By Mourad Chatar & Sarah Bahous, Partners at Value Square, Dubai
On April 28, 2022, the United Arab Emirates Ministry of Finance (UAE MoF) released a public consultation document on the upcoming corporate tax regime. The regime’s guiding principles were announced three months prior, at the end of January 2022.
Although public consultation is not new in the UAE, it is the very first time that this approach has been used for a tax regulation in the country. As a useful reminder, VAT and excise and customs are effective taxes applied in the UAE, and the business community wasn’t consulted in their application. On the contrary, the implementation of VAT in 2018 has been a very difficult process and the business community in general still remembers the trauma of indirect tax implementation.
With the announcement of the guiding principles and this new public consultation before the official publication of the corporate tax law, the UAE MoF has learned the lesson and is changing gears communicating well in advance what fate it has in store for taxpayers.
The public consultation approach must be welcomed by the business community. It is another smart move by the UAE MoF, which is carefully balancing its own interests with those of the business community. Taxpayers need a tax system that is fair, certain, convenient, and efficient as per the fundamental taxation principles laid down by Adam Smith in 1776 in his famous classic work “The Wealth of Nations”.
The public consultation, which will close on May 19th, came as a surprise, falling right before the week-long end of Ramadan Eid El Fitr break. As a result, the business community will have 10 days to digest the document and share comments through the digital platform made available for this purpose.
The OECD-inspired modus operandi has been used during BEPS and GloBE initiatives as well, but it has been heavily criticized given it left the business community with the impression that their comments were not considered. In this case, the very short period to share comments raises question on the real intentions of the UAE MoF, which acknowledges the regulations are about to be released anyway soon.
At this stage, one might give UAE MoF the benefits of the doubt and the business community will be watching this carefully as it could be a real opportunity of a true, honest, and open dialogue between the private and the public communities on the tax space.
Based on the content shared in the public consultation document, the UAE corporate tax regime is set to be the most attractive corporate tax regime not only regionally, but globally. Together with the numerous initiatives taken by the country to ease long-term residency for expatriates and investors, such as the new golden visa scheme, the OECD GloBE initiative, and especially Pillar 2, have been catalysts for the UAE to design a corporate tax regime with the goal of attracting foreign direct investments. For this, we shall take our hats off to UAE leadership and long-term vision.
The UAE DNA Reflected in the Federal Corporate Tax Regime
It is not given to anyone or any country to transform an apparent challenge into an opportunity. When the first indications of the OECD Pillar 2 minimum tax were made public, many were betting on the negative impact it would have on the UAE competitiveness. Jumping from zero to any single- or double-digit corporate tax rate was seen as a bridge too far.
On the contrary, with these changes coming right after the COVID-19 pandemic, the UAE is demonstrating true antifragility or so-called resilience 2.0, which means that when pressure has been put on its system, it is not only getting back to its original stage, but it is growing bigger and stronger.
The public consultation document gives precious information on the key principles and drivers underlying the design of the UAE corporate tax regime. It is set to support and accelerate the UAE development and transformation. In other words, it must attract business and investments allowing the UAE to accelerate its economic-diversification journey and become completely independent from oil-related revenues.
With the above long-term goal in mind, the UAE designed a corporate tax regime that is in line with international standards and truly competitive given (i) it is simple in its basic rules relatively speaking compared to other much more complex corporate tax regimes in the world, (ii) it provides lowest-tax rates and a reduced compliance burden, and last but not least (iii) it is backed by an extensive network of double tax treaties to prevent double taxation, which is the sensitive point for the business community.
The UAE is a small country with big ambitions to remain a peer competitor to yet much bigger neighbouring markets, which are trying to challenge its leadership position as preferred regional hub. This constant competitive DNA of the UAE is reflected in its new federal corporate tax regime and the following sections are detailing how this has been achieved.
In-scope Businesses
As expected, the UAE corporate tax regime will be applicable to any business incorporated in the UAE as well as branches of foreign legal entities. All forms of legal entities are in scope including limited-liability companies, private shareholding companies and public joint-stock companies established under the UAE laws.
To align with other corporate tax regimes, partnerships, unincorporated joint ventures, and associations of persons are to be treated as transparent for UAE corporate tax perspective i.e., not taxed in the UAE. Given UAE’s strategic goal to be a leading asset and wealth management hub, this measure mainly aims to address investment funds commonly organized as limited partnerships. The regulated investment funds and real estate investment trusts would be prompted to apply for the exemption towards the FTA if they meet the requirements.
It is useful to note the reference to entities that are incorporated in foreign jurisdiction but effectively managed and controlled from the UAE. Those would be treated as being incorporated in the UAE for corporate tax purposes, which is de facto the common application of the permanent establishment (PE) rules.
Here the MoF is targeting those groups, which have set up entities for intellectual property (IP) ownership in exotic places such as the British Virgin Islands (BVI) when economic substance is well in Dubai.
The exempt persons are also the expected ones being mainly businesses engaged in the extraction and exploitation of UAE natural resources, public bodies such as the federal and Emirate governments. Both groups will enjoy automatic exemption while wholly government owned UAE companies that carry out sovereign or mandated activities as well as charities and public-benefit organizations would be exempt upon request.
Knowing many business activities are carried out directly by the government, the UAE corporate tax regime would be applicable to any business under a trade license even if carried by the government. The trade license is one of the triggering events to be in scope of the UAE corporate tax law.
The Free Zones Conundrum
In the UAE, the Free Zones are a big thing, and this is for a good reason. These organizations have attracted most of foreign businesses given the benefits offered when it comes to establish a business (tax free, limited reporting obligations, no local sponsor required, etc.).
Such attractiveness is being eroded over time as the corporate tax regime making it more burdensome to enjoy tax free status.
The UAE MoF has very wisely massaged the Free Zones’ ego by allowing them to still provide a tax-free environment, subject to some conditions such as providing audited financial accounts.
As announced in January, the businesses established in Free Zones will enjoy on one hand a 0% corporate tax on income earned from transactions with businesses located outside the UAE or in any other UAE Free Zones. On the other hand, the regular corporate tax will be applicable on income sourced from mainland unless those are passive incomes such as interests, royalties, and dividends. The sale of goods from designated zones for VAT purposes would also benefit from the 0 corporate tax rate when the importer of record of such goods is a mainland business. Any other mainland-sourced income will disqualify the Free Zone business from enjoying the 0% corporate tax for all their income.
The Free Zones conundrum must be navigated smartly and there is a palpable tension between the UAE MoF and the Free Zones’ authorities, which are obviously trying to defend their businesses.
A careful reader will have noticed that the Public Consultation Document references the important role the Free Zones had in encouraging foreign direct investment and enhancing the ease of doing business in the UAE. Reading between the lines, the message seems clear: Free Zones have done their job well up to now, however going forward the UAE authority will be taking the upper hand to develop its economy.
Free Zones businesses will have to assess carefully whether they are better off being subject to corporate tax or not given the possibility to irrevocably opt to be subject to the regular corporate tax rate.
The Taxable Base
On the taxable base front, it can be stated that the UAE is trying to have the simplest and straightforward approach. The accounting net profit (or loss) as stated in the financial statements will be the basic reference.
In terms of accounting standards, a reference has been explicitly made to International Financial Reporting Standards (IFRS), although the UAE remains flexible allowing alternative ones to ensure reduced compliance costs for smaller taxpayers such as startups and SMEs.
Large exemptions are foreseen for dividends and capital gains on shares from UAE businesses as well as from foreign companies although the latter would be applicable provided some conditions are met such as minimum 5% ownership and minimum taxation of 9% of foreign ownership.
The UAE corporate tax regime will avoid double taxation and has therefore foreseen both a foreign tax credit mechanism for taxes paid by foreign branches as well as an exemption regime upon voluntary claim which would be irrevocable.
The tax losses could be carried forward indefinitely provided some ownership conditions are met and be used against taxable income up to a maximum of 75% each year. The UAE is obviously looking at closing the potential juicy business of structural loss-making companies. It is also clear that there would be no tax relief for losses created before the effective date of corporate tax.
Based on the Public Consultation Document, very few book-to-tax adjustments are to be expected in the corporate tax law. The main ones referred to in the document are the interest- capping rules at 30% of EBITDA to align with Action 4 of the BEPS action plan and the non-deductible expenses limitation to 50% for the expenses made to entertain customers, suppliers, and shareholders which could be non-business.
The Three-tiered Tax Rates
The Public Consultation Document is confirming the previously announced corporate tax rates (0% below and 9% above AED 375,000) and addresses the SMEs community by announcing some relief in the form of simplified financial and tax reporting obligations. Here, the business community is eager to know what shape the relief will take.
Some uncertainty remains on Pillar 2, like which MNEs would be subject to a separate corporate tax rate. This will be announced later as work is ongoing with the OECD Inclusive Framework.
It is not surprising to see the UAE playing the clock on this point, given important details and guidance on the implementation are requested to the OECD around the income inclusion rule and undertaxed profit rule. The UAE has also well noted that many countries have already announced delays in implementing Pillar 2 rules such as in the EU which directive’s entry into force has been delayed for tax years beginning on or after 31st December 2024 instead of initially announced 2023.
The UAE Attractive Withholding Tax Policy
Since the announcement in January 2022, the UAE withholding tax policy has been clear. The UAE corporate tax regime must avoid double taxation to ensure the UAE keeps its position as a global financial center and international business hub. Therefore, a 0% withholding tax will apply on domestic and cross-border payments made by UAE businesses and no withholding tax return would be required.
Together with the extensive double-tax treaty, it is a very welcomed policy as withholding tax is often a tax-planning dealbreaker for MNEs. This is very often forgotten by many tax practitioners mainly focused on the corporate tax and transfer pricing schemes to flow taxable basis towards low-tax jurisdictions.
The UAE withholding tax policy is by far the most attractive in the region where most Middle East neighboring countries have implemented hard withholding tax rules where nearly every outbound flow is taxed given their importing economies.
As an illustrative example, Qatar, which is often taken as a proxy for the UAE competitiveness, has implemented withholding taxes and the related refund process undersigned double-tax treaties is still a lengthy process the business community would prefer to avoid.
This also favors the UAE as preferred location for holding companies, which are always seeking to upstream and distribute the shareholder value with limited to no tax frictions.
More Flexibility for Groups
Provided the 95% common ownership condition is met, groups would have the option to file one single consolidated corporate tax return for all their UAE-based subsidiaries subject to corporate tax. To form a tax group, a notice signed by the parent company and all its subsidiaries would need to be sent to the FTA and an accounting consolidation would need to be prepared.
In what seems to be a non-arm’s-length-relief measure, the UAE corporate tax regime will allow simple transfer of tax losses from one group company to another group company with profits provided both have at least 75% common shareholder. The total tax-loss offset would be limited to 75% of the taxable income of the company receiving the losses in the relevant period.
One might ask why a third party would accept to receive losses from another party except if it is only to reduce its tax base which seems to be purely tax-driven transactions. It is especially relevant because the UAE corporate tax regime includes the arm’s length principle and transfer pricing reporting obligations.
The Transfer Pricing Reporting Obligations
The UAE will apply the arm’s length principle and fully align with the OECD Transfer Pricing Guidelines.
Although thresholds are not yet communicated, a specific disclosure form will have to be prepared as well as local file and master file documentation to support the arm’s-length nature of the intragroup transactions, which have been defined as “transactions between related parties and connected persons.”
While related parties’ concept is familiar to most, the interesting development is around the definition of “connected persons,” which is targeting individuals behind the corporate layer.
In absence of personal tax, the UAE wishes to prevent the obvious planning of high salaries to owners to create taxable deductions at corporate level. Accordingly, payments or benefits provided by a business to its “Connected Persons” will be deductible only if the business can demonstrate that the payment or benefit correspond to market value and is incurred exclusively for the purposes of the taxpayer’s business.
In any case, such payments would need to be reported in the disclosure, which seems to be a first transparency step towards individual taxation. Although the UAE keeps at underlying the absence of willingness to tax personal incomes, if you are not able to bring the demonstration, the individual income would be inevitably taxed at 9% through the non-deductible character of the payments and benefits earned by the “connected person”.
This example preserves the rationale of corporate tax and overall tax treatment of corporations when you remind yourself that behind any corporations you have individuals, capital owners who seeks to protect themselves from individual income tax or seek political influence such as lobby groups.
While the VAT does not attack the capacity of this separate legal entity to protect its capital owners from personal tax (given it is in principle neutral for corporations being the mere VAT collector), the corporate tax principal goal is well to reduce the value of such protection and through data, keep an eye on profits generated by corporations and their owners behind.
The Administrative Aspects
If it would be subject to corporate tax, a business would need to register with the Federal Tax Authority (FTA) and obtain a Tax Registration Number (TRN). It is not clear yet whether it would be a different TRN or the one already provided for VAT purposes. Some clarifications would be welcomed on this front given in most countries there is a unique tax-identification number for each taxpayer independently of the tax field. This voluntary compliance comes also with the ability of the FTA to automatically register a business for corporate tax purposes if it does not do it voluntarily.
To keep a low compliance burden, there will be one single corporate tax return to be submitted to the FTA not later than nine months after the end of the relevant tax period. The payment of the tax due will also have to be made within the nine-month period.
It is mentioned that FTA will ensure the review of the corporate tax returns filed and issue assessment, if need be, in line with the tax procedures law. Here, the business community will have to be vigilant and scrutinise the investigation powers of the FTA which could be extended.
In this respect, it is welcomed to allow the taxpayers to seek clarifications from the FTA on the corporate tax treatment of intended arrangements. Here, it would be interesting to know whether this would extend to transfer pricing matters and whether an FTA clarification could have the same value as an advance pricing agreement or ruling given the clarifications provided are meant to be binding on the FTA.
Based on the public consultation document, the burden of proof sits on the taxpayer’s side which will have to maintain all financial records as well as supporting evidence used to file the tax return.
Here it is very interesting to note UAE MoF additional pressure on the free zones’ authorities given that the apparent zero-rate gift is conditioned to the obligation to produce audited financial statements, which is, for many businesses, a dealbreaker. It is not a secret that through various initiatives such as removing the need of local sponsor and allowing 100% owned businesses, the UAE has been pushing businesses to establish into mainland to counterbalance the growing economic power of free zones.
Concluding Remarks
On September 5, 2021, the UAE announced its 10 principles for the next 50 years to come. The second principle states that the UAE will laser focus on, not less than, building the best and most dynamic economy in the world.
In those principles, it is stated that the economic development of the country is the supreme national interest and that all state institutions across federal and local levels shall bear collectively the responsibility of building the best global economic environment.
In this regard, it can be firmly stated that the UAE MoF has fulfilled its responsibility with the newly designed corporate tax regime. The business community is looking forward to the publication of the law, its executive regulation as well as needed guidance to clarify the grey zones to roll this out smoothly.
— Mourad Chatar & Sarah Bahous are regional tax partners at Value Square, Dubai
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