Menu
The introduction of Corporate Income Tax (“CIT”) in the United Arab Emirates (“UAE”) has been a pivotal moment in the country’s continuous development. Historically, the UAE operated as a jurisdiction where no federal corporate income tax (CIT) was applicable. In this regard, Aurifer published a number of articles on the topic which are available here. With the implementation of CIT, the government has introduced transitional provisions to facilitate a smooth transition for businesses adapting to the new regime.
This article examines the most significant transitional provisions under UAE CIT Law (Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses) and Ministerial Decision No. 120 of 2023, focusing on their key objectives, tax implications, and compliance requirements. By discussing both the accounting aspects and asset revaluation mechanisms, we highlight how these provisions have impacted and continue to impact businesses and the broader financial reporting environment in the UAE.
These provisions have a twofold objective. First, they ensure that financial statements accurately reflect businesses’ positions at the time CIT is introduced, requiring companies to align their balance sheets with recognized accounting principles and fair market valuations. Second, they allow businesses to lock in pre-tax period gains on specific assets, including immovable property, intellectual property, and financial assets and liabilities, preventing unintended taxation on value appreciation that occurred before CIT implementation.
Given that the Federal Tax Authority (“FTA”) very closely scrutinized transitional provisions when Value Added Tax (“VAT”) was introduced in 2018, a similar level of oversight is expected for CIT implementation. These transitional rules are critical for businesses to understand since they impact how companies report financial positions, manage tax liabilities, and plan for the future.
Below, we first consider the adjustments required for financial statements before examining the tax treatment of pre-existing assets and the options available to businesses.
Ensuring Balance Sheet Compliance with Transfer Pricing Principles
For taxpayers transitioning into the CIT regime, the opening balance sheet for tax purposes will correspond directly to the closing balance sheet of the financial year ending immediately prior to the first tax period. Consequently, entities operating on a Gregorian calendar year must utilize their closing balances as of 31 December 2023 as the opening balances for the first tax period starting 1 January 2024.
Crucially, these opening balances must comply strictly with the Arm’s Length Principle (“ALP”) from a Transfer Pricing (“TP”) perspective. This implies that taxpayers must ensure their prior year-end balances accurately reflect arm’s length values, thereby aligning the tax and accounting positions at the outset of the new CIT regime.
Moreover, it is essential that these balances also adhere to the General Anti-Avoidance Rules (“GAAR”). In practical terms, transactions that could be perceived as artificial or structured primarily to secure undue tax advantages must be revisited. Such arrangements, unless justifiable under economic and commercial rationale, could trigger the application of the GAAR provisions, potentially leading to adjustments by the FTA.
Practically, this means that if related party transactions were not previously recorded at arm’s length, the FTA expects taxpayers to make necessary adjustments in the first tax period. Adjustments may involve increasing taxable income or reducing deductible expenses, thus aligning recorded amounts with market conditions. These adjustments could also extend to subsequent tax periods, if relevant.
Additionally, recognizing that not all taxpayers, such as entities following a cash basis of accounting, were previously required to maintain formal financial statements, the FTA mandates these entities to prepare an opening balance sheet in accordance with an appropriate accounting standard, irrespective of their previous accounting basis.
Transitional Provisions offering Opportunity for Locking in Gains for Specific Assets
Under the transitional rules, Taxable Persons who hold Financial Assets or Financial Liabilities, Immovable Property, and Intangible Assets before the first Tax Period and recorded these assets on a historical cost basis may elect to adjust their Taxable Income. This adjustment allows the exclusion of gains or losses attributable to the periods preceding the introduction of the CIT. These elections are optional, implying that taxpayers are not forced to apply these provisions. However, once elected in the first Tax Period, they become irrevocable, except in exceptional cases.
The rationale behind these transitional relief rules is to ensure taxpayers are not subjected to CIT on gains or losses realized after CIT implementation that have accrued in periods before CIT was introduced. In other words, the provisions permit taxpayers to rebase or step up their asset values, locking in gains, although without creating an associated right to claim deductible depreciation or amortization expenses.
The transitional provisions bridge the gap between the pre-CIT and post-CIT eras. Considering the potential unfairness of taxing investors on gains accumulated before the implementation of CIT, particularly when these gains were not considered in long-term tax planning. In this regard, the UAE CIT Law provides transitional measures for different asset types. These include:
While taxpayers have only one method available to apply the transitional adjustment to Qualifying Intangible Assets and Qualifying Financial Assets and Liabilities, taxpayers holding Qualifying Immovable Property can select between two methods of exclusion.
The following sections will further elaborate on these transitional provisions, including the methods available, definitions of qualifying assets, and the conditions for their application. The table below provides an overview of these aspects.
For the transitional provisions to apply, the following requirements must be met:
– The asset must be owned prior to the first Tax Period.
Since the transitional provisions specifically target assets existing at the start of the first Tax Period, ownership must have commenced before this period to qualify.
– The asset was recorded on a historical cost basis.
The transitional provisions apply exclusively to assets accounted for under a historical cost basis. Taxpayers holding assets at fair market value are excluded, as their asset values have effectively already been adjusted (or rebased) prior to CIT commencement. Consequently, any future disposal of such fair-valued assets inherently excludes gains relating to pre-CIT periods, rendering transitional provisions unnecessary.
As noted previously, applying these provisions involves an elective decision by the taxpayer through the CIT return and is not compulsory.
If the market value of the asset at the start of the first tax period is below its cost basis or if the taxpayer anticipates a decline in the asset’s value, making the election would typically not offer any tax benefit.
We now discuss each asset type separately in more detail.
Qualifying Immovable Property
The UAE’s real estate sector, notably Dubai, has seen significant appreciation in recent years, making the transitional rules especially relevant for business taxpayers holding immovable properties.
Qualifying Immovable Property (“QIP”) is a unique asset class for tax purposes, as it permits taxpayers to select either the valuation method or the time apportionment method to exclude pre-CIT gains from taxable income.
Under UAE CIT regulations, immovable property includes:
For the transitional provisions related to QIP to apply, specific conditions must be satisfied. Primarily, the immovable property must be disposed of, or deemed disposed of, during or after the first tax period at a value exceeding its net book value for determining taxable income.Practically, this means that the QIP is either explicitly sold or considered notionally disposed of (“deemed disposed”) to lock in the market price at the start of the CIT regime.
Under the valuation method, taxpayers exclude gains accrued before the first tax period based on the market value at the start of that tax period. Importantly, such market value must be assessed and approved by the relevant governmental authority of each Emirate, such as the Department of Municipalities and Transport (DMA) in Abu Dhabi, the Dubai Land Department (DLD) in Dubai, or corresponding authorities in other Emirates.
The transitional rules provide taxpayers with flexibility, particularly in the choice of methods available for immovable property, facilitating a smooth shift to CIT.
An example illustrating the application of the valuation method is provided below:
A company’s first Tax Period runs from 1 August 2023 to 31 July 2024. At the start of the first Tax Period (1 August 2023), the company’s opening balance sheet indicates the following in regard to an immovable property:
The immovable property was purchased on 1 August 2020 at arm’s length, and the asset was recorded on a historical cost basis.
In its Tax Return for the first Tax Period, the Company makes an election for transitional relief under the valuation method. The valuation method applies as follows:-
Alternatively, under the time apportionment method, the gains attributable to the period before the first Tax Period are excluded based on the duration the asset was held. An illustrative calculation based on the same example is presented below:
Calculation of Taxable Gain (Post-CIT Gain):
The transitional provisions apply individually for each QIP, allowing taxpayers to selectively apply the election on an asset by asset basis. This differs from the treatment for Qualifying Intangible Assets (“QIA”) and Qualifying Financial Assets and Liabilities (“QFAL”), where the election applies collectively to all assets within those categories.
Qualifying Intangible Assets
For CIT purposes, as stated above, intangible assets are defined according to applicable accounting standards. The FTA clarifies that intangible assets typically include goodwill, trademarks, and patents.
Transitional provisions related to QIA specifically apply when such assets are disposed of or deemed to be disposed of during or after the first Tax Period at a value exceeding their net book value. Practically, this means the QIA is either sold during the first Tax Period or notionally treated as disposed of to lock in its market value.
Only the time apportionment method is available for QIA. Under this approach, gains accrued before the start of CIT are excluded proportionally based on the duration of ownership prior to CIT implementation. In applying this method to intangible assets, a maximum ownership period of ten years prior to CIT commencement is considered.
The methodology mirrors that used for QIP, meaning gains related to periods before the introduction of CIT are proportionally excluded based on the number of days the asset was held before the first Tax Period relative to the total ownership duration.
Qualifying Financial Assets and Liabilities
As clarified by the FTA, Qualifying Financial Assets and Liabilities (“QFAL”) for CIT purposes are determined in line with applicable accounting standards. According to the FTA’s guidance, examples of QFAL typically include investments held in trading accounts, such as shareholdings that do not meet the criteria for the Participation Exemption, and financial instruments, such as loans payable or receivable.
Unlike Qualifying Immovable Property, taxpayers can only use the valuation method for Qualifying Financial Assets and Liabilities. Additionally, this election applies collectively to all qualifying financial assets and liabilities. Taxpayers cannot apply the method selectively to individual assets.
In applying the valuation method, there is no official government procedure to determine the market value. However, the FTA strongly suggests that taxpayers appoint an independent expert to carry out the valuation.
An illustrative example of applying the valuation method is as follows:
Company A holds a financial asset recorded at a historical cost of AED 70. At the start of its first Tax Period in 2024, Company A appoints an independent expert who determines the asset’s market value as AED 100. The company then elects in its CIT return to exclude the gain of AED 30 (being the difference between the market value and historical cost). In the following year, 2025, Company A sells the financial asset for AED 120. Accordingly, Company A is liable for CIT only on the gain attributable to the period after CIT implementation, amounting to AED 20 (the total accounting gain of AED 50 minus the AED 30 excluded pre-CIT gain).
Group Ownership of Assets
The transitional provisions also accommodate scenarios involving assets previously owned by another member of the same Tax Group or Qualifying Group.
In such cases, taxpayers may look through to the prior ownership period by the other group member entity, ensuring consistent and fair calculation of the excluded gain or loss.
This rule effectively acknowledges prior group ownership to accurately reflect the asset’s true holding period for transitional adjustment calculations.
Conclusion
The transitional provisions introduced under the UAE CIT are essential in safeguarding taxpayers from unintended taxation on asset gains accrued before CIT commenced, i.e. during the UAE’s tax-free environment. These rules provide taxpayers the option, although not the obligation, to adjust their taxable income to exclude pre-CIT gains or losses, thus preventing unexpected tax liabilities.
Given the elective and irrevocable nature of these provisions, it is critical for businesses to carefully consider their asset portfolios, anticipated market conditions, as well as the convenience and practical implications of each transitional method.
Developed By Volga Tigris Digital Marketing Agency
