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.
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.
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.
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.
- 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