The United Arab Emirates (“UAE”) took a significant step forward on 9 December 2022 with the release of the Federal Decree-Law no. 47 of 2022 on ‘the Taxation of Corporations and Businesses’ (the “Corporate Tax Law”). This legislation, which became effective on 25 October 2022 and applicable to Taxable Persons (as defined below) as of 1 June 2023 onwards, marks the introduction of the UAE's first federal corporate tax regime.
The Corporate Tax Law lays a solid foundation for the UAE's alignment with the global minimum tax initiative proposed under "Pillar Two" of the Organization for Economic Co-operation and Development (the "OECD") Base Erosion and Profit Shifting (the "BEPS") project. As the UAE continues to adapt to the ever-evolving tax landscape, authorities are expected to provide further clarifications and practical guidance throughout 2023, solidifying the country's position as an attractive destination for businesses.
The Corporate Tax Law specifies a rate of 0% on the portion of the taxable income that is below or equal to AED/375,000/ and a rate of 9% on the portion of the taxable income that is above AED/375,000/.
2. Who is Taxable?
A Taxable Person can either be a natural or juridical person. A taxable natural person is any individual conducting, entirely or partially within the UAE, any type of activity, whether continuous or for a set period of time, with the intention of generating profits (the “Taxable Activities”).
It is sufficient for such person to have the ‘intention’ to generate profit from the Taxable Activities, regardless of whether or not such person actually realize a profit.
While a taxable juridical person is any entity established or otherwise recognized under UAE laws and regulations, or under the laws of a foreign jurisdiction, having a legal personality separate from its founders, owners and/or directors and which can be, among other type of entities, a Limited Liability Company, Public or Private Joint Stock Company. It is important to note that a taxable juridical person can be either resident or non-resident juridical person in the UAE.
A resident juridical person in the UAE is a legal entity incorporated or recognized under UAE laws, including free zone entities. It also includes entities established in a foreign jurisdiction but effectively managed and controlled in the UAE. Although the concepts of residency may differ between the Cabinet Decision No. 85 of 2022 and the Corporate Tax Law, a juridical person effectively managed and controlled in the UAE is considered a tax resident.
Unless specifically exempted, resident juridical persons under UAE laws are subject to the Corporate Tax Law, regardless of their type or level of activity. This includes all activities and assets used or held for taxable activities.
A non-resident juridical person can fall under the Corporate Tax Law if it has a fixed establishment in the UAE, habitually exercises authority for taxable activities on behalf of another person, has any form of nexus in the UAE, or derives state-sourced income. This means that even non-resident juridical persons can be subject to the Corporate Tax Law under certain conditions.
3. Dividends under Corporate Tax Law
Article 22 of the Corporate Tax Law specifies the types of income and related expenditure that are exempt from Corporate Tax, provided that certain conditions are met.
The following types of income are exempt from Corporate Tax:
• Dividends and other profit distributions received from a UAE resident person;
• Dividends and other profit distributions received from a foreign juridical person, provided that the taxpayer has a qualifying Participation (as defined below) in the foreign juridical person;
• Gains derived from the disposal of shares and other ownership interests in both UAE and non-UAE juridical persons, provided that the taxpayer has a qualifying Participation in the foreign juridical person;
• Income of a foreign permanent establishment, provided that the taxpayer elects to exempt this income from Corporate Tax and meets certain conditions;
• Income from international transportation, provided that the taxpayer meets certain conditions;
The exemption for dividends and other profit distributions received from a UAE resident person is unconditional, meaning that there are no specific conditions or requirements that the taxpayer must meet in order to qualify for the exemption. However, the exemptions for dividends and profit distributions received from (i) foreign juridical persons, (ii) gains derived from the disposal of shares and other ownership interests, (iii) income of a Foreign Permanent Establishment, and (iv) income from international transportation are all subject to certain conditions.
A participating interest is defined as a significant, long-term ownership interest in a juridical person (the "Participation") that suggests some degree of control or influence over the Participation and that meets the conditions stipulated in Corporate Tax Law.
The Participation Exemption is a mechanism used in residence-based tax systems to reduce or eliminate economic double taxation. It prevents both domestic and international double taxation for a juridical person distributing profits or selling shares that may have already been taxed. This exemption applies to both income and expenditure, including capital gains and losses. Importantly, it is automatic and does not require the Taxable Person to file an application with the Federal Tax Authority in the UAE. Additionally, a permanent establishment in the UAE can also claim the Participation Exemption for qualifying income from ownership interests.
Additionally, the Corporate Tax Law sets out the following cumulative conditions under which an ownership interest in a Participation will be considered a Participating Interest:
• The participating interest must represent a 5% or greater ownership interest in the Participation.
• The participating interest must be held, or intended to be held, for an uninterrupted period of at least 12 months.
• The Participation must be subject to Corporate Tax (or equivalent) of 9% or more.
• The ownership interest in the Participation must entitle the holder to at least 5% of the profits and liquidation proceeds.
• 50% or less of the assets of the Participation must consist of non-qualifying ownership interests.
• The participating interest must meet any other conditions as may be prescribed by the Minister of Finance.
The Corporate Tax Law further establishes in this respect that even if a Participation is not subject to Corporate Tax or a similar tax of at least 9%, the Participation can nevertheless be treated as having met the subject to tax test under Clause 2(b) of Article 23 of the Corporate Tax Law where its principal objective and activity is the acquisition and holding of shares or equitable interests, provided such ownership interests meet the conditions of Clause 2 of Article 23 of the Corporate Tax Law.
Once the conditions are met, the following income shall not be taken into account by a Taxable Person in calculating their Taxable Income for Corporate Tax, as follows:
• Dividends and profit distributions received from a foreign Participation that is not a Resident Person;
• Gains or losses on the transfer, sale, or other disposition of a participating interest (or part thereof);
• Foreign exchange or impairment gains or losses in relation to a participating interest.
While noting that the Participation Exemption does not apply in the following circumstances:
• Income that is directly related to the ownership of a participating interest, such as income from services provided to the Participation or Interest income earned under a loan granted to the Participation;
• Dividends or other profit distributions for which the Participation can claim a deduction under an applicable tax legislation;
• Income and gains from a participating interest up to the amount of a deductible impairment loss that was recognized prior to the ownership interest becoming a qualifying participating interest;
• Income and gains from a participating interest where the Taxable Person or a Related Party has recognized a deductible impairment loss in respect of a loan receivable from the Participation.
The Participation exemption is a key feature of the Corporate Tax Law that is designed to reduce or eliminate economic double taxation under a residence-based tax system. It is a valuable tool for businesses that invest in other businesses, and it helps to promote economic efficiency by allowing businesses to operate freely and efficiently across borders.
The Participation Exemption applies to a wide range of income, including dividends and profit distributions received from foreign juridical persons, gains derived from the disposal of shares and other ownership interests in both UAE and non-UAE juridical persons, and income of a foreign permanent establishment. However, there are certain conditions that must be met in order to qualify for the Participation Exemption. Overall, the Participation exemption will help to attract and retain foreign investment in the UAE.
This article was written by corporate lawyer Maroun Abou Harb and focuses on Corporate Tax in the UAE.
BSA is a regional Law Firm in the Middle East with offices in the UAE, Oman and Saudi Arabia. As a full-service law firm our practice areas include litigation, arbitration and corporate services, including M&A, banking & finance, Intellectual Property, TMT, Fintech, employment and insurance.
Published on 7 December, 2023.
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