The UAE’s Ministry of Finance (MoF) is seeking public input on the proposed Corporate Income Tax (CIT) implementation.
On 28 April 2022, the UAE Ministry of Finance (MoF) issued a public consultation paper on the proposed UAE corporate tax (CIT) regime. The consultation paper is released to obtain input from interested parties.
The consultation paper does not represent the final legislation and cannot be relied upon to make individual or commercial decisions.
The consultation period lasts for three weeks, from 28 April 2022 until 19 May 2022.
At a glance:
As the UAE MoF recognizes the importance of consultation with the business community and interested stakeholders and is launching this initiative before the final legislation is released, the consultation paper outlines the rationale for a federal CIT regime and fundamental principles. The covered key vital areas on the proposed CIT include the following:
- Taxable persons
- Basis of taxation
- Calculation of taxable income and CIT liability
- Tax Groups
- Withholding taxes
- Transfer pricing
As emphasized by the MoF, the information contained in the consultation paper serves solely as guidance and could be subject to change based on the feedback received.
We have summarised below some of the critical aspects revealed in the consultation paper and the intention/direction of the MoF.
Based on the consultation paper, all-natural persons will be subject to tax to the extent they are engaged in a business or commercial activity in the UAE. UAE CIT will apply to all UAE companies and legal persons incorporated. The definition of legal persons includes foreign legal persons with a permanent establishment (PE) in the UAE or effectively managed and controlled in the UAE, in line with international practice.
Limited and general partnerships will be treated as transparent for UAE CIT purposes, meaning their income will flow through and be taxed in the hands of the partners or members only. This will also apply to investment funds organized as limited partnerships. Where none of the partners has unlimited liability for the partnership’s obligations or other partners’ actions, the partnership will be subject to UAE CIT in the same manner as a UAE company.
In addition to businesses engaged in the extraction and exploitation of UAE natural resources, the UAE government and its wholly UAE entities are exempt from UAE CIT concerning sovereign or mandated activities (i.e. activities that are non-commercial).
Charities and Public Benefit Organisations can apply to the MoF to be exempt from UAE CIT as long as they do not undertake any commercial activities per se.
Regulated investment funds and real estate investment trusts (REITs) can apply to the Federal Tax Authority (FTA) to be exempt from UAE CIT subject to meeting specific requirements (listed in the consultation paper).
Free Zone entities
The 0% CIT rate applies to income earned from transactions with businesses outside the UAE, in the same Free Zone, or any other Free Zone. A Free Zone entity earns any mainland sourced income that is not passive (i.e interest, royalties, dividends, capital gains, etc.). All its income will be disqualified from the 0% CIT regime. As an exception, a 0% tax rate will apply on income earned by a Free Zone entity located in a designated zone for value-added tax from the sale of goods to UAE mainland businesses that are importers of record of those goods.
Transactions between Free Zone entities and their group entities located in mainland UAE will be subject to 0% tax; however, the associated payments made by mainland entities will not be deductible for UAE CIT purposes. This will not apply to transactions between UAE mainland entities, and a UAE mainland branch of a Free Zone entity, as the latter should be subject to UAE CIT at the applicable rates.
A Free Zone entity can make an election to become subject to regular CIT in the UAE. Such an election is irrevocable.
Basis of taxation
The UAE CIT system will be a residence-based CIT regime that taxes the worldwide profits of UAE resident businesses and only the UAE-sourced business income of non-residents. Where a business is resident for CIT purposes would be determined based on the place of incorporation or the place of effective management and control of the business. For non-residents, taxation will depend on whether they create a PE in the UAE (definition in line with Article 5 of the OECD Model Tax Convention) and whether they derive UAE sourced income (subject to withholding tax at 0%).
A Free Zone entity could create a PE in mainland UAE under the same principles.
Regulated UAE investment managers may provide discretionary investment management services to foreign customers without triggering a PE in the UAE for the investor or the foreign investment fund, subject to meeting certain conditions.
Calculation of taxable income and CIT liability
UAE CIT will be payable on the accounting net profit (loss) as stated in the financial statements, subject to certain adjustments. In addition to International Financial Reporting Standards (IFRS), consideration is being given to allowing alternative financial reporting standards.
Unrealized gains or losses
A distinction should be made as to whether these relate to capital items or revenue items, where the latter should be taken into account when calculating taxable income.
Participation exemption will apply to dividends and capital gains earned by UAE entities.
Dividends earned from UAE companies (including Free Zone companies) will be exempt from UAE CIT.
Dividends from foreign companies and capital gains from disposals in UAE and foreign companies will be exempt from UAE CIT subject to a 5% ownership threshold. The foreign company is taxed at a rate of at least 9%.
Income of foreign branches
UAE companies can either claim a foreign tax credit for tax paid by their foreign branches in the foreign jurisdiction or elect to claim an exemption for their foreign branch profits. The election to claim an exemption applies to all foreign branches of the UAE company and is irrevocable. The exemption might not be available if the foreign branch is not subject to sufficient tax in the foreign jurisdiction.
Income earned by a non-resident from operating or leasing aircraft or ships (and associated equipment) used in international transportation will be exempt from UAE CIT, provided the same tax treatment is granted to a UAE business in the relevant foreign jurisdiction.
Expense deduction limitations
Deductibility of interest expense is limited to 30% of EBITDA. Businesses may be allowed a deduction up to a safe harbour / de minimis amount irrespective of the EBITDA limitation. These rules will not apply to financial services entities. Related party interest should be set at arm’s length with a valid commercial reason to be deductible. This can be satisfied if the related party lender is subject to at least 9% tax on the interest income earned.
Payments made to Free Zone entities from related UAE mainland entities will not be deductible.
Entertainment expenses will be deductible up to 50%.
Penalties, recoverable VAT, and donations (paid to an organization that is not an approved charity or public benefit organization) will not be deductible.
Tax losses can be carried forward indefinitely (with offset limited to up to 75% of each year’s taxable income) provided no change in ownership of more than 50% occurs. If more than 50% ownership change occurs, tax losses can still be carried forward only if the new owner carries out the same or similar business. These conditions do not apply to listed businesses.
Losses incurred before the effective date for CIT or before a person becomes a taxpayer in the UAE will not be available for future periods. Similarly, losses generated concerning an exempt income and losses incurred by a Free Zone entity not attributable to a mainland PE will not be available for future periods.
Foreign tax credits are available subject to certain limitations. It will not be possible to carry forward or back any unutilized tax credits or apply for a refund.
A UAE resident group of companies can elect to form a tax group if the parent company holds at least 95% (direct and indirectly through other subsidiaries) of the subsidiaries’ share capital and voting rights. A UAE branch of the parent or one of the subsidiaries can also be part of the tax group. All entities (including the parent) should be subject to CIT in the UAE and have the same financial year to form a tax group.
Transfer of losses
Companies that do not meet the 95% common ownership requirement or do not want to form a tax group can transfer tax losses to each other as long as they are at least 75% commonly owned. No loss transfers will be allowed from exempt companies or those that benefit from a 0% Free Zone CIT regime.
Transfer of assets and liabilities between UAE resident companies at least 75% commonly owned can be undertaken tax neutrally, provided the assets/liabilities transferred remain within the same group for three years (carryforward period). Where the relief is claimed, the relevant assets/liabilities should be recognized at net book value.
Certain restructuring transactions (e.g. mergers, spin-offs, etc.) can also be undertaken tax neutrally. A three-year carry forward period will apply in case of a subsequent transfer to a third party.
As listed in the consultation paper, specific income streams will be subject to a 0% withholding tax. There will be no obligation to make deductions or file associated withholding tax returns.
Transfer pricing (TP)
The UAE introduces TP regulations, which means that qualifying Related Party transactions and transactions with Connected Persons (“intercompany transactions”) will need to comply with the applicable transfer pricing requirements, according to the arm’s length principle as set out in the OECD Transfer Pricing Guidelines. The announcement further enlists a set of criteria for defining both concepts of “Related Parties” and “Connected Persons”.
Where the value of the related party transactions exceeds a threshold (to be specified) during the relevant tax period, qualifying businesses will also need to prepare a Local File and Master File (according to the format and content prescribed under OECD BEPS Action 13). Also, the arm’s length nature of the intercompany transactions will need to be supported using either internationally recognized TP methods or a different method. The business can demonstrate that the specified methods cannot be reasonably applied.
Additionally, where conditions are met, businesses will be required to prepare and submit a TP disclosure form containing information regarding their intercompany transactions. It remains to be seen whether the TP disclosure form would need to be submitted simultaneously as the tax return (i.e. within nine (9) months of the end of the relevant tax period) or a different deadline.
The intention is that there will be simplified reporting for small and medium businesses.
The CIT return and payment will be due within nine months after the end of the relevant tax period. One tax return will need to be filed, and one CIT payment will be made. It is also possible to request a CIT refund from the FTA.
The period during which the FTA can issue assessments will be according to the Tax Procedures Law (within five years from the end of the relevant tax period, which may extend to 15 years in case of tax evasion or non-tax registration). Similar treatment will apply for challenges submitted by taxpayers.
Businesses can submit clarification requests regarding certain tax positions to the FTA. Provided the facts and circumstances outlined in the clarification request continue to apply, such clarification would bind the FTA.
There is a requirement to maintain financial and other records by taxpayers. This will also apply to certain exempt persons.
Audited financial statements are not required for UAE CIT purposes except for Free Zone entities benefiting from a 0% CIT regime.
There is no requirement for UAE businesses to restate their balance sheet upon entering the UAE CIT regime.