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Venture Capital Funds and Corporate Taxation: Finding the Winning Formula

Venture Capital Funds and Corporate Taxation: Finding the Winning Formula

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Introduction

In recent years, the United Arab Emirates (“UAE”) has emerged as a recognized hub for technology and innovation. One of the pivotal drivers of this transformation has been the increase in venture capital (“VC”) activity in the UAE. VC is a form of private equity funding used as a viable alternative to traditional bank financing for new businesses.

VC investments are crucial in nurturing start-ups to scale their operations and promote innovation in key technologies. Although VC funds may well stimulate innovation and growth in the economy, the core mandate of these investment vehicles (like all others) is ultimately to produce satisfactory returns for its underlying investors.

The recent introduction of corporate income tax (“CIT”) in the UAE may significantly impact persons involved in VC funds, both investors looking to deploy capital strategically and maximize returns and entrepreneurs seeking funding for the ‘next big thing’. Due to the international structure of modern investment strategies, it is also important that VC fund stakeholders are sufficiently aware of the international tax implications associated with their investments.

In this article, we discuss some of the nuances VC fund investors must consider going forward as part of the new UAE CIT and international tax landscape.

UAE CIT Law Overview

Broadly, the UAE Federal Corporate Tax Law (“UAE CIT Law”)[1] identifies two types of partnerships, namely:

  1. Incorporated Partnerships: these include limited liability partnerships (“LLP”), partnerships limited by shares, and other types of partnerships where none of the partners have unlimited liability, and
  2. Unincorporated Partnerships: these essentially involve a contractual relationship between two or more persons. The main feature of an unincorporated partnership is that the partners have unlimited liability for the debts and obligations of the unincorporated partnership and its business. Examples include general partnerships (“GP”) and joint ventures (“JV”). We have previously commented on applying this regime for law and professional services firms[2].

A VC fund is typically structured as a partnership, with a general partner responsible for managing the fund’s investments and limited partners providing the capital (the so-called classic GP-LP structure). Limited partners tend to be passive investors who have limited liability, while the general partner is actively involved in managing the fund. Below, we have included a diagram of the common VC fund structure.

Unincorporated Partnership and Fiscal Transparency

As discussed above, one of the primary considerations in characterizing a partnership for UAE CIT purposes is the concept of limited or unlimited liability. In this regard, an incorporated partnership where all partners have a limited liability is relatively straightforward from a UAE CIT perspective. Given the limited liability status of the partnership, it is considered to have a separate legal personality and taxable status, similar to a limited liability company or other juridical person. It is ultimately treated as a juridical person and taxed accordingly under the UAE CIT Law.

More complex is the UAE CIT treatment of unincorporated partnerships (which may involve an incorporated entity where partners have unlimited liability). A partner in an unincorporated partnership is regarded as conducting the partnership’s business as if it were his own, and he is jointly or severally liable for the obligations resulting from being in such arrangement.[3] For this reason, this type of partnership lacks independent legal personality[4] and is considered “transparent” for UAE CIT purposes.

According to Article 16 of the UAE CIT Law, any income derived by a tax-transparent vehicle shall be treated as earned by the underlying investor(s). In this regard, depending on the tax profile (natural persons vs. juridical persons) and tax residence status of the underlying investors, they may be subject to UAE CIT on the income derived from a tax-transparent entity. For example, a corporate investor in a UAE tax-transparent vehicle is subject to UAE CIT on the income to which that corporate investor is entitled. Conversely, a UAE tax resident natural person not conducting a business activity would not be subject to UAE CIT on their portion of the profit earned from the tax transparent entity, in so far as the activities of the unincorporated partnership do not bring a natural person within the scope of UAE CIT[5].

Each partner of an unincorporated partnership would need to assess whether they are within the scope of UAE CIT and, if so, register, prepare, and file annual UAE CIT returns accordingly, based on their portion of the income generated from the partnership. This causes important administrative obligations.

Another significant drawback of a transparent vehicle such as an unincorporated partnership is that they generally cannot claim any benefits under a double tax treaty (“DTT”) in so far as those vehicles do not meet the “liable to tax” criterion under Articles 1(2) and 4 of the OECD Model Tax Convention (“MTC”)[6].

As outlined above, VC structures typically have partners with both limited and unlimited liability. This potentially creates a so-called “partially tax-transparent entity” for UAE CIT purposes since the partnership is only considered transparent with respect to the income attributable to the partners with unlimited liability.

VC Funds and Taxable Person Election

To avoid some of the abovementioned administrative complexities associated with being a ‘transparent’ or ‘partially transparent’ investment vehicle, a VC fund may opt to be treated as a fully taxable person under the UAE CIT Law.[7] One of the benefits of this approach would be that the taxable person would be able to make a substantial claim to the application of rights under a DTT, given that it would be liable to tax. Additionally, this would reduce the compliance burden on individual partners, particularly where they are within the scope of the UAE CIT regime.

While, at first view, this option may seem inefficient from a tax perspective, as it would ensure the full partnership is within the scope of UAE CIT, several potential exemptions are available to a VC fund, as discussed below.

Qualifying Investment Fund

In the first instance, a VC fund may submit an application before the UAE Federal Tax Authority (“FTA”) to be considered exempt from UAE CIT as a Qualifying Investment Fund (“QIF”) where all of the following conditions are met:[8]

  1. The investment fund or the investment fund’s manager is subject to the regulatory oversight of a competent authority in the State, or a foreign competent authority recognized for the purposes of this Article. 
  2. Interests in the investment fund are traded on a Recognized Stock Exchange, or are marketed and made available sufficiently widely to investors. 
  3. The main or principal purpose of the investment fund is not to avoid CIT. 
  4. Any other conditions as may be prescribed in a decision issued by Cabinet at the suggestion of the Minister.

As regards the fourth condition above, we note that a Cabinet Decision was issued[9] (no. 81 of 2023) containing other requirements to be considered a QIF, namely: 

  1. The main business or business activities conducted by the investment fund are investment business activities, and any other business or business activities conducted by the investment fund are ancillary or incidental.
  2. A single investor and its related parties do not own the following: 
    – More than 30% of the ownership interests in the investment fund, where the investment fund has less than ten investors. 
    – More than 50% of the ownership interests in the investment fund, where the investment fund has ten or more investors.
  3. The investment fund is managed or advised by an Investment Manager that has a minimum of three investment professionals.
  4. The investors shall not have control over the day-to-day management of the investment fund.

This exemption is likely to apply to many VC fund structures. However, some criteria (particularly the related party/ownership structure requirements from the Cabinet Decision) may be a potential tension point for certain funds. 

Qualifying Free Zone Person

For those VC funds that may not meet the criteria for a QIF but are established in any of the UAE economic free zones (“FZs”), there is also the possibility to qualify for the 0% beneficial rate available to Qualifying Free Zone Persons (“QFZP”).

Given the continuing discussion regarding the QFZP regime and the prospect of upcoming modifications due to the public consultation on the UAE FZ CIT regime closed last August, we will only briefly summarize the key requirements below. Notably, a FZ person is considered a QFZP for UAE CIT purposes where it meets the following conditions[10]:

  1. It derives Qualifying Income.
  2. Its Non-Qualifying Income does not exceed the prescribed de-minimis requirements.
  3. It is compliant with the arm’s length principle and transfer pricing (“TP”) documentation requirements.
  4. It maintains adequate substance in the UAE.
  5. It does not elect to be subject to CIT (at 9%).
  6. It prepares and maintains audited financial statements.

Important in the context of VC funds is that the income generated from these vehicles will likely meet the definition of income derived from a “Qualifying Activity”[11] (i.e., it would be considered “Qualifying Income”). This is because the “Qualifying Activities” list includes, amongst others, the holding of shares and other securities.[12]

However, another important consideration and potentially critical point for a VC fund is that a QFZP must be a juridical person under the UAE CIT law.[13] Hence, the qualification for the QFZP regime depends on how the VC fund is structured, including assessing whether it has a separate legal personality for tax purposes.

International Tax Considerations

The UAE has more than 140 DTTs with partner jurisdictions[14]. This makes the UAE an appealing destination for VC funds to establish operations and engage in international investment opportunities. As such, it is also very important to consider the implications of the domestic tax treatment of a VC fund from an international tax perspective, particularly whether the VC fund can access benefits under a DTT.

A person can only claim treaty benefits under a DTT when he resides in one of the two Contracting States. One of the key criteria under Article 4 of the OECD MTC for tax residence is that the person is “liable to tax” in the Contracting State. We mentioned previously that a tax-transparent partnership is typically not eligible to claim treaty relief due to non-fulfillment of the “liable to tax” criteria.

For partially or fully tax-transparent entities, it is possible that the underlying investors may be considered tax residents in the UAE (provided they meet the relevant conditions in the DTT) and, therefore, be entitled to treaty benefits. However, tax treaty residence eligibility is subject to complex assessments for the VC fund and its investors.

The difficulty in accessing treaty benefits for tax-transparent entities is one of the key reasons a VC fund may elect to be a taxable person under the UAE CIT Law. However, there is also an argument that a QIF or QFZP would not meet the “liable to tax criteria”. The OECD Commentary on the MTC effectively leaves the interpretation of whether an entity satisfies the “liable to tax” criterion at the discretion of the source jurisdiction.

From our experience, ZATCA in the Kingdom of Saudi Arabia (“KSA”) has historically sometimes rejected claims by UAE FZ entities under the KSA-UAE DTT because they are not liable to tax in the UAE and, therefore, do not meet the residency criteria. Where the VC fund is not considered resident in the UAE, it could result in foreign withholding tax being applied on the payments received at gross, with no domestic credit available, as the VC fund is exempt from UAE CIT or is subject to tax at 0%.

Nevertheless, it is important to consider each DTT and transaction or arrangement on a standalone basis, as in some jurisdictions, a person is considered liable to comprehensive taxation even if the Contracting State does not actually levy any income tax.[15] As such, there may be scenarios where a VC fund can elect to be considered a taxable person and qualify as either a QIF or QFZP such that there is no domestic UAE CIT while maintaining access to treaty benefits.

Conclusions

This article has outlined some potential intricacies that VC funds must consider when determining their “winning formula” under UAE CIT Law. This decision requires a critical evaluation by VC funds of the different options available (transparent vs. opaque, QIF, QFZP, etc.). VC funds must also evaluate the extent of their international portfolio, as well as the tax profile and residency of underlying investors, if they want to continue maximizing investor returns in the changing world of taxation in the UAE.

Summary Table

==

[END NOTES]

[1] Federal Decree Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“UAE CIT Law”).

[2] T. Vanhee, “Impact of UAE Corporate Tax on Law Firms and Professional Services Firms“, https://aurifer.tax/uae-corporate-tax-which-impact-on-law-and-professional-services-firms/, accessed on 2 October 2023.

[3] Article 16(9), UAE CIT Law; Clause 8.2, Corporate Tax General Guide issued on 11 September 2023.

[4] Clause 8.2, Corporate Tax General Guide issued on 11 September 2023.

[5] This is determined by Article 11(6), UAE CIT Law, for which the UAE Federal Cabinet issued Cabinet Decision No. (49) of 2023 On Specifying the Categories of Businesses or Business Activities Conducted by a Resident or Non-Resident Natural Person that are Subject to Corporate Tax. This Cabinet Decision determines that for resident and non-resident natural persons, wages, personal investment income, and real estate investment income are not subject to UAE CIT. For more details on the application of UAE CIT to natural persons, please refer to our previous articles: T. VANHEE, “Tax Implications for Resident and Foreign Investors in the UAE Real Estate”, https://aurifer.tax/tax-implications-for-resident-and-foreign-investors-in-the-uae-real-estate/, accessed on 2 October 2023; T. VANHEE., “CIT in the UAE: The PE Clause for Individuals”, https://aurifer.tax/cit-in-the-uae-the-pe-clause-for-individuals/, accessed on 2 October 2023.

[6] See Paragraph 8.3., OECD Commentary to the OECD Model Tax Convention (“MTC”) on Article 4, which states the following: “Where a State disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not liable to tax and may not, therefore, be considered to be a resident of that State”. This reflects the idea of when a person is covered and is entitled to the benefit of a double tax convention (“DTT”) as specified in Article 1(2) of the OECD MTC (as updated in 2017) as regards wholly or partly transparent entities. Some treaties will, however, specifically note that a partnership is a resident. See Article 4(1)(b) of the DTT between the United States and Luxembourg or Article 4(1) of the DTT between Belgium and Luxembourg

[7] Article 16(8), UAE CIT Law. 

[8] Article 10(1), UAE CIT Law.

[9] Cabinet Decision No. 81 of 2023 On Conditions for Qualifying Investment Funds for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses.

[10] For more details on the QFZP regime, see L. Purcell, “To Qualify or not to Qualify: Analysis and Tax Advisory on the UAE Free Zone Regime, Interaction with Pillar Two, and Beyond”, https://aurifer.tax/to-qualify-or-not-to-qualify-that-is-the-question-the-uae-free-zone-regime-interaction-with-pillar-two-and-beyond/, accessed on 2 October 2023. See also UAE Corporate Tax on Qualifying Free Zone Persons, https://youtu.be/HmjnOAUFm7g, accessed on 2 October 2023.

[11] Ministerial Decision No. 139 of 2023 Regarding Qualifying Activities and Excluded Activities for the Purposes of Federal Decree Law No. 47 of 2022 on the Taxation of Corporations and Businesses. 

[12] Article 2(1)(c), Ministerial Decision No. 139 of 2023. It should be noted, however, that both management services and wealth and investment management services must be subject to the regulatory oversight of the competent authority in the State.

[13] Article 11(3)(a), UAE CIT Law.

[14] UAE Ministry of Finance (MoF), “Avoidance of Double Taxation Agreements” https://mof.gov.ae/wp-content/uploads/2023/08/Avoidance-of-Double-Taxation-Agreements1.pdf, accessed on 2 October 2023.

[15] Paragraph 8.6, OECD Commentary to the OECD MTC on Article 4.

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UAE Corporate Income Tax UAE Tax

Tax Implications for Resident and Foreign Investors in the UAE Real Estate

Tax Implications for Resident and Foreign Investors in the UAE Real Estate

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Real estate is a thriving and dynamic sector within the UAE’s economy. This sector is an important source of foreign direct investment to sustain the UAE’s continuous growth, attracting many investors worldwide each year.

The treatment of income from immovable property under the new UAE Corporate Income Tax (UAE CIT) is, however, complex. An accurate analysis of the impact of UAE CIT on this sector is, therefore, crucial for both UAE and non-UAE individuals and companies to maximise their investment strategies.

The infographics below help you navigate the intricacies of the UAE CIT and its impact on your real estate investment strategy, whether you decide to invest in immovable properties in the UAE mainland or any of the over 40 UAE Free Zones.

Aurifer published a more extensive article on UAE CIT and Immovable Property. You can access and download it here.

Get in touch with our team of experts if you want to maximise your growth strategy by investing in the UAE’s thriving real estate market.

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UAE Corporate Income Tax UAE Tax

UAE CIT and Immovable Property

UAE CIT and Immovable Property

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The treatment of income from immovable property under the UAE Corporate Income Tax (UAE CIT) can be complex.

Income from immovable property, whether derived from rent or sale, may be subject to UAE CIT at rates of 9% or 0%, or it might be exempt, depending on various circumstances.

A 9% UAE CIT rate applies to the income that a UAE company earns from real estate located both within the UAE mainland and outside the UAE’s territory. Conversely, a 0% UAE CIT rate is available in certain situations for income from immovable property located in UAE Free Zones (FZs) when earned by FZ entities recognized as Qualifying Free Zone Persons (QFZPs).

Income from real estate situated outside the UAE, when earned by UAE businesses, is taxable in the foreign country. Additionally, as of 1 June 2023, it is also subject to the UAE CIT. However, double tax relief might be available under double tax treaties (DTTs) that the UAE has concluded with other countries, or based on provisions within the UAE CIT law.

Whether you’re a UAE-based or an international business dealing with real estate in the UAE (either in the mainland or FZs) or abroad, this infographic will guide you through the intricate rules surrounding immovable property income under UAE CIT.

Check below to learn more.

 

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UAE Corporate Income Tax UAE Tax

UAE’s New Tax Procedures Executive Regulations

UAE’s New Tax Procedures Executive Regulations

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The UAE has recently issued Cabinet Decision No. 74 of 2023, impacting its Tax Procedures. This Decision replaces the previous Executive Regulation on Tax Procedures and aligns it with the most recent version of the Tax Procedures Law, which was effective since 1 March 2023 but did not have Executive Regulations yet. The New Executive Regulation shall be effective from 1 August 2023.

The FTA has additionally issued guidance by way of a Public Clarification on Tax Procedures (TAXP006). The Public Clarification aims to highlight the differences between the previous and new Executive Regulations and provides additional clarification on the new provisions.

We have listed what we consider the most notable changes as per the new Executive Regulations:

  • Article 1 – Under the newly expanded definition, the term ‘Assets’ now encompasses not only tangible assets but also intangible assets such as patents, brands, licenses, trademarks, computer programs, copyrights, goodwill and customer lists.

The relevance of the expansion relates to the potential seizing of these assets and record keeping.

  • Article 2 – Businesses have an obligation to maintain “documents supporting the entries in the accounting records and commercial books”. This provision was broad in the new Federal Tax Procedures Law, and its execution was delegated to the Executive Regulations. It is now clear that the obligations include:
  • Business-related documents such as correspondence, invoices, tax invoices, licenses, and agreements/contracts.
  • Documents containing details of any election, determination, or calculation made by a taxable person in relation to its tax affairs, including the basis, method of estimation, determination made, and calculations performed, are required to be maintained.

In other words, this suggests, amongst others, that the working papers to prepare a CT return are also records that the FTA may consult.

  • Documents related to related party transactions and the circumstances under which such transactions were made, including transfer pricing documents, are required to be maintained.

We note, however, that Pillar Two companies and businesses with a turnover of more than 200M AED are already subject to the requirement to prepare a master file and local file under Ministerial Decision No. 97 of 2023. In addition to that, Qualifying Free Zone Persons also need to adhere to transfer pricing principles.

The takeaway here presumably is that no matter the size of the business, when there is a related party transaction, these need to be documented and analyzed. In other words, there seems to be no de minimis rule for related party transactions, which, particularly for SMEs, may pose certain challenges.

We note further that there is no guidance as to what are not considered business records. Do internal emails constitute business records? There seem to be little or no limitations to the audit power of the FTA.

Additionally, there seem to be no limitations to potential fishing expeditions nor to audits with one taxpayer to detect noncompliance with another taxpayer.

  • Article 3 – The New Federal Tax Procedures Law delegated this provision to the Executive Regulations. It specifies that the default record-keeping period is five years as from the year following the tax period to which they relate.

For real estate records, the period is seven years. Article 71(2) of the VAT Executive Regulations still states that it is 15 years, and the Capital Asset Scheme for VAT purposes requires a taxable person to monitor the use of a real estate asset over 10 years’ time. While the Executive Regulations to the Federal Tax Procedures Law could claim the lex posterior principle, it is unclear whether it would be a lex specialis. Irrespective of a potential academic discussion on the matter, it is likely that the law of the lowest common denominator will determine that taxpayers will still keep real estate records for 15 years.

The period for record-keeping is extended in case of an audit, dispute or voluntary disclosure, in line with the extensions of the statute of limitations made in the new Federal Tax Procedures Law.

  • Article 4 – Further contains requirements for the electronic keeping of records.
  • Article 5 – Previously, only documents in Arabic were prescribed for submission to the FTA. However, now taxpayers have the option to submit these documents in either English or Arabic. When submitted in English, the FTA may request a translation.

This provision is essentially legalizing a practice which was currently in existence, where many records were already submitted in English and accepted. The UAE courts system in recent years has been more accepting of the use of English, and the new Civil Procedures Decree-Law No. 42 of 2022 already foresaw the use of English in mainland courts as from 2023 onwards.

  • Article 6 – Businesses that are tax-registered with the FTA are required to promptly notify the FTA of any changes in their e-mail address, trade license, or legal status.
  • Article 7 – All licensing bodies responsible for issuing trade licenses to businesses in the UAE are now required to promptly notify the FTA with essential data and information on each business within 20 business days of the issuance or renewal of the trade license.
  • Article 10 – Taxpayers should submit a voluntary disclosure to rectify errors in the Tax Return, including errors that do not affect the tax due. The Clarification gives the example of imports of services made by a taxable person with a full right to recover input VAT or incorrect Emirates reporting.
  • Article 11 – The FTA can now notify individuals through various means, including text messages on mobile phones, notifications via smart applications, and notifications through the FTA’s electronic systems.
  • Article 12 – A natural person seeking to register as a tax agent must meet the minimum educational requirements and possess relevant experience in tax, accounting, or legal fields as per the new Executive Regulations.

The tax agent is no longer required to be proficient in both Arabic and English, as fluency in either language is now acceptable. Additionally, there is no need to submit proof of medical fitness to perform the duties of the profession.

This change is important and will substantially increase the number of available tax agents and will add to the diversity of available tax agents. There will be further Decisions providing a tighter framework of the tax agent concept. Organisations, i.e., Companies, will also be able to register as a tax agent (this was previously referred to as an “agency”).

  • Article 13 – The New Executive Regulations provides comprehensive guidelines and procedures for both listing and delisting tax agents by the FTA.
  • Article 14 – The New Executive Regulations introduces additional obligations for tax agents in addition to the ones specified in the previous Executive Regulation, such as, for example, meeting continuous development and record-keeping requirements.
  • Article 16 – The New Executive Regulations mandates that the FTA must provide a person with a minimum of 10 business days’ notice before initiating a tax audit. Despite this change, the general procedures, rights, and obligations related to the tax audit remain unchanged and in effect.

The New Executive Regulations do, however, include certain modifications and updates to ensure compliance with the latest tax regulations and practices.

  • Article 17 – Tax audits can be done on data stored electronically.

By conducting tax audits on electronically stored data, the FTA aims to enhance transparency and compliance in tax reporting. It enables the FTA to verify the accuracy of tax returns and ensure that taxpayers are fulfilling their tax obligations in accordance with the law. Having readily available electronic records also reduces taxpayers’ burden during the audit process, as they can provide the required information in a digital format.

The provisions presumably prepare for E-audits and audits of the E-invoicing records under the E-invoicing obligations, which will enter into force in July 2025.

  • Article 22 – A new provision was added in the new Executive Regulations where the FTA is now authorized to sell seized and abandoned goods that are perishable or susceptible to shortage or leakage.
  • Articles 23 & 24 – In cases of tax evasion crimes and deliberate failure to settle administrative penalties, individuals have the option to submit a reconciliation application to the FTA before any criminal proceedings commence. The application is made with the Federal prosecutor.

To be eligible for reconciliation, the person must commit to fully settling the payable tax and administrative penalties owed to the FTA as part of the reconciliation process. This measure allows individuals to rectify their tax-related misconduct and avoid further legal consequences by resolving outstanding tax obligations through reconciliation.

The new Executive Regulations provide additional details and guidance on the procedural aspects of the reconciliation.

  • Article 25 – The new Executive Regulations provide provisions for the extension of deadlines with 20 days for relevant tax assessment review requests, objections, accepting submissions, and reconsideration. The Tax Disputes Resolution Committee may also extend its period to decide on an objection by another 60 days and may even, in exceptional circumstances, accept a late submission of an objection by a taxpayer.
  • Article 27 – Upon the appointment of a bankruptcy trustee, the FTA must inform them about the due tax amount for the business subject to bankruptcy. If required, the FTA will also notify the trustee of its intention to conduct a tax audit for a specific tax period within 20 business days of the trustee’s appointment.

We note further that there is still no manager’s or director’s liability foreseen in the tax procedures law (see our earlier comments here).

The changes in the Executive Regulations are not substantial, and they are not meant to be, as substantial changes would need to go into the law. The changes around tax agents are important, though and will have an important effect on the sector.

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UAE Corporate Income Tax UAE Tax

UAE Releases Cabinet Decision on CT Admin Penalties

UAE Releases Cabinet Decision on CT Admin Penalties

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The Ministry of Finance (“MoF”) published Cabinet Decision No. 75 of 2023, adopted by the UAE’S Federal Cabinet, outlining the Administrative Penalties for Violations of the Corporate Income Tax legislation. This new Decision is set to be effective from August 1, 2023. We’ve incorporate our own insights based on this Cabinet Decision. Read on to know more.

The following penalties apply for different violations related to CT compliance:

  1. Failure to maintain the required records and information will result in a penalty of AED 10,000 for each violation. In case of repeated violations, the penalty increases to AED 20,000.

    These are the same penalties as for VAT and Excise Tax violations.
  1. Non-compliance with the request to submit tax-related data, records, and documents in Arabic will incur a penalty of AED 5,000.

    This is a different penalty than for VAT and Excise Tax violations, where the penalty is AED 20,000.
  1. Failing to submit a deregistration application within the specified timeframe will be penalised with AED 1,000 monthly, with a maximum cap of AED 10,000.

These are the same penalties as for VAT and Excise Tax violations.

  1. Neglecting to notify the authorities of cases that may require amendments to the provided information will result in a penalty of AED 1,000 for each violation. In case of repeated violations within 2 years from the date of the last violation, the penalty increases to AED 5,000.

This is a different penalty than for VAT and Excise Tax violations, where the penalty is AED 5,000 for the first-time violation and AED 10,000 in case of repetition.

  1. Failure of the Legal Representative to provide notification of their appointment within the specified timeframes will be subjected to a penalty of AED 1,000.

This is a different penalty than for VAT and Excise Tax violations, where the penalty is AED 10,000, and the penalty is due from the Legal Representative’s funds.

  1. Failing to file a Tax Return within the timeframes will incur a monthly penalty of AED 500 for the first 12 months and AED 1,000 per month from the 13th month onward, whether by the taxable person is his legal representative.

This penalty is marginally lower than the failure to submit a VAT and Excise Tax return, which attracts a penalty of AED 1,000 for the first violation, and AED 2,000 for any subsequent violations.

  1. Failure to settle payable tax will attract a monthly penalty of 14% per annum.

This somewhat intriguing formulation presumably means that the penalty will be prorated per month, which would result in a monthly penalty of 1.17%. This is comparably high and does more than just compensate for the value of money over time (even with high inflation). It also does not mention the starting date from which the penalty applies, presumably the filing due date of the CT return.

This again is different from VAT and Excise Tax, where the late payment penalty could potentially not apply in case of a Voluntary Disclosure before being notified of an audit and settling the VAT or Excise Tax on time (we note another penalty may be applied though which can range from 5 to 40%).

  1. Submitting an incorrect tax return will result in a penalty of AED 500 (unless corrected before the deadline).

This penalty is again marginally lower than the failure to submit a VAT and Excise Tax return, which attracts a penalty of AED 1,000 for the first violation, and AED 2,000 for any subsequent violations.

  1. Submitting a Voluntary Disclosure related to Tax Return errors will lead to a monthly penalty of 1% on the Tax Difference.

Presumably, this penalty would not apply when the taxable person incurs a loss, and there’s a negative change to the loss (i.e. after correction, there are more tax losses). It will remain to be seen what will happen to a change in loss, where after the correction, there are fewer tax losses (e.g. a company recorded a tax loss of 100, and after correction, it’s only 50). The described situation, in regard to losses, does require the compulsory submission of a Voluntary Disclosure.

The penalty provision is not comparable to VAT and Excise tax, where the equivalent penalty would range from 5 to 40%, and is also time-dependent but structured in a different manner. We encourage readers to check out our webinar, where we covered the 2021 changes to the UAE penalties regime for VAT and Excise Tax.

  1. Neglecting to submit a Voluntary Disclosure in relation to errors in the Tax Return before being notified by the authority will incur a fixed penalty of 15% on the Tax Difference and a monthly penalty of 1% on the Tax Difference.

To write this provision in a positive way, it describes the penalties applicable to a business after it has been notified of an audit and it has not submitted a Voluntary Disclosure.

The penalty provision is not comparable to VAT and Excise tax, where the equivalent penalty would be 50% for violations detected during an audit. For VAT and Excise Tax, there is an additional penalty of 4% per month from the due date of the tax for the relevant tax return until the issuance of the Tax Assessment.

  1. Failing to facilitate the Tax Auditor during the Tax Audit will result in a penalty of AED 20,000.

This provision is the same as for VAT and Excise Tax and is the exceptional stick the FTA will use in case of non-cooperation.

  1. Not submitting or late submission of a Declaration to the Authority will lead to a monthly penalty of AED 500 for the first 12 months and AED 1,000 per month from the 13th month onward.

This may be applicable to a range of requirements, such as the declaration to be filed on behalf of the partners in an unincorporated (transparent) partnership or the declaration to request for an exemption of CT (e.g. for a qualifying public benefit entity, a qualifying investment fund, a public pension or social security fund).

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UAE Corporate Income Tax UAE Tax

New Cabinet Decision Provides Additional Exemption Conditions For QIFs and REITs

New Cabinet Decision Provides Additional Exemption Conditions For QIFs and REITs

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The recently published Cabinet Decision No. 81 of 2023 introduces new conditions for Qualifying Investment Funds (“QIF”) that must be fulfilled to qualify for the CT exemption (aside from the ones under the CT law).

The conditions are as follows:

  • ‘Investment Business’ activities should be the main business activity conducted.
  • The ownership of the investment fund by a single investor and its related parties is limited as follows:
    • If the investment fund has less than ten investors, the investor and its related parties cannot own more than 30% of the ownership interests;
    • If the investment fund has ten or more investors, the investor and its related parties cannot own more than 50% of the ownership interests.
  • The Fund must be managed or advised by an Investment Manager with at least 3 investment professionals.
  • Investors should not be involved in the day-to-day management of the Fund.

Other important considerations are that, as per Article 2(3), the ownership interest ratios mentioned above are not mandatory to be met in the Fund’s initial 2 financial years. However, evidence of the investors’ intention to meet these conditions after the first 2 financial years is necessary. If the ownership interest requirements are not fulfilled, the Fund will lose its exempt status from the beginning of the 3rd financial year, and it may not be able to regain this status afterwards.

This provision allows for a buildup in the financial track record for new QIFs. It also means that privately owned funds will be unable to claim a tax exemption. Even funds which are partially privately held may not qualify.

The Decisions also specify exemption conditions for a Real Estate Investment Trust (REIT) as follows (Article 3):

  • The value of real estate assets, excluding land, under management or ownership of the REIT exceeds AED 100 m. Further clarification is needed to determine the exact basis for assessing the value of these assets (i.e., acquisition or carrying value).
  • The REIT have at least 20% of its share capital floated on a Recognised Stock Exchange. Alternatively, the REIT can be directly wholly owned by two or more investors, provided that at least 2 of those investors are not Related Parties.

In the UK, at least 35% of the units should be freely available. In the US, the beneficial ownership of the REIT must be held by at least 100 persons. In Singapore, a listing is required in order to benefit from the tax exemption. Note that we have simplified the conditions.

  • REIT must have an average Real Estate Asset Percentage of at least 70%.

In the UK, US and Singapore, this percentage is 75% (nuances apply). In other jurisdictions, sometimes certain provisions exist around related party transactions (e.g. loans from related parties, investments in related parties’ assets, …). So far, there are no such requirements in the UAE.

We note that the REIT does not have a minimum distribution requirement, contrary to the UK, US and Singapore, which all require that 90% of income is distributed (again, nuances apply).

Moreover, there is no potential initial build-up period or grace period for the Fund or REIT to establish a track record while it is privately held to subsequently list. The UK does provide such a grace period for up to three years. The only way for a REIT to enjoy a similar treatment is if it is first held by institutional investors and then marketed further.

In addition to the mentioned provisions, the Decision further specifies the treatment of Investors’ Income (and related nonresident Investment Manager) and unincorporated partnerships and offers guidance on what constitutes an Institutional Investor. Notably, it states that a non-transparent unincorporated partnership can qualify for the QIF exemption.

Categories
UAE Corporate Income Tax UAE Tax

Impact of UAE Corporate Tax on Law Firms and Professional Services Firms

Impact of UAE Corporate Tax on Law Firms and Professional Services Firms

1. Application of CIT to revenue of law firms and professional services firms

Applying the new UAE Corporate Income Tax (CIT) to law and professional services firms can be complex. This is, mainly, because the underlying structures of legal and professional firms may also be complex. In this section, we will first discuss firms structured as a regular legal person, such as a Limited Liability Company (LLC). We will distinguish between UAE mainland LLCs and Free Zone (FZ) LLCs. Subsequently, we will discuss entities potentially treated as transparent under UAE CIT, together with UAE branches of foreign (non-UAE) companies.

a. Legal Structures

i. Firm structured as a regular mainland UAE LLC

This type of corporate structure will frequently be adopted by several UAE law firms. UAE law firms have rights of hearing, therefore, they are necessarily owned by UAE (or GCC) nationals. Generally, they have no legal reason to be established in a UAE FZ and can, therefore, mostly be found in UAE “mainland” (i.e., non-FZ).

If so, UAE LLCs will be subject to 9% CIT on their worldwide profits, adjusted for tax purposes according to the relevant CIT legislation. This will be the default position for any law firms which are organized through a Limited Liability Corporation (“LLC”) in the UAE mainland.

ii. Firm structured as a mainland UAE partnership

An alternative legal structure may be that of a partnership. To this end, the UAE CIT law distinguishes incorporated and unincorporated partnerships.

The FAQs published by the UAE Ministry of Finance (MoF) provide examples of incorporated partnerships. According to the MoF’s FAQs, incorporated partnerships include Limited Liability Partnerships (LLPs), partnerships limited by shares, and other types of partnerships where none of the partners has unlimited liability for the partnership’s obligations or other partners’ actions[1].

This reference suggests that, where there is unlimited liability for corporate law purposes, the entity must be treated as transparent for CIT purposes[2]. This UAE approach is in line with that followed by other jurisdictions. Seemingly, incorporated partnerships where no partners have unlimited liability are subject to UAE CIT at the standard rate.

Unincorporated partnerships are described under the UAE CIT law as “a relationship established by contract between two Persons or more, such as a partnership or trust or any other similar association of Persons[3].

Unincorporated partnerships are not considered taxable persons in their own right. Instead, they are considered “transparent”. It follows from this that partners rather than unincorporated partnerships are liable to tax, so that those transparent vehicles generally cannot claim any benefits under double tax treaties (DTTs), given that they do not meet the liable-to-tax criterion under Articles 1(2) and 4 of the OECD Model Tax Convention (MTC)[4].

The UAE Commercial Companies (CC) law, which is applicable in the UAE mainland and in any Free Zone not regulating corporate law itself, refers to two types of partnerships, i.e., a Joint Liability Company (JLC) and a Limited Partnership Company (LPC)[5].

Under the UAE CC law, a JLC is a company consisting of two or more physical partners who are severally and jointly liable in all their personal assets for the entity’s obligations[6]. As such, JLC would likely be treated as a transparent entity for corporate law purposes. Joint partners of a JLC are considered traders, and they are deemed to be conducting commercial activities directly.

Under the UAE CC law, an LPC is defined as “(…) a Company which consists of one or more joint partners, having the capacity of traders, who shall be liable, severally and jointly, for the partnership’s obligations, and one or more silent partners who shall not be liable for the partnership’s obligations, except to the extent of their contribution to the partnership’s capital. Silent partners shall not have the capacity of trader.[7]

Given the criterion of “unlimited liability”, which the UAE seems to apply to both types of partnerships, JLC and LPC are likely to be treated as transparent for UAE CIT purposes, despite both being endowed with legal personality. This means that the individual partners will be considered as directly conducting the business, therefore being taxable persons of their own right liable to UAE CIT[8].

If transparency is not a preferred option, the legal entity treated as a partnership can file an application (i.e., an election) to be considered non-transparent (i.e., “opaque”)[9]. Where the application is successful, the status is effective from the start of the tax period in which the application is submitted or since the beginning of a subsequent tax period[10].

The election by an unincorporated partnership for non-transparency treatment under UAE CIT law is irrevocable, unless exceptional circumstances occur and subject to approval by the Federal Tax Authority (FTA)[11]. The unincorporated partnership, presumably only when transparent (since, otherwise, if opaque, the partners are disregarded for UAE CIT purposes), is required to notify the FTA within 20 business days from any partner joining or leaving its organization[12].

The underlying rationale behind an application for an incorporated partnership to be treated as an opaque structure and, therefore, as a full-fledged taxable person under UAE CIT could be:

  •  Relieving the partners from the tax compliance burden and achieving simplicity
  • Enabling the partnership itself to access any of the 137 DTTs concluded by the UAE

iii. Mainland UAE branch of a foreign LLC

Sometimes, foreign firms are organized by way of a branch in the UAE mainland. The carrying out of professional activities through a branch in the UAE does not just have regulatory advantages in terms of the setup of the branch, but, when taxed, may also have the advantage that the branch (i.e., permanent establishment) income may be exempt or excluded from the scope of corporate tax in the country of the head office’s residence (in particular, in case of countries using the exemption method to avoid international double taxation).

There are no specific rules applicable to UAE mainland branches of a foreign LLC. Their profits are, therefore, taxable at the standard UAE CIT rate of 9%.

Complications with UAE-established branches, however, may arise with the allocation of profits between head office and branches, which requires a careful transfer pricing analysis of the functions, assets, and risks, following the OECD’s recommended Separate Entity Approach[13].

The discussions around profit allocations to branches could lead to mismatches between the UAE and the other country concerned, potentially leading to international double or non-taxation of the same profits. It is, therefore, critical for legal and professional firms operating cross-border to seek confirmation with the tax authority on the taxation of their branches, as well as about the method to avoid double taxation in the country of residence (i.e., the country of the head office or first establishment).

iv. Mainland UAE branch of a foreign partnership

It is common that law (mostly) and professional services firms (less so) outside the UAE and GCC region are organized by way of a partnership or LLP. This is very common in some countries like the United Kingdom and the United States.

The partnership structure offers a number of benefits in terms of the flexibility of making partners entitled to profits, but also regulatory, administrative and legal ease of having partners enter and exit, as well as other elements such as profit share entitlement for partners. A partnership is usually treated as transparent for corporate tax purposes in the country of residence or first establishment. It follows that only partners are subject to tax, usually by levying a Personal Income Tax (PIT) on their profit share entitlement.

If available, these partnerships may prefer setting up branches abroad, in countries which consider the branches and their partnerships as tax-transparent. Tax transparency in a foreign country gives the partnership more leeway on concluding cross-border ventures, sweeping up all income and expenses into one pool, determining a bigger profit pool to then subsequently distribute profits to the partners based on their profits share entitlement.

The circumstance that a partnership operates abroad in a jurisdiction where the partnership is not treated as tax-transparent may potentially create what is called, in technical terms, a “source-residence conflict”[14]. Taxation in the country of source cannot be considered in the country of residence if the foreign partnership would not be liable to tax itself in its residence country in the first place.

Whether the country of residence would generally provide an exemption or a credit is irrelevant: in this instance, the taxes paid in the country of source can be regarded only as a business cost for the partnership. Some countries solve this international tax issue through a legal fiction, which consists of allowing the partners to claim the tax credit which would have accrued to the partnership, had it not been transparent.

For this reason, it is often beneficial to set up a full-fledged subsidiary in those countries where the local branch would not be considered tax-transparent and may have an alternative structure catering for the countries where partnerships are not tax-transparent.

The UAE has provided flexibility in the application of its CIT to UAE branches of foreign unincorporated partnerships. The treatment of foreign partnerships under UAE CIT aims to mirror the tax treatment in the country of residence of the unincorporated partnership. If the partnership in the country of residence is tax-transparent, then the UAE would allow the same tax-transparent treatment for the UAE branch of the foreign partnership.[15] This is also the most common approach followed by other jurisdictions[16].

If the foreign partnership is treated as tax opaque in the jurisdiction of first establishment, then the UAE will not consider the UAE branch as transparent and levy UAE CIT upon it accordingly. The UAE CIT treatment will then be the same as the one applicable to a foreign LLC which has a branch in the UAE.

The tax transparency of UAE branches comes with some conditions attached:

  • The foreign partnership is not subject to tax under the laws of the foreign jurisdiction, i.e., if it is subject to tax, it is not transparent[17].
  • Each partner is individually subject to tax with regard to their distributive shares of any income in the foreign partnership[18].
  • The foreign partnership submits an annual declaration to the FTA confirming it meets the above conditions[19].
  • Adequate arrangements exist for cooperation between the UAE and the jurisdiction under whose applicable laws the foreign partnership was established for the purpose of exchanging tax information on the partners in the foreign partnership[20].

We discuss each of these conditions further below.

   – Foreign partnerships not subject to tax

The complication around the application of the conditions laid down above is not so much on the requirement relating to the tax transparency of the foreign partnership. This is a condition which should be met, for example, in the case of a UK and US LLP. For partnerships established in other locations, an analysis will need to be made of the actual tax treatment of a partnership there.

   – Each partner is individually subject to tax

The second condition, in comparison with the former one, is less straightforward. Tax transparency assumes taxation is triggered at another level, i.e., at the partners’ level. In the case of a UK LLP, partners in the LLP pay PIT to the extent they receive the income as self-employed partners.

It should be noted that natural persons, when conducting a business, are also in the scope of UAE CIT[21], and, for UAE CIT purposes, “Business” is defined in the same way as it is in the VAT law[22].

As regards resident natural persons, earning wages cannot be considered as conducting a business, regardless of the wages earned[23]. A wage is defined as “The wage that is given to the employee in consideration of their services under the employment contract, whether in cash or in kind, payable annually, monthly, weekly, daily, hourly, or by piece-meal, and includes all allowances, and bonuses in addition to any other benefits provided for, in the employment contract or in accordance with the applicable legislation in the State” (emphasis added).

In the UAE, partners working in a local branch of a foreign LLP would generally have an employment contract. Without an employment contract, historically, foreign partners could not obtain residency in the UAE, given that they require a visa. Their employment contract dictates their remuneration, which generally consists of salaried income plus a (more rather than less) substantial bonus at the discretion of the law or professional services firm.

This implies that the requirement to be subject to tax for the partners in order to obtain transparency may conflict with their (non-tax) employment status. Therefore, the actual employment relations between the partners and the firm need to be thoroughly analyzed.

If the UAE resident partners are not to be treated as independent or self-employed, and therefore conducting a business for UAE CIT purposes, the UAE mainland branch would be considered taxable, thus creating a “source-residence conflict”, potentially leading to a higher tax burden for the partnership[24].

When it comes to UAE-resident partners who earn salaried income and are entitled to a profits share, the subject-to-tax condition may not be met. A remedy against it could be to provide equity partners with an employment contract with a nominal salary (e.g., “nummo uno” or AED 1), stating that this salary constitutes an advance on their profits share, and reclaim the nominal salary when their profits share is paid out.

When it comes to foreign (non-UAE resident) partners in the partnership, the partner is considered subject to tax if they would be subject to tax on their distributive share of any income from the partnership in his (i.e., that partner’s) country of residence[25].

   – Submission of annual declaration

The form and manner for this compliance requirement are yet to be defined by the FTA.

   – Tax information exchange agreement

It is unclear what the MoF is actually referring to with this condition. There is a wide variety of international agreements which countries enter into for the purposes of exchanging tax information.

If, with this condition, the MoF is referring to the equivalent of Article 26 of the OECD MTC, then the fact that the UAE does not have a DTT with all countries (the United States being a notable absentee in this regard) may prevent the application of tax transparency treatment of a foreign partnership.

However, other tax agreements may also regulate the exchange of financial information, which may eventually be used for UAE CIT purposes. This is the case of FATCA, which requires banks and other financial institutions in the UAE to exchange information on account holders with the United States[26].

v. Firm structured as a UAE FZ LLC or non-transparent entity

The first question which needs to be asked is whether the FZ-established firm is transparent for tax purposes. The Company Regulations for the specific FZ will need to be analyzed to understand whether any of the partners have unlimited liability. In those FZs, different regimes may apply. For example, the DIFC has a separate limited partnership regime[27], and so does the ADGM[28]. These regimes need to be analyzed on a case-by-case basis.

If none have unlimited liability, then the firm will be considered equivalent to an FZ LLC. Subsequently, the firm will need to analyze whether it earns qualifying income subject to 0%.

vi. Firm structured as a UAE FZ partnership

The first question which needs to be asked is whether the firm is transparent for tax purposes. The Company Regulations for the specific FZ will need to be analyzed to understand whether any of the partners have unlimited liability. In those FZs, different regimes may apply. For example, the DIFC has a separate limited partnership regime[29] , and so does the ADGM[30]. These regimes need to be analyzed on a case-by-case basis.

If the partners have unlimited liability, then the firm will be considered tax-transparent. The levying of UAE CIT then moves to the partners’ level. Presumably, the partners will not be able to claim the status as a QFZP, since this is reserved for legal entities only, and, therefore, will be subject to tax at the standard UAE CIT rate of 9%.

vii. Firm structured as a UAE FZ branch of a foreign firm

The first question which again needs to be asked is whether the firm is transparent for tax purposes. The same criteria apply as for UAE mainland branches of a foreign firm.

If the branch is not transparent, the same complications may arise as to the allocation of profits to the branch. Given that it is established in an FZ, when not transparent, it will need to ask itself as well whether its income constitutes qualifying income.

viii. Summary Table

b. Other Considerations

i. Tax Grouping

UAE companies are entitled to form a “fiscal unity” or Tax Group for UAE CIT purposes upon application before the FTA. The most important condition for a Tax Group to comply with is the (in)direct shareholding requirement of 95%. However, FZ entities whose qualifying income are subject to 0% cannot enter into a Tax Group. In addition, the parent (which can be intermediate) needs to be a UAE company. Under this arrangement, only one tax return needs to be filed[31]. These conditions also apply to partnerships or branches of foreign partnerships established in any of the UAE FZs.

The availability of Grouping would require that there are multiple legal entities in the UAE which are taxable persons under the same regime (i.e. the default regime where they are a taxable person)[32].

There are notable differences with VAT grouping, the most important of them likely being that the common shareholding percentage for VAT groups is 50% or more (whereas for tax groups it is 95% or more[33]), and for VAT groups Free Zone entities can be included, whereas Qualifying Free Zone Persons are excluded from entering a tax group[34].

Below is a comparative table comparing tax groups with VAT groups.

ComparisonCITVAT
ConsequenceConsolidation of profits and losses

Disregarding transactions between members

VAT group considered as one taxable person for supplies and purchases and for right to recover input VAT

Common ownership95% share capital, voting rights and entitlement to profits

50% voting/market value interest/control or side agreement

Common Economic, financial and regulatory practices

Inclusion FZ/Exempt taxable personsNoYes
Transfer lossesYesN/A
Intra-group transfersAt no gain/no loss with 2 year claw backOut of scope
Administration and paymentParentResponsible member
Joint liabilityYes – can be ring fenced on approvalYes
ApplicationBy parent and subsidiariesBy Responsible person

2. Expenses of a law or professional services firm

a. Expenses of an LLC or a non-transparent partnership

There are no specific provisions applicable to the expenses incurred by a law or professional services firm. Therefore, expenses borne by both types of firms are subject to the general UAE CIT rules. However, certain matters are specific to UAE law firms and professional services firms, which may be relevant to consider. Those are:

   – Deduction for UAE CIT purposes of paid remuneration

Employee’s remuneration, whether it is a base salary or other types of income allowances, constitutes a deductible expense for UAE CIT purposes. This holds true, irrespective of the nationality of the employee (i.e., UAE, GCC, non-UAE, and non-GCC). It might be assumed that pension and social security contributions, or GOSI contributions, for employees holding GCC nationality would also be deductible.

   – End of Service Gratuity and Pension Contributions for Non-GCC nationals

Employees who do not hold GCC nationality and who are not employed by a DIFC company are subject to the EOS regime, where employers need to provision an amount which is a multiple of their base salaries.

Currently, the UAE legislation does not provide for any treatment of such EOS provisions or other provisions for that matter. In our view, however, provisions created for uncertain future payments, write-off of assets, etc. will most likely not be allowed a deduction under UAE CIT. However, provisions that are created for expenses that are actually crystallized/incurred may be allowed.

For contributions into Private Pension funds made by an employer on behalf of the employees, the total value of contributions is deductible[35]. However, the value of each Pension Plan Member cannot exceed 15% of the total Pension Plan Member’s remuneration, which gives entitlement to a deduction under UAE CIT[36]. We understand this provision to state that one single member cannot benefit from more than 15% of the benefits in the plan in order for the payments into the plan to be deductible[37].

We would normally expect DEWS, the DIFC Employee Workplace Savings Plan to qualify. However, if there are fewer than seven employees with equal contributions, the 15% condition will not be met , and therefore the amount of deductible contribution will be capped at 15%.

For employees of a Qualified Free Zone Person (QFZP), however, the tax deduction entitlement and limitation above may have no tax impact if the QFZP only has qualifying income, being that income taxed at a 0% rate. A tax impact would materialize if a QFZP also earns non-qualifying income.

   – Bonuses

Bonuses are an important component of remuneration packages for fee earners and partners. Bonuses constitute the variable part of monthly or annual compensation, which depends on the monthly or annual financial performance of the law or professional services firm concerned. For fee earners and non-equity partners, those bonuses are usually granted as part of their remuneration package as employees. Bonuses are granted at the discretion of the management or constitute fixed bonuses (tiered or other), as referred to in the employment contract or in the employee manual.

For equity partners, several practices exist. In the UAE, so far, those practices have not been driven by any tax consideration. This explains why examples are known to us where equity partners in UAE firms received their profit share on a cash rather than accrual basis (e.g. 9 months after the end of the financial year to give sufficient time for clients to settle their bills).

Given that audit practices in the UAE were not always consistent, or even absent for some companies, there was less corporate governance, and practices have varied considerably.

Equity partners also often do not actually hold equity stakes. They are only referred to as equity partners in name but hold no shares in the company. They will often hold a right to profits or hold ghost equity. These are contractual rights to profits, rather than the legal right which a shareholder has to receive dividends distributed by a company in which he or she holds shares.

In other situations, partners may hold units, the value of which is, however, annually determined by the partnership’s management. Partners are awarded units, and once the profit pool is determined, the number of units held will determine the profits the partner is entitled.

Both in the cases of ghost equity and units, an important question will be whether this constitutes a deductible expense, or is equivalent to a dividend, and therefore is paid after tax (in which case the profits are higher and, therefore, the net tax liability of the company would be higher).

Given that these constitute rather a contractual right and not a right based on shares held in the entity, the revenues earned from these contractual rights would likely rather be a tax-deductible expense. Should this approach be correct, however, effective entitlement to a deduction under UAE CIT would require careful drafting of the partnership agreement upon a partner joining a partnership.

   – Other employee-related expenses

Insurance such as the workmen’s compensation would likely be deductible. However, insurance paid by the employer on behalf of the employee, like the unemployment insurance scheme in place in the UAE, would likely not be deductible, as it is not an expense for which the employer is liable.

   – The deduction for tax purposes of profits distribution for partners considered as “connected persons” and whether it is considered at a market rate

In order to be deductible for UAE CIT purposes, any payment or benefit granted to a “connected person” must correspond to the market value of what is provided by the connected person and is incurred wholly and exclusively for business purposes.

Connected persons are:

     i. the owner of the taxable person,

The owner would be a natural person who directly or indirectly owns an ownership interest in the taxable person or controls the taxable person.

     ii. a director or officer of the taxable person, or

     iii. a related party of the first two categories.

UAE CIT further provides that partners in a transparent unincorporated partnership are considered connected persons, and so are any related parties of those partners[38].

To determine what is the applicable market value, UAE CIT legislation refers to transfer pricing principles. And yet, none of the transfer pricing methods referred to under the UAE CIT law lends itself to determining what a market rate remuneration for a partner’s salary is. Also, there is a considerable amount of variation between the more traditional courthouse lawyers on the one hand, and corporate or tax lawyers on the other.

For managing partners of a law firm who have a more ceremonial role, and actually do not feature on the trade license as managers, there should be no concern. Similarly, for managing partners who are managers on the license but have no different remuneration package as compared to their peers, there should be no impact.

Given also limited public information on partner remuneration, law and professional services firms may be confronted with complexities around defending partner remuneration for partners qualifying as connected persons.

   – The deduction of entertainment expenses

UAE CIT law puts a 50% cap on any entertainment, amusement, or recreation expenditure incurred for the purposes of receiving and entertaining customers, shareholders, suppliers, or other business partners.

These expenditures include but are not limited to meals, accommodation, transportation, admission fees and facilities and equipment used in connection with entertainment. The MoF also has the possibility to determine other types of excluded expenditure.

Examples of this type of expenditure could be an iftar meal for clients, a reception for the opening of a new office in the presence of business partners, a shareholder meeting abroad in a tourist location, or a new year’s reception. In practice, the deductibility of such expenses may often be litigated and disputed by tax authorities[39].

Interestingly, the entertainment expenditure limitation does not seem to impact such expenses incurred for staff. We assume that this is subject to the general rule and therefore be limited by the requirement that this is a business expense.

   – Expense reimbursements

Quite often, fee earners will incur expenses to be reimbursed (e.g., hotel, transportation, meals, translation fees, research in databases, etc.). In a professional services environment, those expenses are even more important. Also, these costs are often recharged to clients. When they are recharged, they constitute expenses for the firm, and revenue as well.

When expenses are incurred in the name and on behalf of the client (e.g., license fees, court fees, etc.), these costs do not run through the profit and loss account of the company but rather through the balance sheet. These costs are therefore not expenses nor revenues for the company. From a VAT point of view, these types of expenses will be disregarded from the taxable amount as well[40].

   – The deductibility of interest payments

Law and professional services firms sometimes need to borrow money for a variety of reasons (e.g., expansion into new regions, fit out new office, etc.). An interest expense is a deductible expense for UAE CIT purposes.

However, UAE CIT legislation caps the deductibility of net interest expenditure at 30 % of EBITDA[41]. Net interest expenditure is the amount by which the interest expense (including interest expense rolled forward) exceeds the interest income.

By way of an example, if the revenues of a firm are AED 1,000 and its cost of sales and overhead expenses are AED 600, then its EBITDA is AED 400. Any interest expenses it may incur would only be deductible up to a value of AED 120 (i.e., 30% of AED 400).

The MoF has determined a safe harbour of AED 12 million, below which the 30% EBITDA cap does not apply[42]. When the net interest expense is capped, the balance between the cap and the actual net expense can be carried forward for a maximum of 10 years[43].

Any interest expense which would be disallowed under other provisions of UAE CIT law (e.g., because it relates to exempt dividends) is excluded from the net interest calculation[44].

Certain taxable persons are excluded from the 30% EBITDA cap, such as:

  • Banks
  • Insurance providers
  • Natural Persons conducting a business, and
  • Any other Person as determined by the MoF

Finally, a group cap may be available for consolidated businesses[45].

Specific financial assistance rules apply as well, disallowing interest expenses entirely in certain situations[46]. This is the case where a loan is obtained, directly or indirectly, from a related party, and it is obtained for specific purposes, which are:

  • A divided or profit distribution to a related party
  • A redemption, repurchase, reduction or return of share capital to a related party
  • A capital contribution to a related party
  • The acquisition of an ownership interest in a person who is or becomes a related party following the acquisition

The deduction is allowed nonetheless when it can be demonstrated that the main purpose of obtaining the loan is not to gain an advantage under UAE CT[47]. It is considered that there is no UAE CT advantage where the related party is subject to UAE CT (or a tax of a similar character) in the foreign jurisdiction on the interest at a rate not less than the standard rate of 9% under UAE CT.

   – Donations to charitable organisations

Donations, gifts, and grants provided to Qualifying Public Benefit Entities in the UAE constitute a deductible expense[48].

Accordingly, taxable persons will be eligible to deduct an equivalent amount of such contributions for the purpose of calculating the corporate tax liability due for the period.

It should be noted that Qualifying Public Benefit Entities are exempt from UAE CIT, provided they meet the conditions laid down under Article 9 of the UAE CIT law[49].

Amongst others, the activity would need to be:

  • Exclusively for religious, charitable, scientific, artistic, cultural, athletic, educational, healthcare, environmental, humanitarian, animal protection or other similar purposes. 
  • As a professional entity, chamber of commerce, or a similar entity operated exclusively for the promotion of social welfare or public benefit. 

Such Qualifying Public Benefit Entities may have an ancillary business activity, which may push those entities in the scope of VAT but allow them to be exempt from UAE CIT, nonetheless.

Any donations, gifts and grants provided to non-Qualifying Public Benefit Entities will not be deductible. That looks to be the case also when this happens in favor of a foreign entity[50].

The UAE’s Federal Cabinet has listed Qualifying Public Benefit Entities, including entities like universities, chambers of commerce, foundations, and charities, as well as professional, sport and cultural associations.[51].

b. Expenses of a transparent partnership or a transparent branch of a foreign partnership

Due to its transparency, the UAE transparent partnership or the transparent branch of a foreign partnership will have no tax liability themselves. Therefore, there are no meaningful considerations around tax-deductible expenses for those transparent entities.

For the avoidance of doubt as well, the provisions of UAE CIT law state that amounts which are withdrawn from a transparent unincorporated partnership by a natural person who is a taxable person are not deductible[52]. This likely is a reference to the transparent nature of such partnerships[53].

==

[END NOTES]

[1] FAQ #48, UAE Ministry of Finance Corporate Tax FAQs, https://mof.gov.ae/corporate-tax-faq/, consulted on 30 June 2023.

[2] UAE MoF’s Explanatory Guide on Federal Decree-law No. 47 of 2022 on the Taxation of Corporations and Business, pp. 7 and 46, https://mof.gov.ae/wp-content/uploads/2023/05/Explanatory-Guide-on-Federal-Decree-Law-No.47-of-2022-on-the-Taxation-of-Corporations-and-Businesses-2.pdf, consulted on 30 June 2023.

[3] Article 1 UAE CIT law.

[4] See Paragraph 8.3. of the OECD Commentary to the OECD MTC on Article 4, which states the following: “Where a State disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not liable to tax and may not, therefore, be considered to be a resident of that State”. This reflects the idea of when a person is covered and is entitled to the benefit of a DTT as specified in Article 1(2) of the OEC MTC (as updated in 2017) as regards wholly or partly transparent entities. Some treaties will, however, specifically note that a partnership is a resident. See Article 4(1)(b) of the DTT between the United States and Luxembourg or Article 4(1) of the DTT between Belgium and Luxembourg

[5] Title 2 of Law No. 32 of 2021 (hereinafter, the UAE CC law).

[6] Article 39 of the UAE CC law.

[7] Article 62 of the UAE CC law.

[8] See MoF’s Explanatory Guide, p. 47, which reads as follows: “…for Corporate Tax purposes, the Unincorporated Partnership is treated as an aggregation of Persons whereby each Person (partner) is treated as carrying on, and being a part owner of, the Business and the assets and liabilities of the partnership in accordance with the contract underlying the Unincorporated Partnership”.

[9] Article 16, Clause 1 of the UAE CIT law.

[10] Article 16, Clause 10 of the UAE CIT law.

[11] Article 3, Clause 1 of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[12] Article 3, Clause 2 of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law. Presumably, this applies only to equity rather than also salaried partners.

[13] OECD report on the attribution of profits to permanent establishments, 17 July 2008, https://www.oecd.org/tax/transfer-pricing/41031455.pdf, consulted on 30 June 2023.

[14] International tax implications for partnership are described at length in the OECD’s Partnership report, OECD (1999), The Application of the OECD Model Tax Convention to Partnerships, Issues in International Taxation, No. 6, OECD Publishing, Paris, https://doi.org/10.1787/9789264173316-en, consulted on 30 June 2023, and also in OECD/G20 Base Erosion and Profit Shifting Project Neutralising the Effects of Hybrid Mismatch Arrangements Action 2: 2015 Final Report, https://www.oecd-ilibrary.org/docserver/9789264241138-en.pdf?expires=1687676531&id=id&accname=guest&checksum=1A4EEFD494D5FA739D2503603BC67A97, pp. 139 – 143, consulted on 30 June 2023.

[15] See MoF’s Explanatory Guide, p. 47, which, in this regard, explains that “[t]he UAE applying a different tax treatment to a Foreign Partnerships that is treated as fiscally transparent in the relevant jurisdiction(s) could result in unintended and unwanted tax consequences, not only for the UAE resident partners in the Foreign Partnership, but also for any non-resident partners whose UAE tax position can be impacted as a result”.

[16] In this regard, see J. Jones, i.a., “Characterisation of Other States’ Partnerships for Income Tax”, Bulletin – Tax Treaty Monitor, Section 3.2, p. 306,

[17] Article 16, Clause 7(a) of the UAE CIT law.

[18] Article 16, Clause 7(b) of the UAE CIT law.

[19] Article 16, Clause 7(c) of the UAE CIT law and 4, Clause 1(a) of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[20] Article 16, Clause 7(c) of the UAE CIT law and Article 4, Clause 1(b) of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[21] Article 11, Clause 3(c) of the UAE CIT law.

[22] Comparing Article 1 of the UAE CIT law and Article 1 of the GCC VAT Agreement, the two definitions concerned match.

[23] Article 2, Clause 1(a) of Cabinet Decision No. 49 of 2023.

[24] Ultimately, the outcome will much depend on the approach of the country of residence/formation of the partnership towards CIT paid in the UAE as the country of source of the income, and how potentially international double taxation between the two countries may be avoided.

[25] Article 4, Clause 2 of Ministerial Decision No. 127 of 2023 on Unincorporated Partnership, Foreign Partnership and Family Foundation for the Purposes of the UAE CIT Law.

[26] Agreement between the Government of the United Arab Emirates and the Government of the United States of America to improve International Tax Compliance and to Implement FATCA of 17 June 2015, https://home.treasury.gov/system/files/131/FATCA-Agreement-UAE-6-17-2015.pdf, consulted on 30 June 2023.

[27] See the DIFC’s Limited Partnership Law No 4 of 2006, https://www.difc.ae/business/laws-regulations/legal-database/limited-partnership-law-difc-law-no-4-2006/, consulted on 30 June 2023.

[28] See the ADGM’s Limited Liability Partnership’s Regulations, https://en.adgm.thomsonreuters.com/rulebook/limited-liability-partnerships-regulations, consulted on 30 June 2023.

[29] See the DIFC’s Limited Partnership Law No 4 of 2006, https://www.difc.ae/business/laws-regulations/legal-database/limited-partnership-law-difc-law-no-4-2006/.

[30] See the ADGM’s Limited Liability Partnership’s Regulations, https://en.adgm.thomsonreuters.com/rulebook/limited-liability-partnerships-regulations.

[31] Article 40 of the UAE CIT law states on Tax Groups the following:

  1. A Resident Person, which for the purposes of this Decree-Law shall be referred to as a “Parent Company”, can make an application to the Authority to form a Tax Group with one or more other Resident Persons, each referred to as a “Subsidiary” for the purposes of this Chapter, where all of the following conditions are met:
  2. a) The Resident Persons are juridical persons.
  3. b) The Parent Company owns at least 95% (ninety-five percent) of the share capital of the Subsidiary, either directly or indirectly through one or more Subsidiaries.
  4. c) The Parent Company holds at least 95% (ninety-five percent) of the voting rights in the Subsidiary, either directly or indirectly through one or more Subsidiaries.
  5. d) The Parent Company is entitled to at least 95% (ninety-five percent) of the Subsidiary’s profits and net assets, either directly or indirectly through one or more Subsidiaries.
  6. e) Neither the Parent Company nor the Subsidiary is an Exempt Person.
  7. f) Neither the Parent Company nor the Subsidiary is a Qualifying Free Zone Person.
  8. g) The Parent Company and the Subsidiary have the same Financial Year.
  9. h) Both the Parent Company and the Subsidiary prepare their financial statements using the same accounting standards.

[32] Article 40 of the UAE CIT Law.

[33] Article 40, 1, b of the UAE CIT Law.

[34] Article 40, 1, f of the UAE CIT Law.

[35] Article 5, Clause 1 of Ministerial Decision No. 115 of 2023 on Private Pension Funds and Private Social Security Funds for Corporate Tax Purposes

[36] Article 5, Clause 3 of Ministerial Decision No. 115 of 2023 on Private Pension Funds and Private Social Security Funds for Corporate Tax Purposes

[37] The 15% contribution cap likely is meant to avoid opportunistic behaviors by employers which might try to inflate some employees’ (perhaps those with managing positions) pension plan contributions.

[38] Article 36, Clause 4 of the UAE CIT law.

[39] The same applies for UAE VAT purposes. See, in particular, the Taxable Person Guide for Value Added Tax (June 2018), pp.  39-40, which states the following: “A business is generally prohibited from recovering input tax on expenses incurred in respect of the provision of entertainment to anyone not employed by the business, including customers, potential customers, officials, shareholders, owners, and investors in the business. The type of entertainment expenses which are covered by the restriction include hospitality (e.g..accommodation, food and drinks) which are not provided in the normal course of a meeting, access to shows or events, or trips provided for the purposes of pleasure or entertainment. This means that where a business incurs any such expenses, the business will not be able to recover VAT incurred on the expenses”.

[40] See Article 26, Clause 6(c) of the GCC VAT Agreement, which excludes from the VAT taxable amount “c) amounts paid by the Taxable Supplier in the name of and to the account of the Customer. In this case, the Taxable Supplier may not deduct Tax paid on these expenses”.

[41] EBITDA stands for “Earnings Before Interest Tax Depreciation and Amortization”.

[42] Article 30, Clause 3 of the UAE CIT law and article 8 of Ministerial Decision No. 126 of 2023 on the General Interest Deduction Limitation Rule for the UAE CIT law.

[43] Article 30, Clause 4 of the UAE CIT law.

[44] Article 30, Clause 5 of the UAE CIT law.

[45] Article 30, Clause 7 of the UAE CIT law.

[46] Article 31, Clause 1 of the UAE CIT law.

[47] Article 31, Clause 2 of the UAE CIT law.

[48] A contrario, Article 33, Clause 1 of the UAE CIT law.

[49] These are further detailed in Cabinet Decision No. 37 of 2023.

[50] This may fall foul of the non-discrimination provisions in the GCC Economic Agreement of 2001, more specifically Article 3, Clause 1.

[51] Cabinet Decision No. 37 of 2023 Regarding the Qualifying Public Benefit Entities for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses.

[52] Article 33, Clause 5 of the UAE CIT law.

[53] A contrario, a combination of non-deductibility of the expenses in the hands of the non-transparent unincorporated partnership and taxation in the hands of the natural person receiving the income would lead to double taxation.

Categories
UAE Corporate Income Tax

UAE CIT Law: Gathering the pulse of the UAE MoF

UAE CIT Law: Gathering the pulse of the UAE MoF

After the announcement of the introduction of Corporate Income Tax (CIT) and the publication of the Frequently Asked Questions (FAQs) on 31 January 2022, and the release of the Public Consultation Document in April 2022, the Corporate Income Tax (CIT) Law was finally released on 9 December 2022.

 

The UAE CIT Law is Federal Decree-Law No. 47 of 2022 issued on 3 October 2022, and is effective 15 days after its publication in the Official Gazette. The UAE CIT Law was published on 10 October 2022 in issue #737 of the UAE Official Gazette. The CIT law is applicable on business profits effective for financial years starting on or after 1 June 2023.

The CIT regime has been implemented by the UAE in view of achieving the following objectives:

  • Cementing the UAE’s position as a world-leading hub for business and investment;
  • Meeting international standards for tax transparency and preventing harmful tax practices, and;
  • Accelerating the UAE’s development and transformation to achieve its strategic objectives.

We include hereafter the main features of the new regime, as announced by the Ministry of Finance (MoF) and the Federal Tax Authority (FTA). We have already expressed a brief overview of the CIT Law in our earlier newsletter here and in a webinar available on YouTube here. The slide deck presented in the webinar is available on this LinkedIn post. We have also captured the 10 most striking aspects of the CIT law here.  

The UAE MoF conducted 3 Awareness Sessions (Sessions) in the month of January 2023, and we have summarised the major points discussed in the Abu Dhabi Session here and the Dubai Session here.

Below we discuss the main features of the UAE Corporate Income Tax regime and some of our comments and observations.

Scope

CIT will apply on the adjusted worldwide accounting net profits of the business. The UAE CIT regime introduces two different rates:

  • A 0% tax rate will apply for taxable profits up to a a threshold of AED 375,000, is now confirmed in Cabinet Decision No. 116 of 2022. This Cabinet Decision also includes an anti-fragmentation rule (inspired by the General Anti-Abuse Rules, discussed later below). The rule seeks to prevent a business dividing their activities into multiple registered entities such that each entity earns income below the threshold of AED 375,000 and avoids paying tax.
  • The standard statutory tax rate will be 9 per cent. Because of the low tax rate, the UAE will continue to be highly competitive at a global level. There are also many exemptions applicable.

There is currently no mention in the Law of the 15% global minimum tax rate applicable for MNEs that fall within the scope of ‘Pillar Two’ of the OECD Base Erosion and Profit Shifting project (BEPS Project).

Specifically, this would apply to MNEs that have consolidated global revenues in excess of EUR 750m (c. AED 3.15 billion), in any two of the previous four years. The FAQs still refer to the possibility of adoption in the UAE of these rules. In the Dubai MoF Session, it was mentioned that the UAE is a member of the OECD’s Inclusive Framework (IF) and is committed to implementing the ‘Pillar Two’ proposal. Further details in this regard will be released shortly. Until then, the existing rates of 0% and 9% apply to UAE businesses.

Individuals who are residents are subject to corporate tax insofar as they engage in a business activity. The definition of business is inspired by the VAT definition, and is therefore extremely broad. In the Dubai MoF Session, it was mentioned that a Cabinet Decision will be published in regard to the application of CIT to natural persons, including on the nature of ‘business activities’ sought to be covered within the ambit of the CIT regime. A Cabinet Decision on determination of tax residency for tax purposes was already issued in 2022. We have summarised the permutations and combinations for determination of tax residency for an individual in the form of a decision tree here.

For non-individuals (e.g., companies), the tax residency vests with the UAE if the entity is either (i) incorporated or otherwise established or recognised in terms of applicable UAE legislation, or (ii) an entity that is effectively managed or controlled in the UAE. In this regard, the MoF mentioned in the Dubai session that an example of ‘effectively managed or controlled’ is where the Directors are located or where they make key decisions for the entity.

There is a 0% regime for businesses established within UAE free zones that (1) maintain adequate substance, and (2) earn Qualifying Income. What constitutes Qualifying Income will be determined in a Cabinet Decision. Presumably, this is a reference to the requirement not to conduct business with mainland UAE, as previously outlined in the Public Consultation Document. It is confirmed as well that Free Zone businesses can voluntarily elect to be subject to Corporate Income Tax at the rate of 9 per cent. In the Dubai and the Abu Dhabi MoF Sessions, it was reiterated that the UAE’s economy is heavily dependent on Free Zones. At the same time, this relationship is stated to be ‘two sided’. The position of the MoF so far is that while the Government will honour their commitment with respect to Free Zones, Free Zone persons are also required to honour their commitments. Details in this regard will be provided soon.

There will be a 0% withholding tax on categories of State Sourced Income derived by a Non-Resident. This means that foreign investors who do not carry on business in the UAE will in principle not be subject to tax in the UAE.

For foreign entities, they could be considered a resident in the UAE if they are managed and controlled in the UAE. For foreign entities not considered resident in the UAE, but who may have a Permanent Establishment (PE) in the UAE, the Permanent Establishment definitions encompass definitions of a fixed PE and an agency PE. We expect further details about the PEs in a Ministerial Decision. For the financial sector, the Investment Manager Exemption from the Public Consultation Document is retained in the UAE CIT Law.

Specific rules apply for Partnerships. It has been reiterated in the Sessions that if the Partnership is unincorporated (such as an unincorporated association of persons), the profits are taxed at the individual (partner) level. If the Partnership is incorporated, the profits are taxed at the partnership level. The partners may make an application to the FTA to have the business profits taxed at the level of the Partnership. Family Foundations can also elect for tax transparency (i.e., being taxed at the level of the individual(s)). It was mentioned in the Dubai MoF Session that the policy consideration behind the Family Foundation’s default treatment being taxed on its business activities at the level of the foundation is to reduce compliance at the level of the individual(s).

Government Entities and Government Controlled Entities will be exempt from the UAE CIT Law, as will Qualifying Public Benefit Entities and Qualifying Investment Funds. It has been clarified in the Dubai MoF session that entities such as Qualifying Investment Funds are required to first register for CIT if it conducts business activities, and then apply for the exemption (meaning, that the exemption is not automatically granted). Extractive businesses (upstream oil & gas businesses) will also be exempt, to the extent they earn income from the extractive business and are taxed at the Emirate level. Similarly, even non-extractive businesses will be exempt if the income from the business is already taxed at the Emirate level. In principle, banking operations will be subject to CIT (unless the institution is in a Free Zone and qualifies for the 0% rate).

Date of implementation

Article 69 of the UAE CIT Law provides that the Law will apply to Tax Periods starting on or after 1 June 2023.

Businesses with a financial year starting 1 January will be subject to CIT as from 1 January 2024.

Deductible expenses

Expenses incurred wholly and exclusively for business purposes, and which are not to be capitalized, are deductible immediately. Likewise, depreciation and amortisation expenses are also generally tax deductible, in line with international standards. Deductions are not allowed for expenditures incurred to obtain exempt income. When there is a mixed purpose, the deduction is only partially allowed.

Interest expenses are deductible subject to a cap of 30% of the EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation). The so-called financial assistance rules are in place, which prevents businesses from obtaining financing to pay out dividends or profit distributions. Entertainment expenses are capped at 50% deductibility.

Non-deductible expenses include donations made to a non-Qualifying Public Benefit Entity, fines, bribes and dividends. Importantly as well, amounts withdrawals from the Business by a natural person who is a taxable person are not deductible.

Exempt income and relief

The following categories of income will be exempt from CIT (Article 22 UAE CIT Law):

  • Capital Gains, Dividends and other profit distributions from a Resident Person;
  • Capital Gains, Dividends and other profit distributions from a Qualifying shareholding in a foreign legal person, subject to a holding period of 12 months, having a minimum participation of 5%, and at a minimum subject to tax at 9% CIT in the country of source;
  • Income from a Foreign PE, subject to conditions and an election to apply the exemption (rather than a credit);
  • Income derived by a non-resident Person derived from operating aircraft or ships in international transportation (subject to reciprocity).

The following transactions are subject to specific relief, i.e. effectively a deferral of taxes:

  • Qualifying intragroup transactions and restructurings – entities will qualify if they have 75% common ownership
  • Business restructuring relief – subject to certain conditions.

Transfer pricing

 

Article 34 of the UAE CIT Law confirms the requirement for related party transactions to be conducted in accordance with the Arm’s Length Principle (ALP). Furthermore, it outlines the five traditional OECD transfer pricing methods as being appropriate to support the arm’s length nature of related party arrangements, while allowing the use of other methods where suitable.

 Additionally, Article 34 outlines that in the event of an adjustment imposed by a foreign tax authority which impacts a UAE entity, an application must be made to the FTA for a corresponding adjustment to provide the UAE company with relief from double taxation. Any corresponding adjustments related to domestic transactions does not require such an application.

Article 55 covers transfer pricing documentation requirements. UAE businesses will need to comply with the transfer pricing rules and documentation requirements set with reference to the OECD Transfer Pricing Guidelines. This means a three tier reporting, i.e., Master File, Local File and Country-by-Country Reporting (CbCR). There is also a reference to a controlled transactions disclosure form, details of which remain outstanding. Additionally, it is noted that no materiality thresholds have been provided so far. At the same time, in the Dubai Seminar, the MoF mentioned that small businesses are not required to comply with the Transfer Pricing document requirements. Separate legislation will be issued later.

Advanced pricing agreements will be available as well, through the regular clarification process already in place.

While not necessarily transfer pricing, the UAE has implemented provisions requiring payments and benefits made to connected persons to be at market value, for those amounts to be tax deductible. For the application of this principle, the same principles are applied as in article 34 of the UAE CIT Law, which refers to a transfer pricing methodology.

Administration and enforcement 

The MoF seems to remain the competent authority for the purposes of multi-lateral or bilateral agreements and the international exchange of information. The FTA will be responsible for the administration, collection and enforcement of the new corporate income tax regime. Based on the Establishment Law of the FTA, regular engagement between the FTA and the MoF on international tax matters, will be required. Penalties and fines are determined by the Tax Procedures Law.

Businesses will need to obtain a Tax Registration Number (TRN) with the FTA. The TRN issued for CIT purposes is different from the TRN issued for VAT purposes. As on date of writing this piece, according to statements made by MoF, some businesses have already been invited to pre-register for CIT. The FTA released ‘Corporate Tax Registration Manual’ explaining the procedure for application of registration and navigation through the EmaraTax portal. We did a post covering this update here.

Further, it has been clarified in both the Abu Dhabi and the Dubai Sessions that no penalties will be levied on late registration (penalties for late filing of returns and late payment will still be levied nonetheless). It has also been emphasized by the MoF that if business activities are being conducted, the business must register. Further, the MoF has clarified that registration is necessary even if income is earned below the threshold of AED 375,000, or if there is otherwise no tax liability (such as businesses in the Free Zone).

Businesses that are subject to UAE CIT will be required to file a CIT return electronically for each financial period within 9 months of the end of the Financial Period. A financial period is generally any 12-month financial period year. Free Zone businesses subject to 0% CIT are also required to file a CIT return.

Other considerations

  • Foreign tax will be allowed to be credited against UAE corporate tax payable. The mechanism of the application is as in the Public Consultation Document. Businesses can claim the lower of the corporate tax due, or the amount of withholding tax effectively deducted. There will be no carry forward. There are no credits for taxes paid to the individual Emirate.
  • Fiscal consolidation or Tax Group: UAE companies will be able to form a “fiscal unity” or Tax Group for UAE CIT purposes upon application with the FTA. The most important condition for a Tax Group to comply with is the (in)direct shareholding requirement of 95%. Free zone entities subject to 0% cannot enter into a Tax Group. In addition, the parent (which can be intermediate) needs to be a UAE company. Under this arrangement, only one tax return and one set of Financial Statements for tax purposes needs to be declared.
  • Losses can be carried forward up to 75% of the Taxable Income (article 37 of the UAE CIT Law).
  • Losses can be transferred between members of the same group of companies, provided the entities are 75% direct or indirectly commonly held. Losses cannot be transferred from exempt persons or free zone entities. The loss offset is also subject to the 75% cap, as for businesses rolling forward losses. In this regard, it has been clarified in the MoF Sessions that upon meeting certain conditions, two or more UAE entities can constitute a qualifying group automatically (i.e., there is no requirement to apply before the FTA for availing such benefits). Some of the major conditions are (i) common ownership, (ii) none of the entities must be Exempt Persons or Free Zone persons (iii) all the entities follow the same financial year and accounting standard. The individual entities will still be considered as separate taxable persons and need to file separate tax returns.
  • Tax deductible losses can be lost when there is a change of control (50% or more) except if the new owner conducts the same or a similar business. The conditions for this have now been defined.
  • Extensive and broad ranging UAE sourcing rules are applicable. The provision captures the following instances:
    • Income where derived from a Resident Person,
    • Income derived from a Non-Resident Person in connection with, and attributable to a Permanent Establishment of the non-resident in the UAE,
    • Income otherwise accrued or derived from activities performed, assets located, capital invested, or services performed or benefitted from in the State.

The provisions also provide certain examples of income considered to be sourced in the UAE, such as:

    • Income from sale of goods within the UAE,
    • Income from contract wholly or partially performed or benefitted from in the UAE,
    • Income from movable or immovable property in the UAE.
  • The UAE implements a General Anti-Abuse rule, or “GAAR”, which is inspired by the Principal Purpose Test (PPT) found in the Multilateral Instrument (MLI). The GAAR applies to situations where one of the main purposes of a Transaction is to obtain a Corporate Tax Advantage not consistent with the intention or purpose of the UAE CIT Law. The FTA will counteract or adjust the transaction. The GAAR applies for transactions or arrangements entered into on or after the date the UAE CIT Law is published in the Official Gazette. The UAE CIT Law was published in the UAE Official Gazette of 10 October 2022 in issue #737. Quite interestingly, The MoF mentioned in the Dubai session that businesses may choose to reorganise themselves before the operation of the CT Law to the business. At the same time, the MoF maintains that a mere tax benefit is not sufficient for the reorganisation to be approved by the FTA. In other words, a commercial purpose is also necessary for the restructuring to be approved by the FTA. The MoF even gave an anecdote of the ‘newspaper test’ – implying whether the business is comfortable having the reorganisation to be displayed on the front page of the newspaper? The MoF furthered that as long as there is a commercial purpose along with a tax purpose for conducting the restructuring, the FTA will not counteract the tax advantages. At this moment, the letter of the law does not seem entirely aligned with the comments made by the MoF, and we are sure that further clarity will arrive soon on the exact position the interpretation of the GAAR. We expressed our views on Anti-abuse rules, PPT and GAAR from a tax-treaty point of view in one of our earlier articles available here.
  • Business mergers are to be treated in a tax-neutral manner (meaning, there will be a no-gain and no-loss of taxable income). This benefit is subject to the business not being subsequently transferred in the forthcoming two years to another third party. If the business is transferred, the earlier restructuring benefit is ‘clawed back’ and treated at market value.
  • Further details will be provided in due course on the future of Economic Substance Regulation (ESR) compliance upon the operation of the CIT Law.
  • Documentation must be maintained for a period of 7 years for all registered entities, including exempted persons and those entities that do not have a tax liability.

Unanswered questions and final thoughts:

Indeed, the outreach activities of the MoF are certainly laudable, with a few more Sessions scheduled to be conducted soon. Some of the burning questions which we hope will be clarified soon are as follows:

  • The extent of benefits that may be available to Free Zone persons: Specifically, whether a Free Zone Person earning active income from a Mainland person in the UAE loses the 0% CIT benefit on all its income, or only to the extent of that active income earned?
  • The exact position on GAAR: As explained above, it appears that the position taken by the MoF on the interpretation of the GAAR is somewhat more lenient than the wordings of the provisions suggest. Hence, clarity on the exact position of the MoF on GAAR will be welcome for businesses, especially those seeking to restructure before the CIT law becomes operational to such businesses. We expect that the ruling process will be paramount for businesses going forward.
  • Timelines for implementation of the Pillar Two project: In addition to the comments above, the MoF also acknowledged the delays in the global implementation of the Pillar Two proposal in the United States, the European Union, and other regions. Knowing the timelines for implementation of the Pillar Two proposal is very important for businesses with global revenues above EUR 750 million, more so if operating in the Free Zones and subject to 0% CIT rate.    

Overall, the headline rate of 9% along with the relatively simple design elements shows that CIT system has been well thought out. The building blocks of the CIT system reflect the commitment to adapt to the best practices internationally and to minimise the compliance for taxpayers. Many of the design elements are indeed in line with the Public Consultation Document issued in April 2022, and many of the finer details will be issued subsequently by the MoF or the FTA. Businesses have sufficient time to prepare for the new regime as most businesses have their return filing and payment liabilities only in September 2025. Meanwhile, the business community eagerly await further inputs from the MoF in the Sessions.hehere

Categories
UAE Corporate Income Tax

10 things to know about UAE CIT

10 things to know about UAE CIT

The UAE Corporate Income Tax has been introduced recently, and even though the law will be effective starting June 2023, it is crucial to get familiar with it and be ready for its implementation on time.

The new law will bring many changes and will significantly impact all companies. Many still need help understanding how CIT affects their businesses, and what steps to take to ensure compliance. We listed the top 10 things about CIT that everyone should know right now.

See our previous analysis here:

UAE Publishes Corporate Income Tax Law

Categories
UAE Corporate Income Tax

UAE Publishes Corporate Income Tax Law

UAE Publishes Corporate Income Tax Law

After the announcement of the introduction of Corporate Income Tax (CIT) and the Frequently Asked Questions (FAQs) on 31 January 2022, and the release of the Public Consultation Document in April 2022, the Corporate Income Tax (CIT) Law has finally been published today (9 December 2022). The UAE CIT Law is Federal Decree-Law No. 47 of 2022 issued on 3 October 2022, and is effective 15 days after its publication in the Official Gazette. The UAE CIT Law was published on 10 October 2022 in issue #737 of the UAE Official Gazette. The CIT law is applicable on business profits effective for financial years starting on or after 1 June 2023.

The CIT regime has been implemented by the UAE in view of achieving the following objectives:

  • Cementing the UAE’s position as a world-leading hub for business and investment;
  • Meeting international standards for tax transparency and preventing harmful tax practices; and
  • Accelerating the UAE’s development and transformation to achieve its strategic objectives.

We include hereafter the main features of the new regime, as announced by the Ministry of Finance (“MoF”) and the Federal Tax Authority (“FTA”). 

Aurifer will conduct a webinar on 14 December 2022 at 2 pm UAE time. Interested participants can register here.

The text of the UAE Corporate Tax Law (UAE CIT Law), can be found here, and the FAQ’s here.

 

Scope

CIT will apply on the adjusted worldwide accounting net profits of the business. The UAE CIT regime introduces two different rates:

  • A 0% tax rate will apply for taxable profits up to an amount to be specified in a Cabinet Decision, although the FAQ’s refer to a threshold of AED 375,000.
  • The standard statutory tax rate will be 9 per cent. Because of the low tax rate, the UAE will continue to be highly competitive at a global level.

There is currently no mention in Article 3 of the 15% global minimum tax rate applicable for MNEs that fall within the scope of ‘Pillar Two’ of the OECD Base Erosion and Profit Shifting project. Specifically, this would apply to MNEs that have consolidated global revenues in excess of EUR 750m (c. AED 3.15 billion), in any two of the previous four years. The FAQs still refer to the possibility of adoption in the UAE of these rules.

Individuals are subject to corporate tax insofar as they engage in business activity. The definition of business is inspired by the VAT definition, and is therefore broad. A Cabinet Decision will be published in regard to the application of CIT to natural persons.

There is a carve-out regime for businesses established within UAE free zones that (1) maintain adequate substance, and (2) earn qualifying income. What constitutes qualifying income, will be determined in a Cabinet Decision. Presumably, this is a reference to the requirement not to conduct business with mainland UAE, as previously outlined in the Public Consultation Document. It is confirmed as well that Free Zone businesses can voluntarily elect to be subject to Corporate Income Tax at the rate of 9 per cent.

There will be a 0% withholding tax on categories of State Sourced Income derived by a Non-Resident.  This means that foreign investors who do not carry on business in the UAE will in principle not be subject to tax in the UAE.

For foreign entities, they could be considered a resident in the UAE if they are managed and controlled in the UAE. For foreign entities not considered resident in the UAE, but who may have a Permanent Establishment in the UAE, the Permanent Establishment definitions encompass definitions of a fixed PE and an agency PE. We expect further details about the PEs in a Ministerial Decision. For the financial sector, the Investment Manager Exemption from the Public Consultation Document is retained in the UAE CIT Law. Specific rules apply for Partnerships, which could be transparent, and Family Foundations can also apply for tax transparency.

Government entities and government-controlled entities will be exempt from the UAE CIT Law, as will qualifying public benefit entities and qualifying investment funds. Extractive businesses (upstream oil & gas businesses) will also be exempt, to the extent they earn income from the extractive business. In principle, banking operations will be subject to CIT (unless the institution is in a Free Zone and qualifies for the 0% rate). 

 

Date of implementation 

Article 69 of the UAE CIT Law provides that the Law will apply to Tax Periods starting on or after 1 June 2023. 

Businesses with a financial year starting 1 January will be subject to CIT as from 1 January 2024.

 

Deductible expenses

Expenses incurred wholly and exclusively for business purposes, and which are not to be capitalized, are deductible immediately. Deductions are not allowed for expenditures incurred to obtain exempt income. When there is a mixed purpose, the deduction is only partially allowed. Interest expenses are deductible subject to a cap of 30% of the EBITDA. So-called financial assistance rules are in place, which prevents businesses from obtaining financing to pay out dividends or profit distributions. Entertainment expenses are capped at 50% deductibility.

Non-deductible expenses include donations made to a non Qualifying Public Benefit Entity, fines, bribes and dividends. Importantly as well, amounts withdrawn from the Business by a natural person who is a taxable person are not deductible.

 

Exempt income and relief

The following categories of income will be exempt from CIT (article 22 UAE CIT Law):

  • Capital Gains, Dividends and other profit distributions from a Resident Person
  • Capital Gains, Dividends and other profit distributions from a Qualifying shareholding in a foreign legal person, subject to a holding period of 12 months, minimum participation of 5%, at a minimum subject to 9% CIT in the country of source
  • Income from a Foreign PE, subject to conditions and an election to apply the exemption (rather than a credit)
  • Income derived by a non-resident Person derived from operating aircraft or ships in international transportation

The following transactions are subject to specific relief, i.e. effectively a deferral of taxes:

  • Qualifying intragroup transactions and restructurings – entities will qualify if they have 75% common ownership
  • Business restructuring relief – subject to certain conditions.

Transfer pricing 

Article 34 of the UAE CIT Law confirms the requirement for related party transactions to be conducted in accordance with the arm’s length principle. Furthermore, it outlines the five traditional OECD transfer pricing methods as being appropriate to support the arm’s length nature of related party arrangements, while allowing the use of other methods where required. 

Additionally, Article 34 outlines that in the event of an adjustment imposed by a foreign tax authority which impacts a UAE entity, an application must be made to the FTA for a corresponding adjustment to provide the UAE company with relief from double taxation. Any corresponding adjustments related to domestic transactions does not require such an application.

Article 55 covers transfer pricing documentation requirements. UAE businesses will need to comply with the transfer pricing rules and documentation requirements set with reference to the OECD Transfer Pricing Guidelines. This means three tier reporting, i.e., master file, local file and country-by-country reporting. There is also a reference to a controlled transactions disclosure form, details of which remain outstanding. Additionally, it is noted that no materiality thresholds have been provided. Separate legislation will be issued later.

Advanced pricing arrangements will be available as well, through the regular clarification process already in place.

While not necessarily transfer pricing, the UAE has implemented provisions requiring payments and benefits made to connected persons to be at market value, for those amounts to be tax deductible. For the application of this principle, the same principles are applied as in article 34 of the UAE CIT Law, which refers to a transfer pricing methodology.

 

Administration and enforcement 

  • The MoF seems to remain the competent authority for the purposes of multi-lateral / bilateral agreements and the international exchange of information.
  • The FTA will be responsible for the administration, collection and enforcement of the new corporate income tax regime. Penalties and fines are determined by the Tax Procedures Law.
  • Businesses will need to obtain a Tax Registration Number with the FTA.

Businesses that are subject to UAE CIT will be required to file a CIT return electronically for each financial period within 9 months of the end of the Financial Period. A financial period is generally any 12-month financial period year. Free Zone businesses subject to 0% CIT are also required to file a CIT return. 

 

Other considerations

  • Foreign tax will be allowed to be credited against UAE corporate tax payable. The mechanism of the application is as in the Public Consultation Document. Businesses can claim the lower of the corporate tax due, or the amount of withholding tax effectively deducted. There will be no carry forward. There are no credits for taxes paid to the individual Emirate.
  • Fiscal consolidation or Tax Group: UAE companies will be able to form a “fiscal unity” or Tax Group for UAE CIT purposes. The most important condition for a Tax Group to comply with is the (in)direct shareholding requirement of 95%. Free zone entities subject to 0% cannot enter into a Tax Group. In addition, the parent (which can be intermediate) needs to be a UAE company.
  • Losses can be carried forward up to 75% of the Taxable Income (article 37 of the UAE CIT Law).
  • Losses can be transferred between members of the same group of companies, provided the entities are 75% direct or indirectly commonly held. Losses cannot be transferred from exempt persons or free zone entities. The loss offset is also subject to the 75% cap, as for businesses rolling forward losses.
  • Tax deductible losses can be lost when there is a change of control (50% or more) except if the new owner conducts the same or a similar business. The conditions for this have now been defined.
  • Extensive UAE sourcing rules are applicable, which may be of great relevance for the Free zone businesses.
  • The UAE implements a General Anti-Abuse rule, or “GAAR”, which is inspired by the Principal Purpose Test found in the MLI. The GAAR applies to situations where one of the main purposes of a Transaction is to obtain a Corporate Tax Advantage not consistent with the intention or purpose of the UAE CIT Law. The FTA will counteract or adjust the transaction. The GAAR applies for transactions or arrangements entered into on or after the date the UAE CIT Law is published in the Official Gazette. The UAE CIT Law was published in the UAE Official Gazette of 10 October 2022 in issue #737.

Our initial thoughts

The introduction of CIT is a direct result of OECD’s ‘Pillar Two’ which is part of the Base Erosion and Profit Shifting (“BEPS”) project.

With a headline rate of 9% on taxable income and small business relief, the UAE is striking the right balance.

Interestingly as well is that with the implementation of CIT, the UAE also introduced mandatory transfer pricing regulations.

The rules are very much in line with the Public Consultation Document published earlier this year. Much of the detail is deferred to Cabinet and Tax Authority Decisions, and there’s surely a great deal of guidance to be expected. 

Aurifer will conduct a webinar on 14 December 2022 at 2 pm UAE time. Interested participants can register here. In the meantime, feel free to reach out to your regular Aurifer contact for more detail. 

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