United Arab Emirates Introduces Corporate Tax System
The Ministry of Finance of the United Arab Emirates (UAE) announced on January 31, 2022, the implementation of a federal Corporate Tax ("CT") on corporate earnings commencing with the financial year of June 1, 2023. Prior to the announcement of the CT law, the Ministry of Finance released a consultation paper (the "Consultation Document") to gather and evaluate the comments of stakeholders about the most notable characteristics of the legislation and its implementation.
The UAE lacks a federal CT regime at present. Tax decrees at the Emirate level decide what corporate tax in the UAE is. Currently, the UAE exclusively charges corporation tax on oil and gas firms
and international bank branches at the emirate level. In addition, the UAE is home to more than 40 free zones, each with its own set of laws and restrictions. Such zones often provide substantial tax advantages to enterprises formed within them, making the UAE an appealing tax destination. Additionally, employment-based income is not subject to income tax in the UAE.
Fundamental Aspects of the Corporate Tax in the UAE
CT will be charged to companies based in the UAE. This includes LLCs, PSCs, PJSCs, and any other legal entity with its own legal personality, such as LLPs and partnerships limited by shares.
In accordance with tax policies in other jurisdictions, CT will be imposed on foreign legal entities that:
- (i) Have a permanent establishment ("PE") in the UAE, and that produces UAE-sourced revenue;
- (ii) Are tax residents in the UAE by virtue of management and control.
For corporate tax in the UAE purposes, unincorporated partnerships and other unincorporated businesses will be considered "transparent." The income of such businesses can be taxed at the partner or member level. In order to address differences in the categorization of partnerships (transparent vs opaque) in various jurisdictions, the UAE will defer to the tax treatment of international unincorporated partnerships in the appropriate foreign jurisdiction.
Additionally, companies and branches established in free zones
will be subjected to the CT system and will be required to file tax returns. In order to respect current tax arrangements inside free zones, such entities will be subject to a 0% CT rate, providing they retain sufficient substance and meet all regulatory criteria. Where a free zone person transacts with mainland in the UAE but does not operate a branch on the mainland, the free zone person may continue to enjoy the 0% CT rate provided its revenue from mainland UAE is confined to "passive" income (meaning interest and royalties, and dividends and capital gains from owning shares in mainland UAE companies).
The 0% CT rate will also apply to transactions between free zone firms and their UAE mainland group corporations. However, payments by a mainland group firm to free zone companies are not tax deductible. In addition, the Consultation Document notes that, in order to prevent free zone businesses from gaining an unfair competitive advantage compared to businesses established on the UAE mainland, any other mainland-sourced income will disqualify a free zone individual from the 0% CT regime for all income. Once the draft legislation is published, we anticipate that free zone-registered entities will need to review their current status and determine whether they will continue to enjoy tax exemptions or if their position will change due to the corporate tax in the UAE.
Naturally, people will not be required to pay income tax if they do not participate in business or commercial activity in the UAE. The CT system applies to taxable natural people doing business in the UAE via sole enterprises, proprietorships, or as individual partners in an unincorporated partnership. The Consultation Document states that employment-based income earned in the UAE will continue to be exempt from income taxation.
CT will be assessed on a company's yearly taxable revenue as follows:
- 0%, if the taxable income does not exceed AED 375,000;
- 9% for income in excess of AED 375,000; and
- a different tax rate (not yet specified) for large multinationals that meet specific criteria set with reference to Pillar II of the OECD BEPS. Given the Consultation Document's emphasis on the UAE's commitment to implementing the BEPS 2.0 measures, we anticipate that the rate will be set with reference to the rate ultimately determined by the OECD.
The entities on the following list will be exempt from corporate tax, either automatically or upon application (the process is currently unknown):
- the federal UAE Government and Emirate Governments, as well as their respective ministries, agencies, and other governmental entities;
- firms completely owned by the UAE government that engage in a sovereign or mandated activity and are mentioned in a cabinet resolution;
- Businesses involved in the extraction and exploitation of UAE’s natural resources that are subject to taxes at the Emirate level (such as upstream oil and gas firms);
- Charities and other public benefit organizations mentioned in a Cabinet Decision made by the Ministry of Finance at the request of the appropriate organization;
- governmental and privately administered social security and retirement funds;
- Typically, investment funds are structured as "flow-through" limited partnerships. . In addition, regulated investment funds and Real Estate Investment Trusts may apply to the FTA for exemption from CT if they fulfill certain standards.
As previously mentioned, tax residence is a deciding element in whether corporate earnings are subject to corporate tax in the UAE. To achieve its purpose of obtaining clarity, the UAE determines tax residence based on international criteria.
According to the Consultation Document, a legal entity established in the UAE would be immediately regarded as a "resident" for UAE tax purposes. Similarly, any natural person participating in a business or commercial activity in the UAE, whether in their own name or via an unincorporated partnership, will likewise be deemed a resident person for the purposes of the UAE's corporate tax law. A foreign firm can be considered a resident if it is successfully "managed and controlled" in the UAE. This will be an issue of fact; however, the Consultation Document suggests that this will "usually examine where the directors or other decision makers of the firm make the most important management and commercial decisions.
Legal entities with UAE residency will be taxed on their international revenue. Natural people will only be taxed on income received from their UAE-based commercial activity. However, some income received abroad, including revenue from international branches and qualified foreign shareholdings, will be free from corporate tax in the UAE. In cases when foreign income is not excluded from UAE taxation, foreign income taxes might be credited against the UAE tax due on the same income to avoid double taxation.
Non-residents are liable to UAE CT on taxable income
- (i) derived from a permanent establishment in the UAE
- (ii) sourced in the UAE
According to the Consultation Document, the legislation will relate to the concept of PE stated in Article 5 of the OECD Model Tax Convention, and overseas enterprises and advisers will be able to rely on OECD Commentary when determining whether they have a PE in the UAE. Thus, the presence of a PE in the UAE will be decided by whether the non-resident person has a "permanent place of business" or a "dependent agent" who regularly exercises the capacity to enter into contracts on their behalf.
Significantly, the Consultation Document notes that the UAE CT regime will permit regulated UAE investment managers to provide discretionary investment management services to foreign clients without triggering a UAE PE for the foreign investor or foreign investment fund – this investment management exemption will be "subject to conditions comparable to regimes in leading financial centers.
Calculating Taxable Income
As a starting point for the calculation of the taxable income, the UAE CT regime proposes to utilize the accounting net profit (or loss) position in the financial statements of a corporation. IFRS standards are the norm for UAE enterprises and will serve as the foundation for this evaluation, although the corporate tax legislation will permit the adoption of other financial reporting standards.
Exemptions & Deductions
The CT statute will contain a participation exemption for dividends and capital gains from the sale of shares of a subsidiary firm. The UAE tax system would exclude all domestic dividends collected by the UAE enterprises, including dividends paid by a free zone-registered company that enjoys a 0% tax rate. To qualify for the participation exemption, the UAE shareholder firm must possess at least 5 percent of the shares of the subsidiary business. This participation requirement is comparable to that of other countries. For instance, the participation exemption in the United Kingdom (the "substantial shareholding exemption") requires the shareholder to hold at least 10% of the ordinary shares in the subsidiary for at least 12 months in a row.
To remain an attractive tax destination for international enterprises, the UAE will let foreign branches of UAE companies to either
- (i) claim a foreign tax credit for taxes paid in the foreign branch country,
- (ii) decide to claim an irreversible exemption for their foreign branch earnings
Interest and other financing expenses will be tax-deductible. In accordance with Section 4 of the OECD BEPS project, the deductibility of interest will be capped at 30% of a business' earnings before interest, tax, depreciation, and amortization (EBITDA) in order to discourage businesses from using excessive levels of debt financing (as opposed to equity financing) in pursuit of a tax benefit. The restrictions limiting interest rates will not apply to banks, insurance companies, and other financial service providers.
In accordance with worldwide best practices, a company will be entitled to offset a loss sustained in one period against the taxable income of subsequent periods up to a maximum of 75% of the taxable income in each future period.
Tax losses can be carried forward indefinitely if the same shareholders retain at least fifty percent of the share capital from the beginning of the period in which a loss is incurred till the end of the period and is offset against taxable income.
If the parent business retains at least 95% of the share capital and voting rights of its subsidiaries, a group of UAE-resident corporations will have the option to create a tax group capable of being considered as a single taxable person (or a fiscal unity). To create a tax group, neither the main firm nor any of its subsidiaries will be the exempt person or a free zone entity enjoying the 0% corporate tax rate, and all group members must refer to the same fiscal year. For other groups of firms that do not satisfy the 95% criteria, the CT regime will permit the transfer of losses across group companies if at least 75% of the companies are held in common.
In line with the principles of the OECD Transfer Pricing Rules, transfer pricing rules will apply to transactions between related and linked parties. Therefore, transactions between related or affiliated parties must be performed with complete independence.
Large company groups, especially family-owned conglomerates with international activities may need to reconsider their group structures and review their intra-group transactions from a transfer pricing viewpoint to guarantee that their transactions are really performed under the laws.
As mentioned before, UAE-resident firms are liable to corporate tax in the UAE on their global revenue, which includes foreign-sourced income that may have been subject to a tax of a comparable sort in another nation. To prevent double taxation, the UAE CT system will offer a credit for a foreign tax paid in a foreign jurisdiction against the UAE CT obligation on non-exempt foreign-source income.
A company subject to corporate tax must register with the FTA and get a tax identification number within a legally stipulated timeframe. If a company owner does not voluntarily register for CT reasons, the FTA has the authority to register the firm automatically. In order to reduce administrative efforts and expenses, firms will only be required to prepare and submit one tax return (and necessary supporting schedules) with the FTA every tax period. Within nine months following the end of the applicable tax period, a CT return must be submitted and any CT payment paid.