The UAE Federal Corporate Tax: 3 Important Points to Consider About the New Policy
August 30, 2022
For the longest time, the United Arab Emirates belonged to a handful of countries around the world with a 0% statutory or general corporate tax. It kept company with the Bahamas, Bahrain, the Cayman Islands, Guernsey, and the Isle of Man. However, in January 2022, the Ministry of Finance announced that the federal government will start levying a corporate tax in the UAE.
How this new corporate tax will affect a UAE business entity's profits and operations bears careful thought and consideration.
To this end, we provide this short discussion on the essential points to consider about the UAE federal corporate tax.
1. The new corporate tax directive has a direct impact on ROI.
The UAE federal corporate tax will be computed against a company's taxable income — i.e., net profit — using the following tax rate schedule:
| Taxable Income | Tax rate |
|---|---|
| AED 375,000 and lower | 0% |
| Higher than AED 375,000 | 9% |
Note: There may be a higher rate for UAE companies that are part of large multinational corporations meeting specific criteria that follow the OECD BEPS Pillar 2 approach.
Meanwhile, the proposed CT regime provides for certain exemptions like enterprises extracting and exploiting natural resources
Under the new tax regime, if a non-exempt company earned a taxable income of AED10,000,000, it will pay a corporate income tax of AED 866,250 or 9% * (10,000,000 - 375,000).
(e.g., upstream oil and gas companies), charities/public benefit organizations carrying out noncommercial activities, etc., who shall not be subject to UAE corporate tax.
Under the new tax regime, if a non-exempt company earned a taxable income of AED10,000,000, it will pay a corporate income tax of AED 866,250 or 9% * (10,000,000 - 375,000).
Suppose the company is in the business of manufacturing plastic pipes and plans to purchase additional plastic pipe extrusion machines, each of which costs AED 165,300. In this scenario, the corporate tax the company will pay costs roughly the equivalent of five extruders.
The impact of the corporate income tax goes beyond the money lost to tax payments. Suppose the five extrusion machines the company couldn't buy would have produced 5,000 pieces of 10-foot pipes in a month. If each pipe retails at an average of AED 200 per pipe, they would have generated an additional AED 1,000,000 in monthly revenues.
In other words, the federal corporate tax will affect a company's return on investment. As such, a company's leadership has to review the value chain to see where it may reduce costs and maximize revenues.
For instance, existing supplier and vendor agreements may have to be reassessed and renegotiated. Product pricing and marketing strategies may also have to be revisited.
Additionally, the company must review its current business model to see if the business has to be restructured. It must take an in-depth look at its information systems, technologies, and accounting procedures. It should also train its people to ensure they know their new responsibilities under the new tax scheme.
At the very least, the company must prepare for a future FTA audit and undertake/ put in place measures to mitigate tax risks.
2. Corporate tax for UAE free zone companies.
The new federal corporate tax regime applies to mainland and free zone companies unless the law explicitly exempts them. Generally speaking, however, the new tax regime will honor free zone authorities' tax incentives.
Therefore, a free zone company with an existing 0% free zone corporate tax can retain this favorable tax rate as long as it can fulfill certain conditions, including:
- Religiously filing tax returns
- Remaining in good standing with the free zone authority
- Maintaining operational and economic activity (i.e., adequate substance)
- Subjecting itself to regular, mandated audits
- Complying with applicable government and free zone regulations
- Not actively earning income from the mainland unless otherwise permitted under the law; passive income like royalties, interest earnings, gains, and dividends do not count
One of the propositions could be that free zone companies can establish a mainland branch if it wishes to earn income from the mainland. In this case, the free zone's tax rate (typically 0%) will apply to its free zone income, but the new federal corporate tax rate will apply to its mainland branch income.
Further, free zone persons can continue to enjoy the 0% CT benefit for transactions with group companies located in UAE Mainland. However, there could be restrictions on claims of such payments from a group company perspective. Note that if a free zone company has mainland income that hasn't been coursed through a duly instituted mainland branch, that free zone company will lose all of its preferential tax treatment. If this happens, all of its income will become subject to federal corporate tax. An exception is an income earned through the sale of goods in a designated zone for VAT purposes, as long as the buyer is the importer on record.
They must also implement stricter accounting procedures to ensure separation between mainland and free zone incomes. Finally, they must comply with applicable regulations, fulfilling their procedural and reporting obligations.
3. The federal corporate tax will likely lead to the review of agreements between free zone and mainland group companies.
Free zone persons can continue to enjoy the 0% CT benefit for transactions with group companies located in UAE Mainland. However, the differential treatment of free zone companies under the new corporate tax regime has implications for mainland group companies doing business with free zone entities. Specifically, the new corporate tax scheme's provisions say any payment to a free zone company by a mainland group company may not be deducted as an expense when deriving taxable income.
For free zone companies, this can mean a loss of long-standing sources of income, although they may be able to circumvent this by establishing a mainland branch.
A Comprehensive Review Is a Must
Beginning on 1 June 2023 (or 1 January 2024, depending on the applicable fiscal period), UAE companies within the scope of UAE's new federal corporate tax must pay a 0%, a 9%, or an even higher tax rate on their income. Before then, UAE businesses must comprehensively review their financials and operations to mitigate risks, minimize losses and uncover new opportunities.
MBG Corporate Services is an international organization that provides business consulting and support services in the UAE and other parts of the world. You can rely on our tax and allied consulting services to help confirm your readiness for the new corporate tax regime in the UAE. Contact us now.
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Article contributed by:
Corporate Tax team - UAE
