Participation Exemption – UAE CT Update

Introduction to Participation Exemption

The UAE has introduced a new corporate tax regime that applies to corporations and businesses operating in the country. This article will explain the main aspects of the Participation Exemption and its implications for taxpayers. We will discuss the ownership interests, aggregation of ownership interests, transfer of ownership interests, treatment of debt instruments, tax implications for participation, conditions for holding companies, minimum acquisition cost, assets of the participation, expenditure related to acquisition and disposal, income from ownership interests, liquidation proceeds, and foreign Permanent Establishment tax losses. 

What is Ownership Interest? – Article 2 

As per Article 23 of the UAE Corporate Tax Law, the ownership interest will include these or a combination of these instruments: 

1. Ordinary Shares 
2. Preferred Shares. 
3. Redeemable Shares. 
4. Membership and Partner Interests. 
5. Other types of securities, capital contributions, and rights to get profits and liquidation proceeds. 

Recognition of Equity Interest under Accounting Standards: An ownership interest treated as an equity interest under the Accounting Standards will be treated as such under clause 1. 

Holding of Ownership Interest: A Taxable Person will hold ownership interest if: 

1. He controls the ownership interest and  
2. He has the right to economic benefit produced by the ownership interest as per Accounting Standards 

Consideration of Islamic Financial Instruments: If you have an Islamic Financial Instrument or a set of arrangements that are part of an Islamic Financial Instrument, they will be considered as ownership interest but only if it is considered an equity interest by the accounting rules made by the Accounting and Auditing Organization for Islamic Financial Institutions.  

Calculation of Ownership Percentage: The percentage of ownership interests is to be calculated as per: 

1. The total paid-up capital of the Participation, or 
2. Total equity interest contribution. 

Aggregation of Ownership Interests – Article 3 

To ascertain if the Taxable Person has Participation Interest, these need to be considered:  

1. Different types of ownership interests in the same juridical person are aggregated.  
2. Ownership interests in the same juridical person held by members of a Qualifying Group are aggregated with those of the Taxable Person. 

Minimum Ownership Requirement: Aggregation is applied to determine whether the minimum ownership requirement is satisfied. 

Transfer of Ownership Interests – Article 4 

When a Taxable Person transfers ownership interest in a juridical person with another, it shall be treated as continuous ownership interest if these are satisfied:   

1. Continuous Ownership Interest: Ownership interests exchanged for another interest in accordance with Article 27 of the UAE Corporate Tax Law. 
2. Participating Interest: The ownership interest in the legal person must qualify as an eligible Participating Interest according to Article 23 of the UAE Corporate Tax Law. 

Treatment of Debt Instruments – Article 5 

Income from debt instruments issued by the Participation which does not have an ownership interest, will be treated as income from a Participating Interest as if such instruments are classified as the equity interest under the applicable Accounting Standards. 

Tax Implications for Participation Exemption – Article 6 

Meeting the Tax Requirement: A Participation will be considered to have met the conditions if it is a resident in the same Tax Period in a foreign territory and fulfills these conditions: 

1. The applicable tax is on a similar basis as that of the UAE Corporate Tax Law 
2. The rate of tax is not less than 9%. 

Considerations for Similar Basis: These will be considered as tax applied on a similar basis to the UAE Corporate Tax: 

1. Differences in reductions and reliefs,  
2. Lower tax rates on particular income brackets,  
3. Targeted incentives or exemptions that are of temporary nature, and  
4. Alternative taxes on income or profit. 

Exclusion as Similar Tax: Taxes applicable in the foreign territory will not be considered similar to UAE Corporate Tax:  

1. Tax applicable only to selected activities, 
2. Tax paid is refunded at the time of distribution, and  
3. Taxes are due only upon the distribution of profits or income. 

Participation to have met the requisite criteria: The Participation will have met the criteria under Article 23(2)(b) in either of the following: 

1. Subjected to tax at not less than 9% 
2. If it recalculated its accounting net profits and then the tax is levied, it is not  

Conditions for Holding Companies: 

To qualify as a Holding Company, these conditions need to be satisfied:  

1. Participation must be directed and managed in another country or foreign territory,  
2. A Participation has to comply with regulatory requirements of document submission to the relevant authority,  
3. A Participation should have adequate personnel and premises for acquiring and holding the shares or equitable interest, considering the activities carried on by the Participation and the extent of activities performed on behalf of the Participation or for the benefit of the Participation,  
4. A Participation does not conduct activities other than those ancillary to the acquisition and holding of shares or equitable interests. 

A Participation will have met the conditions if the income during the relevant Tax Period and previous Tax Period is 50% or more of: 

1. Dividends,  
2. Capital gains and  
3. Other income from Participating Interest 

Minimum Acquisition Cost: 

Minimum Acquisition  Threshold: A Taxable Person is considered to have a Participating Interest if the aggregated acquisition cost of ownership interests in the juridical person equals or exceeds AED 4 million. 

Calculation of Minimum Acquisition Cost: The minimum acquisition cost is calculated by aggregating: 

1. Value of the equity interest or capital contribution made or paid in cash or kind  
2. Value of  subsequent equity interest and capital contributions made less the value of equity interest or capital repayments made by the Participation  
3. Expenditure incurred to the acquisition or transfer of ownership interests should be capitalized as part of the acquisition cost  

Note: The value of an equity interest or capital contribution, consideration paid or repayment of equity interest or capital is to be determined at the time the contribution or repayment was made without taking subsequent value adjustments under the Accounting Standards. 

Acquisition cost in Foreign Participation: For the acquisition cost of an ownership interest in a foreign Participation, the exchange rate at the date of acquisition or formation of the relevant ownership interest is to be applied. 

Ownership Interest is Partly sold, transferred, or disposed of: If an ownership interest is partly sold, transferred, or otherwise disposed of, then the aggregated acquisition cost is to be decreased in portion to the average acquisition cost attributable to the part of the ownership interest. 

Does not satisfy 12-month criteria: If the Taxable Person who holds the ownership interest does not satisfy the minimum acquisition cost for an interrupted period of 12 months, then the income previously not taken into account will be included in the Taxable Income in the Tax Period when the minimum acquisition cost threshold criteria were not met. 

Assets of the Participation: 

To determine if the requirement in Article 23(2)(d) of the UAE Corporate Tax Law are met, it can be on either of the following basis: 

1. The consolidated balance sheet of the Participation and the accounting values of its assets.
2. Market Valuation of the direct and indirect ownership interests and other assets of the Participation.

The requirement mentioned must be continuously fulfilled throughout the Tax Period. 

Expenditure Related to Acquisition and Disposal: 

Deductibility of Expenditure: Expenditure related to the acquisition or disposal of Participating Interest (whether in part or whole) is generally not deductible for tax purposes. 

The expenditure shall be capitalized as part of the acquisition cost of the Participating Interest. 

Deductibility of Interest Expenditure: Interest Expenditure related to the acquisition or subsequent holding of Participating Interest is deductible for tax purposes under Chapter 9 of the UAE Corporate Tax Law. 

What will be included in the Expenditure?

Expenditure includes: 

1. Professional fees.  
2.  Due diligence costs.  
3.  Litigation costs.  
4.  Commissions and brokerage fees.  
5.  Stamp duty, registration duties, and other irrecoverable taxes.  
6. Appraisal and valuation costs.  
7. Refinancing costs. 

Income from Ownership Interests: 

Income from ownership interests is exempt from UAE Corporate Tax if received by the Taxable Person in his capacity as owner of an ownership interest. 

The income from ownership interests by any other person in any other capacity is not exempt from UAE Corporate Tax.  

Liquidation Proceeds: 

When a company ceases to exist legally, it will be considered a liquidation termination of the company. 

Evaluating Liquidation Loss and Its Calculation 

Liquidation loss represents the financial loss incurred when a company ends. To calculate it, one must subtract the fair value of liquidation proceeds received by the Taxable Person from the acquisition cost of the Participating Interest. Additionally, adjustments need to be made as outlined in Article 8(5) of the decision. 

Exemption from Corporate Tax Law Rules in Asset and Liability Distribution 

When receiving assets or liabilities from the company during its liquidation, the regulations stated in Articles 26 and 27 of the UAE Corporate Tax Law do not apply.  

Adjustment of Liquidation Loss for Tax Purposes 

The liquidation loss, as defined in Clause (1) of this Article, must be adjusted in the current tax year and the preceding tax year (if applicable) based on the following factors: 

1. Tax losses transferred by the Participation to the Taxable Person. 
2. Exempt Dividends or other profit distributions that received by the Taxable Person from the Participation. 
3. Income or gains resulting from the transfer of assets or liabilities between the Taxable Person and the Participation, not subject to taxation under Article 26 or Article 27 of the Corporate Tax Law. 

Foreign Permanent Establishment Tax Losses 

If a Taxable Person has utilized a Tax Loss, it must be fully offset by the Taxable Income from the Foreign Permanent Establishment in a subsequent Tax Period or Tax Periods before either of these: 

1. Election for Foreign PE: Taxable Person can elect to apply for the Foreign Permanent Establishment exemption. 
2. Conditions for Utilization: Income coming from or after the incorporation of the Foreign PE will get benefits under Article 23. 

FAQs on Participation Exemption

1. What does Participation Exemption under the UAE Corporate Tax mean? 

Income from a Participating Interest is exempt from Corporate Tax, subject to certain restrictions, according to Article 23 of the UAE Corporate Tax Law. 

2. What is considered a Participating Interest? 

A 5% or higher ownership stake in the shares or capital of a legal entity is referred to as a “Participating Interest”. 

3. What is the ownership interest for Participation Exemption? 

An ownership interest will include holding any or a combination of these:  

1. Ordinary Shares.
2. Preferred Shares.
3. Redeemable Shares.
4. Membership and Partner Interests.

4. Can Islamic Financial Instruments be treated as ownership interest for the purpose of Participation Exemption? 

Yes, an Islamic Financial Instrument or a combination of arrangements can be considered as an ownership interest. 

5. What is the threshold limit for the minimum acquisition cost requirement? 

A Taxable Person will be treated as having a Participating Interest in a Participation where the aggregated acquisition cost of the ownership interests is equal to or exceeds AED 4,000,000.