UAE Federal Tax Authority releases Corporate Income Tax Guide on determination of taxable income
Introduction
The UAE Federal Tax Authority (FTA) has released Corporate Income Tax (CIT) Guide with reference CTGDTI1 on the calculation of taxable income for CIT purposes. The Guide elaborates on the rules for calculating taxable income, broadly established under the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (CIT Law).
Whilst some practical aspects on the calculation of taxable income where already anticipated both in the CIT Law and other Guides previously issued by the FTA, the current Guide delves into the practicalities of certain topics.
The Guide includes nine (9) detailed case studies, which illustrate some of the key concepts for determining the taxable income of a taxpayer (interest expenditure, tax loss relief, cash basis for accounting and unrealised gains and losses, amongst others).
Overview on the calculation of CIT payable
As anticipated in article 20 of the CIT Law, the taxable income of a taxpayer shall be calculated on the basis of its standalone Financial Statements, prepared in accordance with accounting standards accepted in the UAE (i.e., IFRS or IFRS for Small and Medium Enterprises (SMEs) for taxpayers whose revenue does not exceed AED 50 million).
The Guide emphasizes that entities with a revenue exceeding AED 50 million are required to maintain audited Financial Statements, which shall be conducted by a UAE-registered auditor as per the applicable legislation in the UAE.
The accounting income derived from the standalone Financial Statements will then be subject to certain adjustments, which include non-deductible expenses, exempt income, reliefs for certain transactions or adjustments on transactions carried out between related parties. If available, a taxpayer may reduce its taxable income by offsetting tax losses carried forward from previous years.
Once a taxpayer arrives at the taxable income, the CIT payable will be calculated by applying the 9% rate on taxable income exceeding AED 375,000. For Qualifying Free Zone Persons, the portion of taxable income which is Qualifying Income will be subject to 0%, while the portion of taxable income which is not Qualifying Income will be subject to the 9% rate.
The CIT liability derived from the above calculation may then be reduced by any applicable withholding tax credit, followed by foreign tax credits, to calculate the CIT payable or refundable (as applicable).
Main considerations from the Guide
Exempt income
The Guide delves into the exemptions on certain income streams foreseen in the UAE CIT Law, which include:
- Dividends distributed by UAE juridical persons (i.e., domestic dividends), which are exempt without further requirements;
- Dividends and other profit distributions from foreign entities in which the recipient has a participating interest (i.e., holds at least 5% in its shareholding or an acquisition cost exceeding AED 4 million, and the participation has been held for a period of at least 12 months);
- Other income and gains derived from entities in which the recipient holds a participating interest as stated above (including gains or losses on disposal, foreign exchange gains and losses or impairment gains and losses); and
- Income and associated expenditure derived from a foreign Permanent Establishment (subject to an election being made by the taxpayer) which is subject to CIT or tax of an equivalent nature at a rate of at least 9%.
The above exemptions are addressed from a practical perspective in two case studies (case study 7a and 7b) within the Guide.
The Guide also emphasizes that these exemptions are symmetrical, which entails that expenditure incurred in deriving any income which is exempt for CIT purposes will not be deductible.
Non-deductible expenditure
As a general rule, expenditure which is incurred wholly and exclusively for the purposes of the taxpayer's business, and is not capital in nature, will be deductible for CIT purposes. The UAE CIT regulations restrict the deductibility of certain categories of expenses. Expenses which are deemed non-deductible for CIT purposes shall be added back when calculating the taxable income.
Non-deductible expenditure for CIT purposes includes:
- Expenditure which is not incurred for the purpose of the taxpayer's business;
- Expenditure which is incurred in deriving exempt income;
- Expenditure which is capital in nature;
- Donations or gifts made to organisations which are not Qualifying Public Benefit Entities;
- Fines, penalties, bribes and illicit payments;
- Expense registered for the recognition of CIT;
- Tax imposed on income outside the UAE;
- Recoverable VAT;
- Payments to related parties / connected persons which are not valued at arm's length; and
- Losses which are not connected to the taxpayer's business.
Expenditure incurred for more than one purpose
When expenditure is incurred for more than one purpose, the Guide specifies that any identifiable part of the expenditure which is incurred wholly and exclusively for the purpose of deriving taxable income will be fully deductible. With regards to the portion of expenditure which cannot be directly identifiable, only a proportion calculated on a fair and reasonable basis will be deductible.
The Guide states that what is fair and reasonable will depend on the facts and circumstances for each particular case and specifies certain criteria which should be considered when allocating the expenses to a particular income stream. These criteria include:
- Cause and effect relationship (i.e., machinery running hours for allocating maintenance costs); or
- Relationship between the expenditure and the benefits received.
As a relevant addition with regards to the previous regulations, the Guide now specifies that the criteria used to allocate expenditure shall remain consistent during the whole tax period, unless there is a relevant change in the fact pattern which may justify a change in the allocation method.
It also adds that when the expenditure cannot be apportioned on a fair and reasonable basis, it will not be allowed as a deduction for CIT purposes (i.e., it will be disallowed in full).
Pre-incorporation and pre-trade expenditure
Expenditure associated with the process of setting up a business (such as registration fees, feasibility studies, etc.) which are incurred by an entity before its incorporation will be deductible for CIT purposes, to the extent they are recorded in its income statement once the company is incorporated in line with the applicable accounting standards.
The same is applicable for expenditure which is incurred once the entity is incorporated, but before it starts generating revenue (such as costs related to product development, marketing, advertising expenses, etc.). These expenses will also be deductible as long as they are recorded in the financial statements, and they comply with the general deductibility criteria under the CIT regulations.
Creation and reversal of provisions
The Guide specifies that, in general terms, provisions recorded for legal or other obligations which a business applies will be deemed deductible as long as they satisfy the general deductibility criteria under the CIT Law. In line with the above, income derived from the reversal of provisions which were considered deductible for CIT purposes will be fully taxable.
General interest deduction limitation
Deductibility of net interest expenditure (understood as the excess of interest expenditure over interest income) for CIT purposes is limited to the higher of (i) AED 12 million or (ii) 30% of a taxpayer's adjusted EBITDA. For this purpose, the adjusted EBITDA shall be calculated as the taxable income for a tax period (except for the adjustments related to general interest deduction limitation and tax loss relief provisions), with adjustments for:
- Net interest expenditure;
- Depreciation and amortisation expenditure;
- Any interest expenditure (minus interest income) related to historical financial assets and liabilities held prior to 9 December 2022; and
- Interest expenditure (minus interest income) relating to Qualifying Infrastructure Projects.
Net interest expenditure disallowed under the above rules can be carried forward and utilised in the subsequent ten (10) tax periods.
The Guide provides certain examples which illustrate the calculation of the net interest expenditure and the adjusted EBITDA.
Specific interest deduction limitation
In addition to the above, the CIT regulations set forth a specific limitation on certain transactions. Interest expenditure incurred on a loan obtained from a related party for the following transactions will not be deductible:
- Dividend or profit distribution to a related party;
- Redemption, repurchase, reduction or return of share capital to a related party;
- Capital contribution to a related party; or
- Acquisition of an ownership interest in a business that is, or becomes, a related party after the acquisition.
The above restriction will not be applicable if the taxpayer can demonstrate that the purpose of obtaining the loan was not to gain a CIT advantage. This will be deemed demonstrated in case the entity receiving the interest is subject to CIT or tax of a similar nature at a rate of at least 9%.
Tax loss relief
A taxable person which generates tax losses during a particular tax period may carry them forward to offset taxable income in future periods, with a limit of 75% of the taxable income.
The above is not applicable for (i) losses incurred before CIT was introduced, (ii) losses incurred by a person before such person is considered a taxable person for CIT purposes and (iii) tax losses incurred in relation to exempt income.
If a taxpayer is not able to offset the tax loss against its own taxable income, the CIT regulations foresee the possibility to transfer those losses to another taxable person, where certain requirements are met (i.e., one entity holds at least 75% of the shareholding of the other entity or common ownership exceeding 75%, same financial year, same accounting standards, etc.).
The CIT regulations include a change of control restriction on tax losses, whereby carry forward tax losses will be forfeited if there is a change in ownership in the entity of over 50%. Tax losses may nevertheless be carried forward if such a change in ownership occurs, provided the entity continues carrying out the same business.
Foreign tax credits
Taxpayers may deduct from the CIT payable foreign taxes paid on foreign sourced income which are of a similar nature to CIT, provided certain requirements are met.
The amount of foreign tax credit cannot exceed the amount of CIT that would have been payable in the UAE on that foreign source income.
The Guide emphasizes that foreign tax credits are available under the domestic CIT regulations even if foreign tax is paid in a jurisdiction with which the UAE does not have a Double Tax Treaty in force.
Unutilised foreign tax credits cannot be carried forward to future tax periods or carried back to previous tax periods.
Conclusion
Whilst the general framework on the calculation of the taxable income was already anticipated by the CIT Law, along with other Guidance previously released by the FTA, the current Guide provides practical examples and a set of case studies which shed additional light on the practicalities of the CIT calculations for UAE taxpayers.
Please note that all Guides issued by the FTA are intended to provide guidance on the practical application of the CIT regime for UAE taxpayers, but are not legally binding documents and, hence, should be read and interpreted in combination with the CIT Law and the applicable Cabinet Decisions and Ministerial Decisions.
