In the fifth and final part of a series on the introduction of corporate tax in the United Arab Emirates, Parwin Dina of Global Tax Services highlights some of the key aspects of the recently issued law.
On Dec. 9, 2022, the United Arab Emirates issued the Federal Decree-Law No. (47) of 2022 on the taxation of corporations and businesses, the CT Law. The CT Law will apply for financial years starting on or after June 1. In this article, we highlight some of the key aspects of the new law.
While the new tax is referred to as “corporate tax” it does not just apply to companies. Under Article 12 of the CT Law, individuals (whether resident or not) are subject to corporate tax on their income derived from a business activity carried on in the UAE.
Resident companies are subject to CT on their worldwide taxable income (subject to certain exemptions—see below), while nonresident companies are taxed under Article 11(4) of the CT Law if:
· They have a permanent establishment (PE) in the UAE;
· They have income sourced from the UAE; or
· They have a nexus with the UAE.
Although Article 13 of the CT Law comprehensively defines income sourced from the UAE, Article 45 applies withholding tax at a 0% rate to UAE source income that is not attributable to a PE.
The actual PE definition in Article 14 of the CT Law is relatively standard and includes the usual “fixed place of business” in the UAE requirement as well as dependent agents.
Many jurisdictions also deem there to be a PE if services are provided in a jurisdiction for a certain period in any 12-month period; however, the CT Law does not include a services PE. Oman for instance, deems there to be a services PE if a foreign person provides consultancy services or any other services in Oman for a period of at least 90 days in any 12-month period.
While on first glance the absence of a services PE can be extremely attractive for nonresidents providing services in the UAE, the inclusion of other nexus requirements in the CT Law is interesting.
More details as to what constitutes a taxable nexus in the UAE are to be provided in a Cabinet Decision; this could significantly widen the scope of the CT Law.
The CT rates are provided in Article 3 of the CT Law as 0% up to a prescribed threshold and 9% on taxable income above this. While the CT Law provides that the 0% threshold will be stated in a Cabinet Decision, the FAQs on the CT Law issued by the Federal Tax Authority states that this is to be 375,000 UAE dirham ($102,000).
Interestingly, the original CT consultation document stated that there would be a different tax rate for large multinational enterprises that met specific criteria set with reference to Pillar Two of the Organisation for Economic Cooperation and Development BEPS 2.0 project. This has not been included in the current CT law, and the FAQs confirm that the general CT regime will apply to MNEs. If Pillar Two is implemented internationally, UAE entities could be subject to significant top-up tax under Pillar Two if the low headline CT rate were unchanged.
Article 3 of the CT Law provides that free zone entities are taxed at a 0% rate on their qualifying income. Qualifying income is not defined in detail in the CT Law.
Various conditions need to be met to qualify for the beneficial free zone tax treatment, including maintaining adequate substance, and not electing to be subject to CT.
Importantly, Article 18 of the CT Law requires a qualifying free zone person to apply the arm’s-length basis to related party transactions and comply with transfer pricing documentation requirements. As such, free zone entities will need to ensure they can correctly identify related party transactions and comply both with the arm’s-length basis requirements and have the documentation to support such transactions if they wish to continue to benefit from the 0% CT rate.
Nevertheless, a number of key aspects relating to the tax treatment of free zone entities remain unaddressed, including the definitions of qualifying income and adequate substance, and the treatment of transactions between entities located in free zones and the UAE mainland.
While existing free zone entities benefit from a tax holiday from the date of incorporation, after June 1 they will need to ensure they comply with the provisions of the CT law to continue to benefit from a 0% CT rate.
The CT Law includes both entity level tax exemptions as well as exemptions for certain types of income. Entity level exemptions include government entities, extractives and natural resource businesses, public benefit entities, investment funds, and public pension funds.
Article 22 of the CT Law provides for certain income streams to be specifically exempt from CT. This includes:
· Dividends from any resident company;
· Dividends from a foreign company where the UAE resident holds at least 5% of the ownership interest for at least 12 months and the foreign company is subject to a foreign corporate income tax rate of at least 9% (unless the UAE company can meet certain requirements to establish itself as a holding company); and
· Capital gains on shares and other ownership interests as well as qualifying foreign exchange gains and impairment gains.
The lack of withholding tax on outgoing dividends, and the CT exemption for domestic dividends and qualifying capital gains and foreign dividends, therefore provide a number of highly tax efficient structuring opportunities that businesses with activities in the UAE may wish to consider.
The 5% ownership requirement is particularly attractive internationally, given many jurisdictions (for example, Portugal, Poland, and Germany) apply a 10% holding requirement.
Additionally, although resident companies are subject to CT on their worldwide income, Article 24 of the CT Law introduces an element of territoriality and provides for a foreign PE exemption election. Where this election is made, profits and losses of a foreign PE are excluded from the scope of UAE CT. The election is only available where the PE is subject to foreign tax at a rate of at least 9%. A key point to take into account when considering this election is that it applies to all PEs. As such, a UAE resident that is considering making this election should carefully consider the impact of not being able to claim loss relief for PE losses in the UAE, or any foreign tax credit relief.
As in many corporate income tax systems, the CT Law includes provisions to enable tax efficient corporate restructuring. This includes:
· An exemption from CT on capital gains from transfers of assets within a qualifying group; and
· A CT exemption where a company transfers its entire business or an independent part of its business to another taxable person in exchange for shares or other ownership interests.
Under Article 37 of the CT Law tax losses can be carried forward for offset against up to 75% of future taxable income. There is no provision for a loss carry back.
Importantly, there is no time limit for the loss carry forward—unlike Oman, for instance, which has a five-year limitation on losses carried forward. However, this is tempered by the fact that the loss relief itself is restricted to 75% of the future taxable income, whereas Oman has no such restriction.
The CT Law provides that resident entities can apply to form a tax group where a 95% direct/indirect ownership requirement is met. This then treats the group as a single taxable person with consolidated taxable income and intra-group transactions eliminated. This is a welcome provision to ease tax compliance for resident groups.
To form a group, both the parent and the subsidiaries need to be UAE-resident entities. Where there are a number of UAE entities held by a foreign company, a tax group could not be formed, unless additional tax structuring was undertaken.
It should be noted that as the group is treated as a single taxable person, the group would lose the benefit of multiple 0% thresholds (currently proposed to be 375,000 UAE dirham) and instead would benefit from only one.
Foreign Tax Credits
Article 47 of the CT Law provides for a tax credit for foreign tax suffered on income subject to UAE CT. As is pretty much universally the case, the tax credit is limited to the UAE tax on the income.
The UAE foreign tax credit is relatively simple in its application and does not require basketing of income (i.e., separate categorizing of income according to its type with each having specific limitations) nor does it have complex sourcing rules, as the US does, for instance.
Excess foreign tax credits that cannot be offset against a current year CT liability will be lost. The UAE approach is in line with Oman, which also does not allow excess foreign tax credits to be carried forward or back, whereas Egypt, for instance, provides for a carry forward.
As is the case in many jurisdictions, the UAE includes specific anti-avoidance rules to target excessive interest deductions, in Articles 29-31 of the CT Law. While there is no thin capitalization rule, it does apply both a general and a specific interest deduction limitation rule. This approach is different from certain other Middle Eastern jurisdictions. Oman, for instance, applies a thin capitalization rule where the debt–equity ratio exceeds 2:1 and Qatar has a 3:1 debt–equity thin capitalization requirement.
The general interest deduction limitation rule provides that businesses with net interest expenditure above a certain threshold (not yet determined) can deduct net interest expenditure up to 30% of their earnings before interest, tax, depreciation and amortization (EBITDA), excluding any exempt income. Net interest expenditure which exceeds this limit may be carried forward and utilized in the subsequent 10 tax periods.
The 30% interest-to-EBITDA requirement is very common internationally, with numerous jurisdictions applying a similar rule—for example, Luxembourg, Korea, Italy and Germany.
The specific interest deduction limitation rule provides that where a loan is obtained from a related party and is used to finance certain income that is exempt from CT (for example, dividends), the interest on the loan will not be deductible unless the taxpayer can demonstrate that the main purpose of obtaining the loan and carrying out the transaction is not to gain a CT advantage. It is deemed that there was not a CT advantage where the interest receipt is taxed at a rate of at least 9% in the corresponding foreign jurisdiction.
Given interest represents a significant tax deduction for many taxpayers, this is an area that should be carefully considered.
Chapter 10 of the CT Law introduces transfer pricing requirements for transactions between related parties and requires the application of the arm-length basis.
The CT Law requires both master file and local file documentation to be retained by taxpayers and sent to the FTA on request; however, further information on when this is required (any thresholds) and the nature of the documentation, will be provided in a Cabinet Decision. The CT Law also states that UAE businesses may be able to apply for advance pricing agreements. Additional guidance is expected from the FTA in regard to this.
It should be noted that the transfer pricing requirements apply to transactions with both resident and nonresident related parties. Therefore, purely UAE domestic groups will need to ensure they correctly identify, value, and document transactions with other related UAE entities.
At this stage, taxpayers should consider the impact of the CT Law on their operations, including whether there are opportunities to restructure to minimize tax leakage, and the potential impact of CT elections such as the foreign PE election.
When considering restructuring, consideration should be given to the general anti-avoidance rule in Article 50 of the CT Law, which targets transactions that are entered into that do not reflect economic reality, and the main purpose of which is to gain a tax advantage. As this applies from the issuance of the CT Law, it is therefore already effective and will need to be considered for any pre-implementation restructuring.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Parwin Dina is Global Tax Leader, Global Tax Services. The comments in this article are for general information and are not intended as advice. Readers should seek professional advice where relevant.
The author may be contacted at: email@example.com