It is becoming increasingly common where companies are looking to develop a regional footprint for them to establish a holding company in the Dubai International Financial Centre (DIFC) or the Abu Dhabi Global Markets (ADGM). This then provides greater flexibility in the future should a sale be contemplated as it avoids issues such as that referred to above.

ii Deal structures

Acquisitions of technology businesses in the UAE are most commonly structured as share acquisitions. There are a number of drivers for this:

1. the intellectual property is likely to be held by the target company being sold or it will have rights over such intellectual property, or both – this becomes particularly relevant where the development of the technology being sold has been outsourced to consultants;
2. there is no requirement to assign or novate contracts, which means in practice less disruption for customers and suppliers;
3. value-added tax (VAT) has only been in effect since 2018 in the UAE and corporation tax only being applicable for financial years on or after 1 June 2023 (as currently proposed), therefore there have been limited concerns about historic tax liabilities to date;
4. employees do not automatically transfer under an asset transaction and their employment is therefore terminated as part of an asset transfer, which ultimately means employees may not transfer as part of an asset transfer; and
5. the target company is likely already to have the relevant licences in place to carry on its business activities within the UAE.

The exception to the above may be where the technology being acquired is a division of a seller and is being sold as a discrete asset. The benefit of an asset sale is that the buyer can cherry pick the assets being acquired and, importantly, elect to leave real or contingent liabilities with the target company (e.g., in connection with any disputes).

Given the early-stage nature of technology companies and particularly in light of recent challenges on valuations, there is an increasing desire from buyers to structure transactions with some form of earn-out or clawback provision should the business not perform in line with the seller’s projections.

iii Acquisition agreement termsConsideration and pricing

Private acquisitions in the UAE are increasingly being structured by way of an internationally recognised pricing mechanism, being on the basis of either locked box or completion accounts. Depending on the structure and context of the transaction, it is also normal to expect consideration payment to include an element of deferred consideration or an earn-out mechanism.

Risk allocation

The UAE market has developed a common law approach to buyer protections by way of warranties and indemnities and, in our experience, technology-related M&A transaction documents are governed by English law (or a law applying English law directly or conceptually, such as ADGM or DIFC laws) and the relevant English law practices and remedies in relation to warranties and indemnities would apply.

In contrast, however, transaction documents governed by UAE law would be subject to the relevant UAE laws and the civil law concepts adopted therein, and the remedies available in relation to any such contractual protections would differ from an English law perspective. The main bodies of law in this regard are the Civil Code³ and the Commercial Transactions Law.⁴ For example, under UAE law, damages for a breach of warranty are calculated on a case-by-case basis to compensate for loss (subject to foreseeability of harm) and recovery can be for actual loss and indirect limbs of loss, such as loss of profit, moral damages and loss of opportunity. There is also no clear distinction for assessing damages on an indemnity basis. Evidence of a breach will be required (along with sums claimed) and any indemnity can be reduced or not enforced by the courts if the person suffering harm contributed to the breach or loss. A general indemnity is likely to be subject to an assessment of loss (as for a general breach of contract).

Under UAE law, it is accepted, however, that any contractually agreed terms will be generally honoured by the UAE courts, and therefore, it is important to have clearly drafted terms of the contract, including the operation, and remedies for any breach, of warranties or indemnities.

Warranty and indemnity insurance (W&I) is becoming more popular in the UAE and, as transaction volumes increase, the premiums attaching to such policies are reducing. Buy-side W&I is prevalent in technology M&A, particularly where sellers are founders of start-up technology businesses, and this gives the buyer comfort in recovering any loss in the event of a breach of warranty or indemnity (subject to such loss being covered by the insurer under its policy terms).

Limitations on liability are invariably included in any technology M&A document to mitigate the seller’s risk. Under the Civil Code, such limitations are generally permitted to be contractually agreed (including fixing compensation), however the Civil Code⁵ provides for any limitation to be varied to reflect the actual loss suffered. Therefore, it is important for parties contracting under UAE law to be aware of these discretionary measures available to the UAE courts.

Good faith

Under the Civil Code,⁶ there is an obligation for parties to perform a contract in a manner consistent with good faith. There is no statutory definition of good faith, but parties must embrace the law, custom and nature of the transaction in this regard and consider the legitimate interests of the other parties.

Interim protections

Any M&A transaction is likely to have a gap between exchange and completion owing to the UAE’s local regulatory requirements for approval of the transfer of certain assets, but particularly in relation to the transfer of shares.

Therefore, it is commonplace to have interim protections for the buyer on the seller’s activities in this interim period. Many interim periods are short in nature and, therefore, do not necessitate any ‘material adverse change’ protections. However if certain regulatory approvals (such as from the Ministry of Health and Prevention or the UAE Central Bank) are conditions to completion, this may lead to longer periods between exchange and completion and require ‘material adverse change’ provisions to protect the buyer.

Dispute resolution and governing law

M&A transactions in the UAE are undertaken utilising the usual forums of dispute resolution, including arbitration and the courts. Contractual parties have the freedom to agree on these matters, except in relation to certain protected matters, such as in relation to employment, criminal matters, commercial agency or public policy, which shall always be subject to UAE law and decided by the UAE courts.

Given the international nature of the UAE and businesses existing there, parties often agree on a governing law and dispute resolution forum familiar to them. The courts of the ADGM⁷ and the DIFC,⁸ for example, are familiar with hearing complex English law disputes and, therefore, contracts are often governed by English law but are heard in ADGM or DIFC courts. We note that arbitration, given its more private nature, is also frequently used, and various well-established arbitral forums are available in the UAE, including the ADGM Arbitration Centre or the Dubai International Arbitration Centre, which recently absorbed the DIFC-LCIA Arbitration Centre⁹.

iv Financing

Typically, technology-related M&A in the UAE (and wider Gulf region) is early-stage and, therefore, debt funding is unlikely to be available for the acquisition. It is more usual for technology M&A transactions to be self-financed by acquirers through existing cash resources. There are an increasing number of venture funds that are seeking to deploy significant capital in the technology sector in the UAE and wider Gulf region.

v Tax and accounting

The UAE introduced VAT on 1 January 2018¹⁰ with a standard rate of 5 per cent, but with some transactions ‘taxed’ at a zero rate and others VAT exempt. The Federal Tax Authority has also published compliance guides and clarifications confirming the VAT treatment of supplies and recovery of input VAT. VAT is not payable on a transfer of shares, and importantly, the transfer of assets making up a whole (or independent part of a) business as a going concern will be exempt from VAT, subject to it meeting all related requirements (which may require specific tax advice). Therefore, M&A asset transfers that are in connection with a going concern business will not attract a VAT charge, but otherwise cherry-picking asset transfers are likely to be subject to VAT.

Corporation tax is to be introduced to the UAE on 1 June 2023. This follows from the UAE’s role as a member of the Organisation for Economic Co-operation and Development (OECD) Inclusive Framework on Base Erosion and Profit Shifting (BEPS)¹¹ (including global minimum tax proposed by Pillar II).¹² The proposed corporate tax rate is a minimum of 9 per cent, below that of many other jurisdictions. There are exceptions for foreign oil and gas companies and branches of foreign banks, where corporation tax is already applicable.

As a general rule, there is no capital gains tax for individual sellers resident in the UAE. There is also no income tax for individuals who are resident in the UAE (other than to the extent that they are expatriates and are caught by tax rules applicable to their home jurisdictions).

The UAE has created a number of free zones across the various emirates, which afford a variety of tax incentives. The regulations giving effect to the new corporation tax have not been published in full and it is not clear at this point the extent to which it will apply to free zone companies. It is, however, anticipated that such free zones will benefit from tax incentives (including those already provided for by law) provided that they meet relevant compliance obligations – it could be, for example, that profits on revenue from companies operating domestically may be subject to corporation tax.

There is no stamp duty (or equivalent) payable on the transfer of shares or assets, other than property where a land registration fee is payable of up to 4 per cent.

There is no withholding tax applicable on domestic or cross-border payments of any nature, which provides greater flexibility for foreign companies to structure funding for acquiring businesses in the UAE.

Under the Companies Law, there is a requirement in the UAE for companies to appoint an approved auditor to audit their annual financial statements. This will typically extend to free zones, which have similar provisions that may also include a filing requirement.

vi Cross-border issuesForeign ownership

Historically, one of the key cross-border issues facing foreign buyers of UAE onshore companies was the requirement to have a UAE national (or company wholly owned by a UAE national) hold 51 per cent of the legal interest in a UAE-incorporated company. This requirement was mostly abolished¹³ under amendments to the Companies Law in 2021, particularly relating to the technology sector.

UAE-incorporated technology-related companies are unlikely to have any foreign ownership restrictions, but buyers should be aware of legacy nominee shareholding arrangements in this regard.

Share transfer approval

Any share transfer requires approval by the relevant UAE jurisdiction’s authority in which the target entity is incorporated (e.g., the authority of the relevant emirate or free zone).

Therefore prior to completion, the share transfer contemplated by the relevant agreement will need to be approved by the authority, which must include corporate approvals of the seller and buyer, and corporate and constitutional documents of the buyer – the exact requirements should be checked with the relevant authority as part of the M&A process.

Owing to such approval requirements, completion of a share sale transaction will need to be conditional upon securing official consent, and the flow of funds should reflect this requirement. Therefore, escrow (or similar) arrangements are common and should be agreed early in the transaction process so as to avoid any unnecessary delays in closing such a transaction.

Licensing

The UAE is made up of seven emirates and a plethora of free zones all with varying licensing requirements. All businesses in the UAE need to obtain a specific licence from the applicable authority in the jurisdiction in which they are incorporated and registered to legally operate there. Different licensing options are available according to several factors, such as the business’s activities, the legal form of the business entity (e.g., a limited liability company or a branch) and the area in which it wishes to operate.

In connection with such licensing requirements, operating across the UAE’s various jurisdictions is generally prohibited without a separate licence (and any related requirements) in each of those applicable jurisdictions or a dual licence (only available in relation to certain business activities and in relation to operation across certain free zone and onshore UAE jurisdictions).

Foreign businesses need to be aware of this in connection with any UAE-related M&A and due attention needs to be paid to what the target business currently does and whether or not this matches with the buyer’s business and what it requires the target to undertake.

Economic substance requirements

In connection with the UAE’s commitment to the OECD’s Inclusive Framework on BEPS¹⁴ and the UAE’s commitment to addressing concerns around the shifting of profits derived from certain mobile business activities to no or nominal tax jurisdictions without corresponding local economic activities, the UAE introduced its economic substance regulations.¹⁵ The regulations include certain notification and reporting requirements for UAE entities (whether a limited liability company or branch, registered in either the onshore or a free zone) of any UAE entity (including offshore companies and branches of local and foreign companies) that carry out and earn income from any of the relevant activities (banking, insurance, investment funds, lease finance, headquarters, shipping, holding companies, intellectual property or distribution and service centre activities) to maintain economic substance in the UAE specific to each relevant activity.

Foreign investors should be aware of the requirements to evidence ‘economic substance’, reducing the ability to have complete control and operate a UAE business remotely from a foreign jurisdiction.

Merger controls

In the UAE, the authority responsible for competition law¹⁶ and its enforcement is the Ministry of Economy (through its Competition Department),¹⁷ which is supported by the UAE Competition Committee.

Cabinet Decision No. 13 of 2016¹⁸ created a threshold (being a market share of the relevant parties in the relevant market exceeds 40 per cent and the concentration may affect competition) that triggers a mandatory notification requirement.

Competition law sets out the anticompetitive practices¹⁹ and any M&A transaction that may fall within these restrictions may require Competition Department clearances to complete the transaction. Failure to comply with these requirements may lead to fines of up to 5 per cent of annual sales in the UAE in the preceding year.

Taxation

A buyer in an M&A transaction will need to be aware of the target’s tax obligations (and, depending on timing, its corporate tax liabilities) and seek the necessary contractual protections in connection with any such historic tax liabilities. See Section IV.v above for more detail regarding tax in the UAE.