The Government of UAE announced on 31st January 2022 that UAE would be promulgating legislation for levying federal Corporate Tax (C T) on business profits and the same shall be effective for the tax period commencing on or after 1st June, 2023.
For years UAE has been considered as a tax free regime but in order to align itself with the recommendations of implementing global minimum effective tax rate under the OECD Pillar Two of the Base Erosion and Profit Shifting (BEPS) Project, the UAE announced levying of Corporate Tax on Business Profits @ 9%.
Federal Tax Authority (FTA) under the Ministry of Finance of the Government of UAE will be the nodal authority responsible for administering and implementing Corporate Tax.
As a part of the implementation process of the C T, the UAE Government released Public Consultation Document on 28th April, 2022 containing information on the proposed C T regime in UAE.
As per the Rationale stated in the Consultation Document, proposed federal C T shall enshrine best practices globally and incorporate principles that are internationally known and accepted. This would ensure that the Corporates are well aware of such principles and will not be required to evaluate any new concept.
The proposed UAE C T has categorized Taxable Persons into Eight Categories and outlines the treatment to be accorded to these persons as regards UAE CT. The same is briefly stated under:
1. Natural Person: Individuals have been categorized as natural persons and have been kept out of the scope of UAE C T unless the individual is carrying out business or commercial activities in the UAE whether as a sole proprietor or as a partner of unincorporated partnership in the UAE. Only business income is intended to be brought under the UAE C T Tax and personal income such as employment, interest, rental income and other investment income are kept outside the purview of the UAE C T.
2. Legal Person: All Companies and other legal persons incorporated in the UAE shall be taxable under the proposed UAE C T. Further, foreign entities having Permanent Establishment or UAE Sourced Income shall also be taxable under the proposed UAE C T. Also foreign incorporated entities whose effective control lies in the UAE will be considered to be taxable in the UAE. Limited Liability Partnership and similar Partnership firms whereby the liability of the Partner is not unlimited shall be treated as Company and will be prone to the UAE C T. However, other partnerships or unincorporated partnerships shall be accorded the treatment of “flow through” and only the partners shall be liable for the UAE C T on their share of Income from the partnership.
3. Exempt Persons: The following persons are proposed to be made exempt from the UAE C T either automatically or through application mode:
1. The Federal and Emirate Governments and their departments, authorities and other public institutions;
2. Wholly Government-owned UAE companies that carry out a sovereign or mandated activity;
3. Businesses engaged in the extraction and exploitation of UAE natural resources that are subject to Emirate-level taxation;
4. Charities and other public benefit organisations;
5. Public and regulated private social security and retirement pension fund;
6. Investment funds, subject to meeting certain conditions.
4. Government and Government owned entities: While recognising that the Government usually carries out sovereign activities and are therefore outside the purview of the UAE C T but any commercial activity carried out by the Government under a Trade License, the same shall be subject to the UAE C T. Similar treatment will be accorded to any activity carried out through Government owned entities or subsidiaries thereof.
5. Natural Resources: It is proposed under the UAE C T that all income earned by the Government from extraction and exploration of natural resources shall be kept outside the purview of the UAE C T. Further, income earned by Private Companies under the concession agreement granted by the Government shall be exempt from the UAE C T which are subject to emirate level taxation.
6. Charities and Public Benefit Organisations: The proposed UAE C T exempts Charities and Public Benefit Organisation only if such organisations are so approved by the Ministry of Finance against the application made by such organisations.
7. Investment Funds: The UAE CT regime intends to treat UAE and foreign funds that are structured as unincorporated partnerships as fiscal transparent status meaning that the investor in the fund is considered as if the investor has invested in the underlying assets directly and therefore such unincorporated partnership will not be taxed on stand alone basis. Further, regulated investment funds and Real Estate Investment Trusts can apply to the Federal Tax Authority (FTA) to be exempt from UAE CT subject to meeting certain requirements.
8. Free Zones: It is proposed to bring Companies and Branches registered in Free Zones (referred to as “Free Zone Persons”) within the ambit of the UAE C T and shall be liable for annual filing C T Returns but however, keeping in mind the Tax free regime offered by the Free Zones, Free Zone Persons (FZP) shall be taxable at Zero rate subject to the condition that such FZP maintain adequate substance and comply with all regulatory requirements. However, FZP may elect irrevocably at any point of time to be subject to regular C T rate. Some of the transactions and their treatment outlined in the Consultation Document are as under:
1. FZP may benefit from Zero rate C T on income earned on a transaction made with businesses outside UAE or on trading transaction within businesses within the Free Zone or in another Free Zone. Zero rate may also apply on income from some of the regulated financial services directed at foreign market.
2. FZP having branch in the mainland UAE will be taxed on a regular rate on the income from mainland sourced income and while continue to enjoy Zero rate C T on the other Income.
3. FZP not having any branch in the mainland UAE will continue to enjoy Zero rate C T only if the income from the mainland UAE is limited to passive income such as interest, royalties, dividends and capital gains from owning shares in mainland UAE companies.
4. FZP will also continue to enjoy zero CT on transactions with Group Companies located in the mainland UAE subject to that the said transaction will not be allowed as an “Expense” in the hands of the mainland UAE Group Company while subjecting it to the UAE C T.
5. FZP which are located in Designated Free Zones as notified under the Value Added Tax shall continue to enjoy zero rate C T on income from sale of Goods to mainland UAE businesses that are the importer on record of those goods.
6. It is proposed in the Consultation Document that if the FZP has any mainland sourced income which is not specifically allowed as above, then the FZP will stand to lose zero rate C T benefit on all its Income and shall be subject to regular C T rate.
As per the Consultation document, other aspects that must be kept in mind by FZP in order to enjoy zero rate C T are as under:
Permanent Establishment Rules and Principles will apply to FZP to determine if FZP has Permanent Establishment in the mainland.
The principles and rules determining UAE Sourced Income will apply to FZP to determine if FZP has UAE Sourced Income.
Dividends paid by FZP shall be exempt from the proposed UAE C T. However, Capital gains on disposal of shares in FZP shall be exempt from the UAE C T provided that FZP is a holding Company and substantially whole of its income is derived from holding in subsidiaries and also it adheres to the Participation condition.
Further, it is likely that Income from Services rendered to mainland businesses or other Free Zone Persons may fall within the ambit of the UAE C T.
The UAE CT regime will require financial statements of FZP to be audited in order to enjoy Zero rate CT.
BASIS OF TAXATION
As per the proposed UAE C T, residency in UAE will be the key determinant of whether business profits will be subject to UAE CT. The basis and tax treatment to be meted out to the Residents and Non-Residents is set out as under:
Legal Person: Legal Persons incorporated in the UAE shall be automatically considered to be resident in the UAE and shall be taxable for the worldwide income but however, income earned by overseas branches and from qualifying shareholding is proposed to be kept exempt from the UAE C T subject to certain conditions.
Natural Person: All individuals that carry out business or commercial activities in the UAE, whether as sole proprietor or through unincorporated partnership, shall be considered resident of the UAE and shall be taxable for the income from business activities in the UAE.
Foreign Entity: Foreign Entities may be considered as resident of the UAE if its effective control and management lies in the UAE and thus become taxable in the UAE.
Non-Residents will be subject to the UAE C T only if they have Permanent Establishment (PE) in the UAE or if they have income which is sourced from the UAE and the basis for the same is as under:
Permanent Establishment: Non-residents will be taxed on the income of the PE in the UAE and the criteria for determining existence of PE in the UAE is based on the OECD Model Tax Convention. The activity threshold that will trigger existence of PE in the UAE is based mainly on two test one being Fixed Place of Business Test and the other being Dependent Agency Test.
However, specific exemption is provided for foreign investors and investment funds dealing through regulated Investment Managers providing discretionary services in which case PE will not trigger for the foreign investors and the investment funds.
UAE Sourced Income: It is proposed that specific rules and guidance will be laid to determine whether the Income has a source in the UAE. Generally, income received from a UAE resident will be treated as a UAE Sourced Income and shall be subject to zero rate withholding tax for Non-Resident if it does not have PE in the UAE. Other criteria for determining UAE Sourced Income may be if such income is attributed to PE in the UAE or is derived from activities or contracts performed in the UAE or rights used for economic purposes in the UAE or from assets located in the UAE.
The UAE CT regime proposes to use the accounting net profit (or loss) as stated in the financial statements of a business, as the starting point for determining their taxable income. It is proposed that the financial statements should generally adhere to International Financial reporting Standards, but start-ups and small enterprises may be allowed in adopting alternate Accounting Standards. The businesses will be allowed to follow their own accounting period. The Profit or Loss as per the Financial Statements shall be adjusted for certain items that have been specifically allowed or disallowed under the UAE C T to arrive at the Taxable Income. The adjustments proposed are as under:
1. Unrealised gain or loss on Capital Assets: Although financial statements may have recognised unrealised gain or loss on Capital Assets due to change in Value as on the last day of the financial period in accordance with the Accounting Standard but it is proposed that such unrealised gain or loss will be reduced or added back to the Net Profit as per the Financial Statement.
2. Exempt Income: It is proposed that certain Income will be exempt from the UAE C T such as Income from Investments in Other Companies and Income from operations carried outside the UAE through branches or foreign subsidiaries and accordingly such exempt income will be reduced from the Net Profit as per the Financial Statement.
3. Income from Dividends and Capital Gains: It is proposed to exempt dividends paid by the UAE Companies including FZP enjoying zero rate C T. Further it is proposed to exempt dividends from foreign Companies and capital gains on sale of the shares of UAE and foreign companies subject to the participation condition that the shareholding of the UAE Company must be at least 5% in the dividend paying Company and further the foreign Company must be subject to Corporate Tax or equivalent tax at a rate of at least 9%. Also capital gains on disposal of shares in FZP shall be exempt if FZP happens to be a holding Company and it derives substantially whole of its income from such holdings and also complies with the participation condition as above.
4. Foreign Branch Profit Exemption: It is proposed that the UAE Companies can either elect irrevocable to be exempt on the profits of the foreign branches subject to the condition that the foreign branch is sufficiently taxed in the overseas jurisdiction or may elect to subject the profits of the foreign branch to the UAE C T and claim credit for taxes paid in the foreign branch country.
5. Other Exempt Income: The UAE CT regime will exempt income earned by a non-resident from operating or leasing aircraft or ships (and associated equipment) used in international transportation, provided the same tax treatment is granted to a UAE business in the relevant foreign jurisdiction under the reciprocity principle.
6. Interest Expense: The UAE CT will limit the deduction of the interest expense to 30% of the Earnings Before Interest, Tax, Depreciation & Amortisation (EBITDA). However, businesses may be allowed to deduct up to a certain amount of net interest expenditure (safe harbour or de minimis amount) irrespective of the interest deductibility limit based on the EBITDA rule. Further, this limit will not apply to businesses carried on by individuals and also to certain types of businesses like banks or insurance.
7. Related Party Payment to FZP: No deduction will be allowed to Related Party for payment made to FZP enjoying Zero rate CT.
8. Entertainment Expense: The UAE CT will allow only 50% of the expense incurred on entertainment of the customer, supplier etc.
9. Other Deductions: The UAE CT will not only any deduction for penalties paid, UAE VAT recoverable or donations paid to unapproved charities.
The UAE CT proposes to allow carry forward of losses incurred by the business to indefinite period and allow set off against the profits in the ensuing periods subject to maximum set off of 75% of the Profit during a tax period. The losses can be carried forward subject to the condition that 50% of the shareholder continue to be shareholder during the period when loss was incurred and when the loss is being set off against the profits. However, even if there is change in the shareholding for more than 50%, the losses can still be carried forward if there is continuity in the same nature of the business. Losses for the prior period of UAE CT becoming effective will not be allowed to be carried forward nor losses pertaining to exempt income will be allowed to be carried forward. FZP enjoying zero rate CT cannot carry forward the losses.
UAE Group Companies may elect to form a tax group and be treated as a single taxable person if the parent company holds at least 95% of the share capital and voting rights of its subsidiaries. To form a tax group, neither the parent company nor any of the subsidiaries can be an exempt person or a Free Zone Person that benefits from the Zero
CT rate, and all group members must use the same financial year. Various other reliefs are proposed for transfer of losses or assets or liabilities amongst the group companies where at least 75% of the shareholding is commonly owned. Similar relief is proposed in terms of restructuring of the businesses by way of mergers, demergers etc.
The UAE CT will have transfer pricing rules based on the “arm’s length” principle for transactions and arrangements between the Related Party and with Connected Persons. The businesses will have to demonstrate that the transactions with Related Party or with Connected Persons are on Arm’s Length basis and have been incurred wholly and exclusively for business purposes.
Related Party: Related Party have been defined to mean whereby 50% or more of the ownership or control of the UAE taxable entity lies with the transacting person either alone or along with related party and whether directly or indirectly. As regards individual, it is to the fourth degree of kinship or affiliation, including by birth, marriage, adoption or guardianship.
Connected Persons: Since natural persons have been exempted from personal income such as salary income or interest income, there exists possibilities of shifting of income from taxable entities to related or connected individuals who enjoy exemption on such income from the UAE CT and in order to plug the loophole, the UAE CT regime will have the concept of “Connected Persons”. Connected Persons in relation to the UAE entity have been defined to mean as under:
1. An individual who directly or indirectly has an ownership interest in, or controls, the taxable person;
2. A director or officer of the taxable person;
3. An individual related to the owner, director or officer of the taxable person to the fourth degree of kinship or affiliation, including by birth, marriage, adoption or guardianship;
4. Where the taxable person is a partner in an unincorporated partnership, any other partner in the same partnership;
5. A Related Party of any of the above.
CALCULATION OF C T LIABILITY:
The UAE CT regime proposes to levy tax on annual taxable income calculated after adjustments as stated above as under:
Although the UAE CT proposes withholding tax, but it is proposed at Zero rate and also since it is at zero rate, no withholding tax returns is required to be filed. Withholding tax under the UAE CT will apply on the following transactions:
1. Payment made to Non-residents by a UAE Entity on UAE sourced Income;
2. Payment made by mainland UAE Company to FZP as mainland sourced Income;
3. Distribution of dividends or other profit distribution to mainland UAE shareholder by FZP enjoying zero rate CT.
FOREIGN TAX CREDIT:
The proposed UAE regime will allow foreign tax credit wherever income from overseas operations is being clubbed for the UAE CT purpose and UAE CT is being levied on the same. Foreign Tax Credit will be limited to the amount of tax payable under the UAE CT on such income from foreign operations.
REGISTRATION AND FILING OF TAX RETURNS:
Every business subject to the UAE CT will require to be registered with FTA and obtain Tax Registration Number with the prescribed period. Further, tax return will be required to be filed within nine months of the end of the tax period along with the payment of the tax due thereon. There will be no requirement of provisional advance tax payment.
The UAE CT regime proposes self-assessment principle but however, FTA may review the tax returns filed and issue amended assessment order within the time prescribed under the legislation. The same can be challenged by the tax payer under the process as may be prescribed.
The UAE CT regime also has provision for the businesses seeking clarification from FTA on a transaction which is proposed to be entered and the applicability of the UAE CT on such transactions. The clarification so issued by the FTA shall remain bound on FTA subject to that there is no change in the facts as were submitted.
The Government of UAE is expected to soon promulgate legislation on the above lines and issue further rules and guidelines for clarity and implementation of the same.
However, all businesses considering setting up their businesses in the UAE or the existing businesses in the UAE may take note of the information as contained in the Consultation Document and can evaluate the likely impact of the proposed UAE CT on their businesses.