Corporate tax: the dawn of a new tax era in the UAE
December 2023 | SPECIAL REPORT: CORPORATE TAX
Financier Worldwide Magazine
December 2023 Issue
The United Arab Emirates (UAE), renowned for its spectacular skyline, business-friendly environment, world-class infrastructure and strategic location between East and West, has emerged as a leading global hub for commerce. One of the UAE’s key attractions has been its favourable corporate tax regime, which has witnessed significant reform in 2023.
The UAE as a federation did not have any income tax legislation before now. The individual Emirates had passed their own tax decrees dealing with corporate income tax, but in practice, corporate income tax was imposed only on oil and gas producing companies and branches of foreign banks.
The radical changes in the tax landscape of the UAE were driven by the Organisation for Economic Cooperation and Development’s (OECD) base erosion and profit shifting (BEPS) project which seeks to set up an international framework to combat tax avoidance by multinational enterprises (MNEs) using base erosion and profit shifting tools.
The UAE joined the G20/OECD Inclusive Framework on BEPS in 2018. Through joining the Inclusive Framework, the UAE has committed to implement, in the immediate to short term, the four BEPS minimum standards actions. In line with its commitment, the UAE introduced economic substance regulations (ESR) as well as country-by-country reporting (CbCR) regulations in April 2019.
The UAE joined over 130 members of the BEPS Inclusive Framework in a historic deal to address the tax challenges arising from the digitalisation of the economy. BEPS 2.0 is a two-pillar solution to reform the international taxation rules and ensure that MNEs pay a fair share of tax wherever they operate and generate profits in today’s digitalised and globalised world economy.
As a significant milestone, the UAE announced the introduction of the federal corporate tax (CT) regime, on 31 January 2022, for financial years starting on or after 1 June 2023, with a headline rate of 9 percent. The move shows the UAE’s willingness to support global minimum tax under the BEPS project along with its commitment to comply with the international tax transparency and fairness standards. The Federal Decree Law No. (47) of 2022 on the Taxation of Corporations and Businesses (CT Law) was published on 9 December 2022.
This landmark tax reform will affect a large number of businesses operating across most sectors in the country. The 9 percent corporate tax may significantly affect the profitability of medium-sized companies. They will now have to establish internal systems and processes to track taxable activities, maintain accurate records and file accurate tax returns. This potentially requires additional resources and expertise and will incur additional costs. Companies may well need to invest in tax advisers or consultants to ensure accurate reporting and compliance with tax laws.
The UAE CT regime has been designed to incorporate best practices globally and minimise the compliance burden on businesses. However, in line with international best practices the CT Law has adopted various distinctive features which makes it quite unique.
The UAE introduced a federal tax structure applicable to all business operations and commercial activities conducted throughout the emirates. The UAE CT is a residency-based tax regime. A number of reliefs and exemptions are also provided for in the CT Law, related either to the categories of exempt persons or the nature of income that will be exempt from CT (qualifying dividends and capital gains, business restructuring reliefs, etc.). Qualifying ‘free zone’ persons will be subject to 0 percent tax subject to certain conditions.
Interestingly, the concept of permanent establishment (PE) has been adopted in the CT Law itself while it is generally a concept applied only through tax treaties. Though the PE definition in the CT Law is relatively standard and includes the usual ‘fixed place of business’ as well as ‘agency PE’ based on the OECD Model Convention (MC), some different nuances between the PE definitions under the UAE CT Law and the OECD MC can be noted. While there is exemption from PE for activities of a preparatory or auxiliary nature, the CT Law takes into account action plan 7 of the OECD’s BEPS project on anti-fragmentation where a non-resident or its related party carries out activities in the UAE through another PE in the UAE and on a combined basis the otherwise auxiliary activities form a cohesive business operation of a non-resident in the UAE.
In relation to the taxability of non-residents, the CT law has introduced the concept of ‘nexus’ in the UAE. The definition of ‘nexus’ provides for the taxability of foreign companies and other overseas legal entities which derive income from immovable property located within the UAE.
The CT Law provides for a small number of adjustments for expense deductions. The deductibility of interest will be capped at 30 percent of a business’ earnings before interest, tax, depreciation and amortisation (EBITDA), in line with action 4 of the OECD BEPS project, in order to disincentivise businesses from using excessive levels of debt financing in pursuance of a tax benefit provided the expenditure exceeds the threshold of AED12m. The definition of interest is very broad and includes interest and associated costs paid to banks as well, whereas in other countries the restriction generally applies only in the case of related parties.
While businesses will be allowed to carry forward and offset losses for an indefinite period subject to certain conditions, the CT Law also provides a very unique and beneficial provision for transfer of losses. Tax loss of one entity can be transferred to another entity subject to certain conditions which primarily revolve around ownership (75 percent director or indirect ownership criteria), subject to certain conditions.
The transfer pricing (TP) regulations provide that taxpayers need to adhere to the arm’s length principle for all transactions and arrangements with related parties, meaning that appropriate transfer prices must be charged between related parties for both domestic as well as cross-border arrangements. The TP methods that are specified in the law are generally consistent with the OECD Transfer Pricing Guidelines and need to be supported by robust documentation. The definition of ‘related parties’ is similar to definitions typically seen in other corporate tax regimes – 50 percent or greater ownership interest or control. Typically, a relationship can also exist through kinship, where individuals are related to the fourth degree of kinship or affiliation including by way of adoption or guardianship.
The law also includes the concept of ‘connected’ persons, which is not commonly seen in other jurisdictions. Owners, directors or officers (or any persons related to them) of a business are within the scope of the UAE corporate tax regime and will be considered as ‘connected’. With the introduction of this concept, the UAE corporate tax regime aims to prevent the corporate tax base from being eroded as a result of excessive payments made to business owners or persons connected with them. This concept will definitely impact the local family-owned conglomerates operating in the UAE.
The CT Law includes general anti-abuse rules (GAAR) intended to disregard transactions or arrangements undertaken without a valid commercial reason for the main purpose of obtaining a CT advantage. Unlike other nations, there does not seem to be any thresholds prescribed for triggering GAAR provisions. The provisions were made applicable even during the transition period of the law which came into force on 1 June 2023.
The tax rate of 9 percent still remains highly competitive in comparison to other jurisdictions. The new corporate tax regime will bring increased transparency in terms of tax compliance and accountability and provide investors with greater confidence in the UAE’s regulatory framework. It is crucial for companies to plan for the new tax regime, assess their current systems and procedures, seek expert advice and adapt their business strategies wherever necessary in order to remain competitive and thrive in the new tax regime and cost environment in the UAE.
Nirav Shah is a director and Karishma Bhuwalka is manager of tax advisory at FAME Advisory DMCC. Mr Shah can be contacted on +971 50 277 1511 or by email: nirav@fame.ae. Ms Bhuwalka can be contacted on +971 58 871 7193 or by email: karishma@fame.ae.
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Nirav Shah and Karishma Bhuwalka
FAME Advisory DMCC
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