A credit exists for foreign tax obligations on a UAE Taxable individual’s income. The foreign tax credited is limited to the amount of Corporation Tax that must be paid on the relevant income. Any unutilized foreign tax relief cannot be carried forward or backdated and will expire and be lost.
Small Business Relief
The Corporate Tax UAE rules provide tax relief for smaller business groups. A tax resident individual may elect to be dealt with as having yet to derive any Taxable money where the revenue for the outgoing and previous tax times is at most a fixed amount and meet certain criteria (to be confirmed by Cabinet Decision). If a tax resident individual asks for “small business relief,” some provisions of the Corporation Tax rules will not be applicable, such as exempt income, reliefs, deductions, tax loss relief, and transfer pricing compliance needs, as specified in the right chapters of the Corporation Tax Law. The FTA may ask for any relevant records or supporting documents to verify compliance within a timeline (to be confirmed).
Transfers within a Qualified Group
The Corporate Tax UAE Law gives tax relief on the intra-group movement of assets or liabilities among Taxable Persons that are parts of the same Qualifying Group. Taxable individuals will be treated as members of the same Qualified Group if all the following things are met:
- The Taxable People are tax resident groups or non-residents that possess a PE in the UAE;
- The Taxable Persons must be at least 75% commonly held and have identical financial years and make the financial statements with the same accounting rules; and
- None of the Taxable Persons are considered as an Exempt Person or a Qualified Free Zone Person.
There is a clawback window of 2 years from the date of the initial movement if there is another transfer of such asset or liabilities outside the allowed group or where the transferor or transferee is no longer to be a member of the permitted group.
Business Restructuring Relief
Similar to the intra-group movement of assets or liabilities within the same Qualifying Group, the United Arab Emirates Corporation Tax Law provides tax exemptions on mergers, spin-offs, and also a lot of other corporate restructuring deals where whole or independent part of the business is being transferred in exchange for shares or other ownership interest provided the following conditions are met:
- the transfer is done following the relevant regulations in the UAE;
- the Taxable People are Resident individuals or Non-Resident Persons that hold a PE in the UAE;
- none of the People are regarded as Exempted Persons or Qualified Free Zone individuals;
- have a common financial year and make the financial statements using identical accounting rules; and
- The movement is undertaken for valid commercial or economic reasons.
There is a clawback window of 2 years from the time of the transfer if there is another transfer to another third party, or stakes or ownership interests rec are transferred or in any way disposed of, the profits or losses on the first transfer will be c in the period in question the subsequent transfer done to the third-party.
Free trade zones (FTZs)
Companies and groups registered in a Free Zone are treated as Taxable Persons as per the Corporate Tax UAE Laws. They are supposed to meet normal rules and obligations, including but not limited to transfer pricing needs. However, given that a Free Zone entity adheres to the conditions needed from a Qualifying Free Zone Person (‘QFZP’), it must be eligible for a zero percent Corporate Tax UAE rate on its Qualified Income. The income of a QFZP which does not come in Qualifying Income will be taxed at a 9% CT rate.
To be qualified for the 0% Corporate Tax UAE bracket, a QFZP must meet all of the below conditions:
- It must be a Free Zone individual (i.e., a juridical person incorporated, made, or otherwise based in a Free Zone, including branches);
- Maintain adequate money in the UAE;
- Derive Qualified Income
- Not have chosen to be subject to the regular Corporate Tax UAE regime;
- Comply with all transfer pricing laws and documentation needs.
- Meet any other conditions as demanded by the MoF.
If a QFZP fails to adhere to any of these things during a tax period, it will not be considered a QFZP and will be held to the standard UAE Corporation Tax system from the beginning of the tax period. Notwithstanding these things, the MoF may set rules for anyone to continue as a QFZP or stop being a QFZP from another date.
Several things remain uncertain, including the exact meaning of Qualifying Income in the treatment of deals between Free Zone groups and related/unrelated entities/branches in the UAE, what will be treated as ‘adequate substance in the UAE’ for a Free Zone Person, and any additional conditions that a Cabinet decision may set.
This article will examine the potential impact of some rules on the UAE’s corporate tax, particularly the UAE free zones rules.
UAE Free Zones and Pillar Two
The impact of the Pillar Two GloBE laws on the UAE’s free zones may be real.
The FAQs on corporate tax (CT) given by the Ministry of Finance state that businesses that are operating in free zones will be subjected to the Corporate Tax UAE. Still, the Corporate Tax UAE system will continue to honor the Corporation Tax CT benefits offered to free zone businesses, given they comply with the legal requirements and do not do business with the rest of the UAE.
As such, entities working in free zones will be given a 0% Corporate tax incentive in UAE on their taxable money, providing the money derived from transactions with entities from outside the UAE, in the same free zone, or some other free zone. If an entity situated in a free zone makes non-passive income from the UAE, all its money will be subject to the regular corporate tax in UAE.
Income-based tax perks, such as the UAE free zones that offer a 0% tax rate, are a major driver of a low Globe effective tax rate (ETR) and will be a major issue in a post-Pillar Two environment. Importantly, tax incentives that affect a wide taxable base, such as free zones, have the potential to have the greatest impact on ETR.
Provided there are no trading activities with mainland UAE, the income is a tax-free part of corporate tax in UAE. Therefore, when calculating the GloBE ETR, tax incentives that directly impact the numerator (covered taxes) as opposed to the denominator (GloBE income) have the most impact on the GloBE ETR.
As such, multinational enterprises (MNEs) operating in 0% tax-free zones could be subject to significant Pillar Two top-up tax.
In isolation, an in-scope MNE with a single free zone entity that qualified for the 0% Corporation Tax rate may derive no tax benefit from the 0% rate, as it would be subject to Pillar Two top-up tax to bring its GloBE ETR to 15%. This, then (dependent on the eventual UAE Corporation Tax rate that will apply to MNEs in the UAE), raises the issue of whether there would be any benefit in retaining free zone status and, for example, conducting trade with mainland UAE.
This is subject to several caveats.
Jurisdictional Blending corporate tax in UAE
First, the Global Rules apply jurisdictional blending. This effectively allows MNEs operating in the UAE to blend the results of low- and high-taxed entities in the UAE when determining the jurisdictional ETR. This jurisdictional ETR is then compared with the 15% global minimum rate.
Therefore, an MNE that operates an entity in a UAE free zone (that does not carry out trading activities in mainland UAE) and other entities in the UAE mainland would have a GloBE ETR above 0%, as the tax paid by the MNE on its mainland operations (at whatever rate is announced) would push the jurisdictional ETR up.
Whether this is significant enough to raise the GloBE ETR above 15%, such that no top-up tax was due, would depend on many factors, including the Corporate Tax UAE rate for MNEs, GloBE adjustments, and the relative profits of the free zone and mainland entities. For example, relatively low profits in the free zone, with substantial profits in mainland entities taxed much higher, could significantly increase the GloBE ETR, and no top-up tax is payable.
For example, take this simple scenario:
All companies are members of an MNE group subject to the GloBE Rules.
Free Zone Co has profits/GloBE income of 1 million UAE dirham ($272,000).
Sub Co 1 has profits/GloBE income of 10 million UAE dirham.
Sub Co 2 has profits/GloBE income of 20 million UAE dirham.
If we assume the Corporation Tax rate for large MNEs in the UAE is 16%, and both Sub Co 1 and Sub Co 2 are subject to that rate, a Corporation Tax of 1.6 million UAE dirham would be paid by Sub Co 1, with 3.2 million paid by Sub Co 2.