Since the implementation of Corporate Tax (CT) into the UAE was announced on 31 January 2022, there has been much excitement (good or bad) and curiosity about how it would apply and what it would entail. After little information has been available to stem these concerns, a Public Consultation Document on the UAE Corporate Tax (the "PCD") has been published for the public's consideration. This is the first major document, and by the far the most informative, giving information on what we can expect from the CT which is going to be effective from 1 June 2023.
So why is the UAE implementing CT?
This is a question on many people's lips and the answer is simple, to ensure the UAE develops and transforms. By the UAE implementing CT, it will ensure that it adheres to international standards, and it will not only permit economic growth but will further assist in cementing the UAE's position as leading jurisdiction for business and investment.
So, what is CT and how will it potentially affect you. Well as the name suggests it is purely a tax that focuses on corporate dealings and earnings therefrom. Thankfully the UAE has adopted well recognized international policies and practices, so for people familiar with tax in other jurisdictions, it should be easy to adapt to the implementation of CT within the UAE.
For the sake of efficiency, we cannot cover everything in the PCD, however we shall highlight what we believe to be the most crucial points of the PCD, in this article including the answers to the following questions:
- What is the CT rate?
- Who will be liable to pay CT?
- What determines if a person must pay CT?
- How is CT calculated?
We believe this is likely to be the most sought-after information.
The UAE has kept it simple as far as the CT rate is concerned which is as follows:
- 10% up to the first AED375,000 of taxable income.
- 9% for taxable income exceeding AED375,000.
These figures will be familiar to businesses within the UAE as the mandatory threshold for registering for VAT is an annual turnover of AED375,000.
The difference here, is that turnover is not relevant but rather net profit. Furthermore, if your annual net profit does not exceed AED375,000, it does not mean you are not required to account for CT but rather, that the due tax will, in practice, be zero, as it will be based on the 0% rate.
This is to assist new and small businesses.
1) Accordingly, tax would be calculated as follows for a company with a AED1,000,000 net profit.
a. The first AED375,000 of the million would be taxed at 0% = AED 0
b. The remaining AED625,000 will be taxed at 9% = AED56,250.
c. Less any foreign credits, if applicable (discussed below) but for our example we will use zero foreign credits.
Final tax payable = AED56,250.
The above is obviously a very simple example but illustrates how it would work within a company or companies.
It is not uncommon in the UAE for businesses to be up of more than one company, but luckily, as with VAT, CT will permit the use of Tax Groups provided the conditions are met. So, this should also simplify the calculation of the final tax payable by large businesses as they can file just one return for numerous related entities.
Now that we have determined the tax rate calculation, the next question to answer is, whom will be liable for CT tax?
As highlighted above, CT will be applicable to only to corporate related work and entities and not on personal income. This does not mean that it will only apply to companies (legal persons) but also to individuals (natural persons) who carry on sole establishments or proprietorships as well as individual partners in an unincorporated partnership. In order to determine if a natural person will be subject to CT, it would generally depend if the individual was required to obtain a license or working permit to carry on their activity. Again, this does not mean that the personal income of that individual will be taxed, but only income solely derived from the commercial activities that individual carries out for their sole proprietorship or partnership.
Mainly, CT will apply to companies. CT will apply to all UAE companies and other legal persons incorporated within the UAE or to foreign entities who have a permeant establishment (discussed below) within the UAE or that earn UAE sourced income. In addition, entities that are incorporated in a foreign jurisdiction, but for all intents and purposes are managed from the UAE, will be treated as though they are incorporated within the UAE for tax purposes.
Limited and general partnerships and other unincorporated joint ventures and associates will be treated as "transparent" for CT purposes. This means that although they won't be taxed in their own right, the income will "flow through" and be taxed in the hands of the partners and members only. This is a widely accepted international principle of how such income is taxed.
There are a few entities who are exempt for CT purposes, and these are:
- The Federal and Emirate Governments and their departments, authorities, and other public institutions.
- Wholly owned UAE government companies that carry out a sovereign or mandated activity and that are listed in a cabinet decision.
- Businesses engaged in the extraction and exploitation of UAE natural resources that are already subject to Emirate-level taxation.
- Charities and other public benefit organizations that are listed in a Cabinet Decision.
- Public and regulated private social security and retirement funds.
- Investment funds, provided they meet the following requirements:
a. The investment fund is regulated by a regulatory authority in the UAE that is recognized by the Ministry of Finance, e.g., Securities and Commodities Authority.
b. There is no group of 5 or fewer investors that have 50% or greater interest in the fund.
c. No single investor has an economic interest of 20% or more in the fund.
d. Interests in the investment fund can be traded on the UAE stock exchange (or a foreign stock exchange) or are widely marketed and made available to the intended categories of investors.
Freezone companies are withing the scope of the CT in the sense that they are obliged to file a tax return, but the UAE government is committed to honoring the tax incentives as was initially intended. Accordingly, a Freezone person or company can benefit from a potential 0% tax rate. As mentioned, this is still accountable, however no effective tax will be paid for income subject to the 0% tax rate.
A Freezone entity can benefit from the 0% rate in the following circumstances:
- On income that is earned from transactions with businesses located outside the UAE or in the same or other Freezones. This may include income from certain regulated financial services directed at foreign markets.
- When a Freezone company has a branch on the mainland, then the income from the branch will subject to the standard CT rate whilst the other excluded income of the Freezone entity will be subject to 0%.
- When the Freezone company interacts with the mainland and there is no branch but the income from the mainland is passive, such as interest, royalties, dividends and capital gains, then the Freezone company may still benefit from the 0% rate.
- Transactions between Freezone companies and any group companies located on the mainland will also be subject to 0%, however the mainland company in such circumstances will not be able to deduct the relevant expense when filing its return.
- Finally, a Freezone company located in a designated zone for VAT, can also benefit from the 0% rate for income on the sale of goods to the UAE mainland businesses that are the importer of record for such goods.
Where a freezone entity benefits from the 0% rate with respect to mainland sourced income, such income will be within the scope of withholding tax, which currently is also to be applied at 0%. Any mainland sourced income, other than what is defined above, will be subject to the usual rate.
The above is a lot to take in, especially to a jurisdiction not familiar with CT so the PCD includes a flowchart for ease of use and which we have included below to determine who is liable to pay tax.
Basis for Taxation
What determines if a person must pay CT?
The UAE has implemented the internationally recognized Residency test to determine if a person or company is liable to pay CT.
A person or a company is either a resident for tax purposes or is not.
For residents, the tests are fairly simple, and the following are residents for CT purposes.
- A legal person incorporated within the UAE or a natural person carrying out business within the UAE; or
- A foreign registered company if it is effectively managed from the UAE.
UAE resident persons are liable for taxation on their worldwide income, barring the exemptions such as foreign branches or foreign shareholdings. Furthermore, where income is not exempt, but tax has already been paid on it overseas, then this can be used as a "foreign credit" for CT purposes.
Even non-residents can be subject to CT if the following applies:
- On taxable income from their permanent establishment within the UAE, or
- On income which is sourced in the UAE.
To ascertain when a non-resident should be liable for taxation, the internationally utilized Permanent Establishment Principle (PEP) is used. The PEP concept for the UAE has been based on the Article 5 of the OECD Model Tax Convention.
The PEP determines if a company, which is generally regarded as a non-resident, has established a sufficient presence within the UAE that would make them liable for CT.
In order to satisfy the PEP, there are two main tests which are used:
- Fixed place of business test
- Effectively, this means that if a company has any form of fixed establishment within the UAE, barring a few exceptions, then this establishment will pass the test and make the establishment liable for CT. This can even include a building site on which activities will exceed 6 months.
- There are a few exceptions to the above:
- If the activities carried on are auxiliary in nature, such as marketing research for e.g., or
- The fixed place is only used as storage for the foreign company's goods.
- Dependent agent test.
- This is where UAE based persons habitually carry-on business on behalf of foreign companies including the ability to negotiate and conclude contracts.
- This would not apply where a person assists a foreign company in the course and scope of their own business, i.e., not employed by the foreign company.
- This test can be utilized in the case of a Freezone company and a person doing business onshore as well.
If a person does not satisfy the PEP requirements but earns a UAE sourced income, it will be subject to a withholding tax at 0%.
Calculation of due tax
We now progress to the all-important question of how due CT is calculated.
Again, the UAE have closely followed the international standards in this regard.
Tax will be paid at the end of each financial year, which if a company does not have a set one, will be the end of each Gregorian year.
As highlighted above, the tax rate is simple and the way it is calculated on the final taxable figure is also simple, but to get to the final taxable figure is slightly more complicated.
The exact method is too complex to explain in detail however for simple purposes, one would need to calculate their net-profit and then include other factors.
Calculating the net-profit itself, is fairly easy, by calculating total profit less expenses. However, this would not necessarily give you your final taxable amount as there are other factors to consider.
If the have been loses in the previous financial year, they may be able to be carried forward up to a maximum of 75% of the future taxable income, or 50% if a single shareholder owns more than 50% of the shares in a company.
There will further be consideration of unrealized gains and loses which will be determined by specific rules which have yet to be published.
Accordingly, it would be advisable, depending on the size of the business, to have a professional firm assist with calculating what tax is due to avoid under payments and related penalties.
Accordingly, one can now see that CT is not just a rumor that may or may not be implemented in the far future, but has been thought out, and is clearly something that is coming soon and will impact the commercial industry significantly.
Businesses need to hit the ground running and where it has been common (especially in smaller or single owner businesses) to have financial books being kept in a casual manner; this will no longer be an advisable option with which to manage a business.
Financial records will need to be kept in a meticulous manner to ensure that reports can be conducted in accordance with international accounting standards and to ensure that the correct tax amounts are paid.
This article merely discusses the basics of the intended upcoming CT and there will be further in-depth considerations that will need to be made by business owners. It is not uncommon for there to be substantial and complicated corporate structures in the UAE that were originally (and legally) made with the intention of not having to pay full tax in foreign jurisdictions and which may no longer work now given the incoming CT and is certainly something for businesses to consider.
CT is going to influence, not just businesses, but everyday life as well, as no doubt companies will increases prices to maintain their profit margins. At the end of the day though, CT is coming, and is just another crucial and necessary step the UAE is taking in transformation and moving away from being reliant on oil.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.