Economic Substance Regulations : What is 3rd Port Shipment?

CA Rajiv HiraCA Rajiv Hira    30 July 2020
Economic Substance Regulations : What is 3rd Port Shipment?

3rd Port Shipment, is a supply chain management method in which the business does not keep goods in stock but instead transfers its customer's orders and shipment details to either the manufacturer, another retailer, or a wholesaler, who then ships the goods directly to the customer. As in business, majority of retailers make their profit on the difference between the wholesale and retail price.

There are various other names used for such trade like “Drop Shipment” ,“Foreign-to-Foreign shipment”, “Triangle Shipment” etc. For the benefit of all, in this article we will use “3rd Port Shipment”.

What are the benefits of 3rd Port Shipment?

Considering 3rd Port Shipment is managed by a UAE company or distributor:

(a)   It reduces supply chain costs;

(b)   Decrease transit time or transportation time from the country of origin to country of destination;

(c)   Optimize the supply chain while dealing with one entity, for example-  UAE entity is a procurement centre for efficient network.

What if UAE company is the related entity of manufacturer / supplier, will this attract Economic Substance Regulation?

Let’s revisit the Economic Substance Regulations, with relevant reference points:

A. Cabinet of Ministers Resolution No. 31 of 2019 Concerning ESR, provides definition for “Distribution and Service Centre Business as below”:

Distribution and Service Centre Business: any of the following businesses: 

(a) purchasing from a Foreign Connected Person and importing and storing in the State: component parts or materials for goods; or goods ready for sale, and reselling such component parts, materials or goods outside the State. 

(b) providing services to Foreign Connected Persons in connection with a business outside the State. 

Commentary: As per definition, "3rd Port Shipment" may not be attracted to the point (a) since “storing in the state” is not satisfied. 

B) Extract from The UAE Economic Substance Regulations Relevant Activities Guide

3.9 Distribution and Service Centre Business 

A “Distribution and Service Centre” Business refers to two distinct activities that are covered under one “Relevant Activity” heading.

A Licensee is considered engaged in a “Distribution Business” if the Licensee purchases raw materials or finished products from a foreign group company, and distributes those raw materials or finished goods.  

A Licensee is considered engaged in a “Service Centre Business” if it provides consulting, administrative or other services to a foreign group company, and those services are in connection with the foreign group company’s business outside the UAE. 

Licensees that only purchase goods from or distribute goods to third parties are not considered engaged in a Distribution Business. Likewise, Licensees that are engaged in the business of providing services to third parties are not considered as carrying on a “Service Centre Business”.  

Commentary: As per Activity Guide, there is no reference to the point related to “storing in the state”, and hence purchases of goods from a foreign-related party, and onward distribution gets covered.  It further gets elaborated that the “Licensees that only purchase goods from third parties are not considered engaged in a Distribution Business”.

Now the question is... can a guide supersede the Cabinet of Ministers Resolution?

Article 6 of the "resolution", states that:

6. The Competent Authority shall issue guidance on how the Economic Substance Test may be met, including without prejudice to the generality of the foregoing, any expression used in this Article for the purpose of that test, including the meaning of “adequate”. 

7. Regard must be had to any guidance under Clause 6 of this Article concerning the interpretation of any expression. 

8. The Competent Authority may revise guidance issued under Clause 6 of this Article from time to time and a reference to guidance includes a reference to revised guidance. 

Concluding Comments:

As per intent of the law and primary read, activity performed under the “3rd Port Shipment” may be classified under the head Distribution and Service Centre” Business.

Model adopted by entity based in UAE may be envisaged as of providing services for the foreign related party i.e. providing services to Foreign Connected Persons in connection with the business outside the state, by facilitating:

1. Order booking.

2. Stock / goods movement management, etc.

3. Managing the payment.

4. Administrative procedures of invoicing / BL/ etc.

There may be further guidance note’son the subject from the competent authorities. Till the time these are clarified, we need to ensure that the intent of the regulation is also read with the verbatim.

Disclaimer: Content posted is for informational & knowledge sharing purposes only and is not intended to be a substitute for professional advice related to tax, finance or accounting. The view/ interpretation of the publisher is based on the available Law, guidelines, and information. Each reader should take due professional care before you act after reading the contents of that article/ post. No warranty whatsoever is made that any of the articles are accurate and is not intended to provide and should not be relied on for tax or accounting advice.

You can access Law including Guidelines, Cabinet & FTA Decisions, Public Clarifications, Forms, Business Bulletins for all taxes (Vat, Excise, Customs, Corporate Tax, Transfer Pricing) for all GCC Countries in the Law Section of GCC FinTax. 

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