The Federal Tax Authority (FTA) of the United Arab Emirates (UAE) announced on Jan. 31, 2022 that a corporate tax (CT) regime would be implemented starting June 1, 2023. The FTA released answers to some Frequently Asked Questions (FAQs) that laid down high-level thinking of the government in terms of the design of the CT regime.
This decision has, of course, arisen because of parallel changes in the global tax landscape, especially in light of the Pillar One and Pillar Two reforms the Organisation for Economic Co-operation and Development (OECD) is seeking to introduce, under its Base Erosion and Profit Shifting Project (BEPS Project 2.0).
Businesses, academics and policy watchers have been speculating on the nuances of the design of the tax regime, and the impact that the regime would have on the UAE economy. The purpose of this article is to offer some perspectives on possible new issues.
This article is part of a series of five articles on the UAE corporate income tax regime. It will examine some of the implications of the proposed regime on the overall business ecosystem in the UAE, and will also give a view of some of the steps that a company that has set up, or is considering setting up, a business in the UAE needs to take for as smooth a landing as possible. Later parts will cover some other aspects in more detail, as and when the FTA releases more guidance.
On April 28, 2022, the Ministry of Finance provided an excellent opportunity for businesses, inviting the public to comment on the design and implementation of the CT regime, and to analyze its impact through the issue of a Public Consultation Document. The comments were due for submission by May 20, 2022. This document has certainly provided more clarity on the intention of the government—especially in Chapters 5 (Calculation of Taxable Income), 6 (Groups) and 7 (Transfer Pricing). We will offer further analysis of this document later.
Cross-Functional Impact on a Business
At the outset, the new tax regime would certainly require a change in the mindset of the tax and finance department of any business. It will be important to examine any transaction or book entry from the point of view of CT from now on.
To some extent, businesses in the UAE generally geared up fairly robustly in the wake of the implementation of the value-added tax (VAT) and excise regimes. In turn, the government supported businesses by showing leniency on issues relating to non-compliance, by significantly reducing penalties, and extending time limits for paying those penalties. The authors have commented on this in an earlier article .
Apart from the tax functions, the impact of the CT regime would also be felt in the general finance functions, supply chain functions, IT functions and legal functions. It will be imperative that the tax functions play an even more crucial role in driving the company’s business decisions. Businesses will also be required to have a robust record-keeping data architecture in line with tax-data and tax-risk management best practices.
This is crucial for businesses because it can be foreseen that the UAE government will probably ensure that some of the tax technology related best practices from other countries be followed from the onset of the tax regime such as e-audits, e-compliance, e-assessments, and e-invoicin).
Therefore, businesses would have to ensure that personnel are well trained and processes are well defined to be prepared for a digitally enabled tax function. Most importantly, businesses need to make sure that their data management is so robust that upon the onset of any regulatory change, the data can be conveniently shared with the FTA, rather than playing catch-up with the new rules.
Of course, it is not possible to know the extent to which the FTA would prioritize these technological functions while implementing the CT until more details emerge. Still, it is critical to be digitally enabled right from the start of the regime itself. Companies must ensure that the mindset of tax professionals moves from a process-centric mindset (compliance, back-office activities, etc.) to a data-centric mindset (risk management, data management) to support business objectives.
Impact on Cost of Doing Business in UAE
In the UAE, the new headline CT rate is 9% for businesses generating a taxable income above 375,000 UAE dirham ($102,000), except for businesses located in the Free Zones that do not conduct business with the Mainland. Separately, there will be another rate announced for those businesses which would fall under the scope of the OECD’s Pillar Two reforms, i.e., multinational enterprises (MNEs) with global consolidated revenues above 750 million euros ($795 million).
It must be appreciated that the 9% rate is still one of the most competitive globally. Even in the Middle East region, it is the lowest rate, not counting Bahrain which has still not introduced a CT regime. A comparison of VAT and CT rates in the region is shown below in Table 1:
In addition to these competitive rates, the government might also reduce or outright remove charges relating to license fees and fees for setting up companies. This would certainly reduce the impact of the tax on profit-making businesses in the UAE. It is also expected that the free zones will attract start-ups and scale-ups away from the mainland if they are profitable. This might, in turn, prompt even the free zones to drastically reduce charges like annual license fees, because of competition within the free zones to attract the maximum number of businesses. Indeed, exciting times lie ahead.
Issues Relating to Individuals
There are also some interesting issues relating to individual taxation. One of the FAQs states:
How do you determine whether an individual has a “business” that will be within the scope of UAE CT?
This would generally be done by reference to the individual having (or being required to obtain) a business license or permit to carry out the relevant commercial, industrial and/or professional activity in the UAE.
If an individual has, or is required to have. a business license or permit, these individuals would be placed on an equal footing as compared to legal entities performing the same activities. Further, it generally appears that if a business license or permit is not required and not possessed either, then the activity is not considered to be a business.
Turning to legal entities, the FAQ states that all activities undertaken by a legal entity will be deemed “business activities” and hence be within the scope of UAE CT.
Considering these statements, an interesting question arises. If a legal entity were, for example, engaged in the activity of trading of assets—real estate, stocks, even cryptocurrency—this would be considered to be a business activity and hence, taxable. Whereas, for an individual, such activities are business activities only if the individual has, or is required to have, a license or a permit to do so.
In this situation, what happens for an individual who is trading—not investing—in the share market in their personal capacity? The FAQ states that individuals will not be subject to UAE CT on dividends, capital gains and other income earned from owning shares or other securities in their personal capacity.
Reading this sentence, it is clear that dividends, capital gains or other income would not be subject to CT. In the UAE, an individual trading in securities is per se not required to obtain any license or permit. What happens if such an individual is engaged in the activity of trading of securities in their personal capacity as a means of their livelihood and is not required to obtain any permit or license?
The condition for taxability, as discussed above, generally, is with respect to (having a requirement to) obtaining a permit or a license. It appears that this individual trading in securities for their livelihood would not be considered to be undertaking a “business,” even though they may have a profit motive, perform the trades in a methodical manner, operate in substantial volumes, and largely undertake the steps and processes similar to an investment firm or a wealth management firm.
This apparent asymmetry between an individual and a legal entity performing similar activities appears to be in place due to the priority of the government to ensure relative simplicity in the tax system. Comparing this system with other more complex tax systems as in the UK or India may not be fruitful. This is because those systems have, to a large extent, sacrificed simplicity in the pursuit of ensuring neutrality as to the economic effect on business activities—irrespective of corporate form—and the prevention of avoidance schemes.
Still, there is leeway for the UAE government to further clarify this position, in view of the words generally by reference to in their FAQ (above). As the tax system matures, the FTA may provide further guidance and clarification.
Tax Grouping Implications
On the issue of tax grouping, the FAQ reads:
Will a group of UAE companies be able to form a “fiscal unity” for UAE CT purposes?
A UAE group of companies can elect to form a tax group and be treated as a single taxable person, provided certain conditions are met. A UAE tax group will only be required to file a single tax return for the entire group.
In this context, a question arises on whether domestic transactions between members of a tax group inter se would be subject to arm’s-length pricing (ALP) for these transactions. In other words, when one entity within a tax group transacts with another entity within the group, does ALP even matter? One way of thinking about this is that as the profit is just shifted between the entities that are within the same tax group, there would be no net effect on the tax-group CT.
Such an arrangement would also lead to other questions, such as whether assets could be revalued when a new entity joins the tax group, thereby affecting depreciation, thin capitalization and related party borrowings (price and level of debt) with entities outside the tax group.
To answer the question regarding interplay of ALP with a tax group, another FAQ is relevant:
Will intra-group transactions be exempt from UAE CT?
Qualifying intra-group transactions and reorganizations will not be subject to UAE CT provided the necessary conditions are met.
We do not yet know the necessary conditions referred to, including whether a tax group is covered in this exemption. Comparison with a couple of other countries may be helpful.
In Germany, there is a concept known as Organschaft. This applies where the parent company holds more than 50% of the voting rights of the subsidiary, and the two companies put together a court ordered profit and loss pooling statement. The two companies are treated as an integrated fiscal unit. Here, profits and losses can be offset, but there is no provision for elimination of intra-group tax profits from the total tax base. On the other hand, in the Netherlands, transactions between the members of the fiscal unity are completely disregarded. No profits arise until goods or services are supplied to an entity outside the fiscal unity.
Given that the UAE generally prefers simple and business-friendly tax policies, it is more likely that it will take more cues from the relatively simpler Dutch tax system, rather than the more complex German tax system. Therefore, given the information available, it may be expected that the UAE may not require domestic transactions between members of a tax grouping to be subject to ALP.
This does appear to be the intention even in the Public Consultation Document, as described in Paragraph 6.8: “To determine the taxable income of the tax group, the parent company will have to consolidate the financial accounts of each subsidiary for the relevant tax period, and eliminate transactions between the parent company and each subsidiary group member (and amongst the subsidiary group members).”
As stated above, the authors have tried to cover those issues that have not been covered by other commentators already, as far as we are aware. There are of course many other issues that are worthy of discussion and the authors intend to publish further articles discussing more issues shortly. For those companies that would be in scope under Pillar Two, the authors have already written a detailed article on how MNEs can start preparing for the Pillar One and Two regime. Such information would also be relevant to preparation for the implementation of UAE CT.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
The comments in this article are for general information and are not intended as advice. Readers should seek professional advice where relevant.
Parwin Dina is Global Tax Leader, Global Tax Services, and Varun Chablani is Tax Researcher, GTS Africa.