UAE Corporate Tax Preparation – Lexology
- The impact of UAE corporate tax will be felt across the majority of the local business community.
- Tax readiness requires a well-considered implementation plan which should be proactively devised by businesses based on information already released and best practice principles to identify categories of tax implications which go beyond the basic requirement for the filing of a tax return.
- In particular, corporate structures of Free Zone and mainland entities should be immediately reviewed, such that appropriate planning can be conducted and tax optimisation and/or mitigation strategies implemented.
While we wait for the specifics of the new UAE tax legislation to be released, certain actions can be taken immediately, based on the information provided to date by the Ministry of Finance and the Federal Tax Authority. The guidance provided and assumptions as to the broad application of corporate tax, according to generally accepted principles, will assist to prepare businesses for the start date of the new rules.
A legal structure that is fit for purpose is mandatory for any business, however, the appropriateness of any legal structure can change over time also taking into account developments in applicable laws and regulations. Accordingly, we strongly recommend the review of the legal structure prior to the enactment of the corporate tax law.
We are already aware that the UAE intends to honor Free Zone corporate tax holidays and exemptions and therefore it is an appropriate time to conduct a legal and strategic review of business operations.
If you have any doubt or question about any of the following issues, immediate action may be taken to prepare and optimise or mitigate certain risks that may arise.
Are you currently operating in a Free Zone? Do you know how the rules and regulations for your particular Free Zone operate? Are your operations restricted to international/offshore or UAE based Free Zone dealings? Do you conduct, or plan to conduct, business with the UAE mainland? Are you operating a tax ‘group’ or have dealings with related parties? Do you meet your other regulatory requirements? Will you be able to maintain your Free Zone tax holiday? Alternatively, could you carve out some of your mainland business to obtain Free Zone tax exemption?
Free Zone/Mainland Structuring
The Public Consultation Document on UAE Corporate Tax has provided some guidance around Free Zone entities and income. For example, it is clear that a ‘Free Zone Person’ includes companies and branches that are registered in a Free Zone.
The eligibility to maintain access to the 0% corporate tax rate will require Free Zone income to be untainted. That is, income should only be received from foreign jurisdictions or the same or other Free Zones within the UAE.
There are some carve outs to this requirement.
Free Zone Persons will also maintain a 0% corporate tax rate if mainland income is restricted to passive income (interest, dividends, royalties and capital gains from ownership of the UAE mainland entity).
In addition, transactions between Free Zone Persons and their respective UAE mainland based Group entities will avail the 0% corporate tax rate. However, to maintain tax neutrality and fairness, payments made by UAE mainland entities to the Free Zone Person will not be tax deductible.
Likewise, a Free Zone Person with a UAE mainland branch will only be taxed on mainland sourced income whilst continuing to maintain a 0% corporate tax rate on its Free Zone/offshore income.
Businesses must maintain statutory and regulatory compliance in order to be eligible for Free Zone corporate tax exemptions. For example, businesses should only conduct activities allowed by the trade license and maintain filing of correct Economic Substance disclosures.
In essence, this means that, with the appropriate corporate structure, it should be possible for a Free Zone business to maintain a tax holiday status. However, depending on the complexity of the business operations, this may require planning and we recommend that this begins immediately.
Once the income year relevant to corporate tax begins (i.e. the first financial year beginning on or after 1 June 2023), it may be too late to restructure because Free Zone income could already be tainted. In addition, a Free Zone Person or Group that maintains a UAE mainland entity will need to review not just the corporate legal structure but also the legal agreements that support the transactions between those entities.
If a Free Zone Person (business or part of a group structure) currently receives or anticipates receiving any mainland derived revenue, an immediate review to determine the appropriateness of the corporate structure is advised. Incorporating a mainland branch or entity, particularly in light of the recent relaxation of onshore ownership, could prove to be wise tax planning for the future. Likewise, mainland entities with significant Free Zone or offshore revenue streams may consider carving out part of the business to a Free Zone entity.
Transfer Pricing, Financial Statements and Good Governance
Another important announcement is that Transfer Pricing (TP) requirements will be aligned with the Organisation for Economic Cooperation and Development (OECD) TP Guidelines. This, in conjunction with the requirement for audited financial statements to be maintained by Free Zone entities intending to benefit from the 0% corporate tax rate incentives, means that planning around TP should also be promptly addressed.
The TP Guidelines and the OECD Model Tax Convention require ‘associated persons’, often referred to as related parties, to deal with each other at arm’s length. While the conditions required to be met in order to form a Tax Group under the local rules (base case of 95% common group ownership) may have some bearing on TP impact, generally the measure of a related party is construed in much broader terms.
In addition, many of the transactions that the TP rules seek to manage may already be embedded in the business. The onus on taxpayers to prove that arm’s length measures are being followed can involve significant documentation which invariably begins with the contractual terms of the arrangement. If transactions for intra-group goods and services are not already supported by contractual agreements then such gaps should be addressed to help manage tax risk. This includes in-house intra-group support services such as IT, HR, finance, legal and strategic management. Anything provided between group companies that would be a source of revenue if provided to a third party or that the other entity would have to procure for itself if not provided by the related party should be supported by a written agreement. These agreements seek to document the legal source and terms of the transaction, similar to the way a tax invoice evidences the purchase of goods or services. However, unlike an invoice in the case of third parties, the raising of an invoice for intra-group transactions is often not sufficient evidence for the purpose of tax authority audits as TP questions the appropriateness of the transaction value. Unless groups are able to address these considerations with appropriate documentation, tax authorities may adjust tax liabilities accordingly.
Another requirement of the new tax rules will be audited financial statements. This particularly applies to Free Zone Persons wishing to avail relevant tax relief, and therefore will be best practice for UAE business going forward. Audited financial statements prepared according to international financial standards, along with documented support for intra-group transactions and appropriately calculated and prepared tax adjustments, will help management make operational and risk based decisions regarding internal tax matters. This will, in turn, be the best preparation for potential future tax audits, along with well documented corporate governance policies covering tax related matters.
Conclusion and Recommendations
The UAE legislators will be seeking to balance the anticipated simplicity required to minimise the compliance burden with sufficient complexity to provide certainty to the taxpayer.
New laws always give rise to a period of adaptation and a need for interpretation. However, this adaptation period can also be used as an opportunity to review legal, financial, governance and risk aspects of businesses because these may affect management decision making and financial outcomes. All areas of structuring, contracting, commercial and employment arrangements may need to be reviewed, and updated, in light of the new tax law. In addition, transactional flows and financial matters, governance and policy should be revisited to ensure tax readiness.
The announcement regarding corporate tax has provided UAE businesses with lead time to prepare for the changes. If tax planning has not already begun, we recommend prompt action.