Summary: The UAE Corporate Tax regime limits excessive interest deductions primarily through the General Interest Deduction Limitation Rule under Article 30 of Federal Decree-Law No. 47 of 2022. Where Net Interest Expenditure exceeds AED 12 million in a Tax Period, the deductible amount is generally restricted by reference to 30% of adjusted EBITDA, subject to the applicable threshold and statutory rules. Disallowed Net Interest Expenditure may generally be carried forward for ten subsequent Tax Periods. Related Party financing requires separate consideration under the specific interest deduction rules and the UAE transfer pricing framework. Businesses should therefore examine not only the quantum of deductible interest but also the commercial purpose of borrowing, utilisation of funds, arm’s-length pricing, financing terms and supporting documentation. Intra-group loans, shareholder financing, cash pooling, guarantees and acquisition financing require particular attention. Effective compliance requires businesses to coordinate the interest limitation computation with transfer pricing analysis and maintain proper records supporting the commercial rationale and pricing of Related Party financing.
- Introduction
- What is Thin Capitalization?
- General Interest Deduction Limitation Rule
- Fixed Ratio / EBITDA Rule
- Carry Forward of Disallowed Interest
- Related Party Financing
- OECD Approach
- Intra-Group Borrowing
- Valid Commercial Reason
- Transfer Pricing Considerations
- Interest Rate Benchmarking
- Documentation
- Practical Business Impact
- Precaution / Action Steps
- Key Takeaway
Introduction
The UAE Corporate Tax regime contains specific rules restricting the deductibility of excessive interest expenditure. The UAE approach is broadly aligned with the OECD’s BEPS Action 4 recommendations and seeks to prevent excessive debt financing from being used to erode taxable profits.
What is Thin Capitalization?
Thin capitalization generally refers to a situation where a business is financed with a disproportionately high level of debt compared with its equity or earnings.
The UAE framework primarily addresses this through Interest Deduction Limitation Rules, rather than relying only on a traditional debt-to-equity ratio.
General Interest Deduction Limitation Rule
Where the taxpayer’s Net Interest Expenditure exceeds AED 12 million in a Tax Period, the deductible amount is generally restricted to the higher of:
- 30% of adjusted EBITDA; or
- AED 12 million.
Fixed Ratio / EBITDA Rule
For example:
| Particulars | AED Million |
|---|---|
| Adjusted EBITDA | 50 |
| Net Interest Expenditure | 20 |
| 30% of Adjusted EBITDA | 15 |
| AED 12 million threshold | 12 |
| Maximum deductible interest | 15 |
| Excess interest | 5 |
Therefore, AED 15 million would generally be deductible and AED 5 million would be subject to the applicable carry-forward rules.
Carry Forward of Disallowed Interest
Disallowed Net Interest Expenditure under the general limitation rule may generally be carried forward for utilisation in subsequent Tax Periods, subject to the UAE Corporate Tax provisions.
The taxpayer should maintain a proper year-wise interest carry-forward schedule.
Related Party Financing
Special attention is required where financing is obtained from a Related Party, particularly where the borrowing is connected with transactions or assets generating exempt income.
The taxpayer should establish:
- Commercial purpose;
- Business necessity;
- Proper utilisation of funds;
- Arm’s-length interest rate; and
- Appropriate documentation.
OECD Approach
The UAE’s interest limitation framework is broadly consistent with the OECD BEPS Action 4 approach.
The OECD approach focuses on limiting excessive interest deductions by reference to the taxpayer’s earnings and, in appropriate circumstances, the group’s financing position.
The principal concepts include:
- Fixed ratio rule;
- Group ratio approach; and
- Carry-forward mechanisms.
Intra-Group Borrowing
Common intra-group financing arrangements include:
- Parent-to-subsidiary loans;
- Shareholder loans;
- Sister-company loans;
- Group treasury arrangements;
- Cash pooling;
- Back-to-back financing; and
- Related Party guarantees.
Such arrangements are not automatically prohibited. However, their commercial substance, pricing and tax consequences should be carefully reviewed.
Valid Commercial Reason
The taxpayer should be able to demonstrate why the borrowing was required.
Examples include:
- Business expansion;
- Acquisition of assets;
- Working-capital requirements;
- Acquisition of another business;
- Construction of business premises;
- Expansion into new markets; and
- Refinancing of genuine commercial debt.
Transfer Pricing Considerations
Thin capitalization and transfer pricing are separate but interconnected issues.
Interest limitation asks:
«How much interest can be deducted?»
Transfer pricing asks:
«Is the financing transaction and interest rate at arm’s length?»
Accordingly, a Related Party loan should generally be reviewed from both perspectives.
Interest Rate Benchmarking
For Related Party financing, the interest rate should be evaluated considering:
- Currency;
- Loan tenure;
- Creditworthiness;
- Security;
- Guarantees;
- Repayment terms;
- Market interest rates; and
- Comparable third-party financing.
Documentation
Businesses should maintain:
- Loan agreement;
- Board approval;
- Commercial purpose of borrowing;
- Fund utilisation records;
- Repayment schedule;
- Interest calculations;
- Bank statements;
- Cash-flow projections;
- Interest-rate benchmarking;
- Transfer pricing documentation, where applicable; and
- Interest limitation computation.
Practical Business Impact
For UAE businesses:
- Excessive interest expenditure may not be fully deductible.
- Related Party loans require additional scrutiny.
- Commercial justification of borrowing is important.
- Interest rates should be appropriately benchmarked.
- Disallowed interest should be tracked for future utilisation.
- Group financing structures should be reviewed before implementation.
Precaution / Action Steps
Businesses should:
- Review all Related Party loans.
- Calculate Net Interest Expenditure.
- Perform the adjusted EBITDA calculation.
- Check the AED 12 million threshold.
- Document the commercial purpose of borrowing.
- Benchmark Related Party interest rates.
- Maintain interest carry-forward records.
- Review financing connected with exempt income.
- Analyse cash-pooling and guarantee arrangements.
- Coordinate Corporate Tax and Transfer Pricing analysis.
Key Takeaway
UAE Corporate Tax does not simply prohibit high debt. The key focus is on limiting excessive interest deductions and ensuring that Related Party financing has genuine commercial substance and is appropriately priced.
Commercial Purpose + Arm’s-Length Pricing + EBITDA Test + AED 12 Million Threshold + Proper Documentation = Better UAE Corporate Tax Compliance
