Exempt Income under UAE Corporate Tax

Introduction – Chapter 7 – Exempt Income under the UAE Corporate Tax Law

Any portion of income which is not taxed according to a country’s Income Tax law is termed as Exempt Income. Such incomes are not included in the calculation of Total Income on which tax is payable. Let us look at the provisions drafted for identifying and calculating the Exempt Income under the UAE Corporate Tax Law.

Article 22 – What incomes are exempted under the UAE Corporate Tax Law?

The law clarifies that Residents must pay UAE Corporate Tax on their worldwide income and Non-Residents must pay tax on the income derived from operations in the UAE. However, the UAE corporate taxpayer can take advantage of the exemptions listed in the UAE Corporate Tax law. For determining Taxable Income, the income that are allowed as exemptions, i.e., they will be considered as Exempt Income, are as follows:

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1. Dividend or profit distribution received from a Resident juridical person
2. Dividend or profit distribution received from a foreign juridical person in which the recipient has Participating Interest
3. Article 23- Any other income received from Participating Interest (Refer to Article 23 below)
4. Article 24- Income earned from a Foreign Permanent Establishment (Refer to Article 24 below)
5. Article 25- Income of a Non-Resident person operating aircraft or ships in international transportation (Refer to Article 25 below)

Want to know which incomes are exempt under the UAE CT law while computing your Exempt Income?

Article 23 : Participation Exemption under the UAE Corporate Tax Law

The underlying aim of drafting provisions to regulate Participation Exemption is to prevent double taxation. What does this mean?

Where a group company pays dividend out of its profits or earns income from sale of its shares within the tax group and the same has been taxed once, the CT Law ensures that such income is not subjected to tax again.

However, to avail Corporate Tax exemption on income from Participating Interest, all conditions as mentioned in Article 23 need to be fulfilled.

What is the meaning of Participating Interest and what are its requisite conditions under the UAE Corporate Tax Law?

Participating Interest means 5% or more ownership interest in either:

• The shares of the juridical person, or
• The capital of the juridical person

This is called ‘Participation’. Further, the requisite conditions to claim exemption from PI are as under:

1. Period of holding: For an uninterrupted period of 12 months, the Taxable Person has held or has the intention of holding the Participation Interest
2. Application of Law: The Participation is subject to be liable to tax similar to UAE CT Law, which is levied in the territory where the juridical person is Resident. The rates of tax should not be less than the rate specified under the UAE CT Law.
3. Rights of a Taxable Person:
   The Participation interest, entitles a Taxable Person to:
   1. Not less than 5% of profits available for distribution, and
   2. Not less than 5% of liquidation proceeds after cessation of Participation
4. Composition of Participation Interest:
   1. Where not more than 50% of the assets (held directly or indirectly) that comprise the ownership interest of the Partnership doesn’t qualify for ‘exemption’ from Corporate Tax if held directly by the Taxable Person.
5. The Minister may prescribe any other conditions regarding the determination of Participation Interest.

A Participation is said to be subject to Corporate Tax or any other tax under the ‘Applicable Legislation’ if :

• The main activity and objective of the Participation is to hold or acquire the shares or equitable interest and;
• The Income of the Participation is substantially derived from the Participating Interest during the relevant Tax Period

Participation in a Free Zone Person or Exempt Person shall be assumed to have met the condition of being subject to Corporate Tax or tax under any other Applicable law ab initio to establish Participation Interest under the Corporate Tax law. It is subject to any additional conditions by the Minister of Finance.

What components of Income shall not be taken to calculate Taxable Income under Participation Interest?

If the conditions prescribed under Article 23 of the UAE CT law have been fulfilled, and a Taxable Person is said to have a Participation Interest in a juridical person, then the following shall not be taken into account, while calculating the Taxable Income:

1. Dividend or other Profit Distributions: The dividends and profit distributions obtained from a Foreign Participation who is not a Resident.
2. Sale, transfer or Disposition of Participating Interest: If after the expiry of the time period of twelve uninterrupted months as per Article 23 (2) or two years in case Article 23(9), there are gains or losses from sale, transfer, or disposition of Participating Interest or any part of the Participating Interest, shall not be taken into account.
3. Foreign Exchange Gains and Losses: Foreign exchange gains and losses with respect to Participating Interest will not be considered.
4. Impairment of Gains or Losses: Impairment of gains or losses with respect to Participating Interest will not be considered.

When does Participation exemption not apply to income derived by the Taxable Person from a Participating Interest?

The Participation Exemption from Corporate Tax for Participating Interest will not apply to the income derived by the Taxable Person from a Participating Interest in case of the following transactions:

1. Deduction of Dividend: Under the applicable tax law, a deduction for dividend or other distribution made to the Taxable Person can be claimed by the Participation.
2. Prior Deductible Impairment loss: Before fulfilling the conditions of Participating Interest under the UAE CT Law, the Taxable Person has recognised the deductible impairment loss for Participating Interest.
3. Deductible Impairment loss on Loan Receivable: If either the Taxable Person or the Related Party has recognised the deductible impairment loss receivable (asset) from undertaking the Participation with respect to a loan that may be received from the Participation.

 

Exemption will be given in case of Reversal of ‘Deductible Impairment Loss on Loan Receivable’: In the case of deductible impairment loss on loan receivable, if the deductible impairment loss is reversed in the succeeding Tax Period, then the income derived from the asset (loan receivable) will be exempt from the income derived by the Taxable Person from the Participating Interest.

Note: If there is loss on liquidation of the Participation, then the exemption won’t apply which means that it will be subject to Corporate Tax and not considered as Exempt Income.

Withdrawal of Exemption given to Participation

The exemption of Participation Interest will not apply for two (2) years in any of these cases:

1. If the Participation was taken in exchange for transfer of ownership interest and the conditions are not fulfilled, or
2. The transfer was exempted under Articles 26 (Transfers within a Qualifying Group) and Article 27 (Business Restructuring Relief).

If the Ownership Interest falls below 5% before the specified time period

A situation can be that a Taxable Person doesn’t hold 5% or more ownership interest in the Participation for an uninterrupted time period of twelve months. In that case, when the ownership interest falls below 5%, then:

1. That income (if not included previously) will be included in the calculation of the Taxable Income
2. For the Tax Period when it falls below 5%.

Power given to the Minister where Minimum Ownership Interest Requirement is not met

There can be a situation where after strategic investment, the ownership interest is not more than 5% as is required under the conditions to qualify as Participation. This may be due to events and factors that are beyond the control of the company.

To help in reducing the administrative burden for continuous monitoring of ‘minimum ownership requirement’, certain powers are given to the Minister

The Minister can prescribe a threshold of ‘minimum acquisition cost’ exceeding which the ownership interest in the juridical person will qualify as Participation under UAE Corporate Tax Law.

Do I have a Participating Interest under the UAE CT law? Can I claim a Participation Exemption for the same?

Article 24 – Foreign Permanent Establishment Exemption under the UAE Corporate Tax Law

A Foreign Permanent Establishment refers to a place of business of a Resident Person which is established outside UAE.

Calculation of Taxable Income- Not accounting for Income or Expenditure from Foreign Permanent Establishment

For determining Taxable Income, a Resident can make an ‘election’ to not take the income and associated expenditure of its Foreign Permanent Establishment.

The Resident will not take the following for calculating Taxable Income:

1. Losses in Foreign PE: Losses in any of the Foreign Permanent Establishments which were determined as if the Foreign Establishment is a Resident;
2. Positive Income and Associated Expenditure: Any positive income and associated expenditure attributable to such income of the Foreign Permanent Establishment which were determined as if the Foreign Establishment is a Resident;
3. Foreign Tax Credit: Under Article 47, if there was any Foreign Tax Credit available if the election was not made.

Ascertaining Income and Associated Expenditure:

• The ‘income and associated expenditure’ will be the aggregate of income and expenditure in relevant foreign jurisdictions.
• Further, for ascertaining income and associated expenditure of a Foreign PE, a Resident and each foreign PE will be treated as independent and separate persons.

Limitation on Applicability of Foreign PE Exemption: The exemption of Foreign Permanent Establishment of the Resident Persons shall be applicable only to those entities which are subject to Corporate Tax or a similar tax treatment in the foreign jurisdiction as per the applicable law there at a rate not less than the ones mentioned under Article 3, i.e., 9%.

Transfer of assets and liabilities between Resident and Foreign Permanent Establishment: Additionally, if there is a transfer of asset and liabilities between the Resident and the Foreign Permanent Establishment, keeping in mind the international principle of arm’s length, such transaction shall be considered at Market Value for calculating Taxable Income of the Resident on the date of the transfer.

How do I calculate my income and expenditure earned from a Foreign PE under the UAE CT Law?

Exemption on Operating and Leasing Activities in International Transportation

• Introduction:

The United Arab Emirates (UAE) is home to many shipping and aircraft companies, making it a significant logistics centre and international travel hub. Therefore, to provide incentives and increase global trade and tourism, the UAE Corporate Tax Law exempts income of a Non-Resident earned from operating or leasing aircraft or ships (and related equipment) used in international transportation. Under the principle of reciprocity, this exemption is only possible if a UAE business receives the same tax treatment, in the country where the Non-Resident operator is a Tax Resident.

Article 25 – Non-Resident Person Operating Aircraft or Ships in International Transportation

If all the conditions under Article 25 are satisfied, then the income derived by the Non-Resident from the operation of aircraft or ships in international transportation will be exempted from Corporate Tax under UAE Corporate Tax Law. The conditions prescribed are as follows: –

1. Business engaged in: If a Non-Resident is in the business of:
   • Internationally transporting goods, passengers, merchandise, mail, etc. by sea or by air; or,
   • Chartering or leasing ships or aircraft which are used in international transportation, or,
   • Leasing equipment that is essential for the seaworthiness of the ships or airworthiness of the aircraft in international transportation.
2. Reciprocity of Tax Treatment in Applicable Jurisdiction: The exemption of a Non-Resident from being liable to Corporate Tax under the UAE Corporate Tax Law for operating ships or aircrafts under this Article shall be applicable only if it is subject to a Corporate Tax or a similar tax treatment in the applicable legislation in the foreign jurisdiction where the Non-Resident is a Resident Person.