UAE Foreign Tax Credit Landscape

For UAE businesses operating in a globalized world and earning income in multiple countries, the enactment of Federal Decree Law No. 47 of 2022 on Taxation of Businesses and Corporation (‘CT Law’) in the UAE, can mean being subject to taxes both in the UAE and the foreign country from where the income is being derived by such businesses.

The CT law has come into force effective from 1^st June 2023 in the UAE. The law has an article on claiming of credit of income taxes paid in any foreign jurisdiction. The Federal Tax Authority has recently issued a guide on Taxation of Foreign Source Income and the ‘Foreign Tax Credit’ relief (‘FTC’) explaining in detail the mechanism to avoid being taxed twice on the same income in two jurisdictions. FTC allows to reduce the UAE tax liability by the amount of income tax already paid in another country on the doubly taxed income thereby preventing double taxation of such income.

1. Who can claim Foreign Tax Credit?

   A Taxable Person (as discussed below) can claim FTC for tax paid on the income in a foreign jurisdiction where the subject income is taxable under the CT Law in the UAE:

   1. A Resident juridical person;
   2. A Resident natural person to the extent such foreign source income relates to a Business or Business Activities conducted by the natural person in the UAE if the total annual Turnover of such a person exceeds AED 1 million in the Gregorian calendar year; and
   3. Non-Resident Person having a Permanent Establishment in the UAE and the foreign source income is attributable to such Permanent Establishment.

1. When is Foreign Tax Credit not available?

   FTC is not available if no Corporate Tax is payable on the foreign source income if such income falls under the category of exempt income in the UAE, or in case Small Business Relief is opted, or when a Natural person’s turnover is below AED 1 million, or where income of a Qualifying Free Zone Person is subject to 0% Corporate Tax, or where a Taxable Person incurs a loss (negative Taxable Income), and accordingly, no Corporate Tax is payable under the CT Law.

1. Eligibility of a Tax paid in foreign country to qualify for Foreign Tax Credit

   A Foreign Tax which is of a similar character to Corporate Tax would be eligible to be claimed as a Foreign Tax Credit in UAE and would be available on satisfaction of the below mentioned conditions cumulatively:

   1. It must be imposed by and payable to a foreign government (federal or state) of a foreign jurisdiction.
   2. Payment of the foreign tax is compulsory and is enforced by the tax laws in that foreign jurisdiction.
   3. The foreign tax should be on profit or net income (income minus deductions). However, foreign withholding tax, though generally not on net basis, would be considered for FTC.

   In jurisdictions where taxes are predominately a tax on a taxpayer’s income, and it is administratively burdensome to split its income and non-income components, subject to them meeting the other conditions specified above, such taxes would be treated as being of similar character to UAE Corporate Tax.

   The provisions of the applicable Double Taxation Avoidance Agreement would also be required to be considered while determining the foreign taxes that are eligible for FTC. Further, to the extent the terms of a Double Taxation Agreement are inconsistent with provisions of the Corporate Tax Law, the terms of the Double Taxation Agreement shall prevail.

   Certain factors which are irrelevant in determining the eligibility includes name given to the tax paid in a foreign jurisdiction, method of tax collection, whether the tax is imposed by an authority other than the primary taxing authority etc. Taxes which are not considered of a similar character to Corporate Tax includes;

   1. Consumption taxes such as VAT, GST, Sales Tax,
   2. Custom/ Excise/ stamp/ capital duty,
   3. Property tax, wealth tax, estate, inheritance tax etc.

   Further, amounts paid to a foreign government such as interest, fines, penalties which are levied due to defaults on late payment of tax etc. would not be considered similar to Corporate Tax.

1. When is a Foreign Tax considered "paid"?

   A Foreign Tax is considered paid when either:

   1. the amount has been remitted to the foreign tax authorities, or
   2. the amount has not yet been paid but has accrued to the foreign tax authorities and represents a committed payment due.

   The amount is not considered as 'paid' to the foreign tax authority, if:

   1. the tax liability in the foreign country is contingent and not yet accrued, or
   2. the tax paid has been refunded or confirmed as being refundable.

1. Subsequent refund of Foreign Tax Credit claimed earlier

   In case the taxes paid on the foreign source income are refunded by the Foreign tax authorities, resulting in a reduced Foreign Tax Credit available to be claimed under the UAE CT Law such that the increase in the Corporate Tax Payable is greater than AED 10,000, the Taxable Person is required to submit a Voluntary Disclosure to the FTA within 20 business days from the date the Taxable Person became aware of the repayment of foreign tax in the foreign jurisdiction.If the increase in the Corporate Tax payable is AED 10,000 or less, the person would be required to correct the Foreign Tax Credit claim either in the Tax Return due for a previous period or in the Tax Return for the period in which the foreign tax is refunded whichever is earlier.However, if the foreign tax paid increases, allowing for a higher Foreign Tax Credit, the person can submit a Voluntary Disclosure along with a Corporate Tax refund application, and the FTA will assess the impact on the higher FTC on the Taxable Person's Corporate Tax position.

1. Calculation of Foreign Tax Credit

   The FTC available in the UAE cannot exceed the Corporate Tax due in the UAE on the subject foreign income. It is the lower of:

   1. the actual tax paid in the foreign jurisdiction; and
   2. the Corporate Tax due on the foreign source income

   Since there are two Corporate Tax rates (0% and 9%) in UAE, the tax on foreign income is calculated using a weighted average formula: i.e.

   Corporate Tax due on foreign source income = (Corporate Tax on Total Taxable Income before any FTC) * (Relevant foreign income) / (Total Taxable income).

1. Unused Foreign Tax Credit

   Unused FTC can neither be carried over to future Tax Periods nor be applied to earlier ones. Further, the same can also not be deducted from taxable profits.

1. Multiple sources of Foreign Income

   The amount of FTC has to be calculated on an income-by-income basis. In case a Taxable Person derives foreign income from multiple sources, the excess FTC from one source cannot offset against the Corporate Tax due on another foreign income source.

1. Documents Required for Claiming Foreign Tax Credit Documentation required to avail FTC includes records which substantiate the amount of foreign income, exchange rates used, financial year, details of foreign tax, type of tax and proof of payment. These documents must be in Arabic or English, or a certified translation must be provided.Payment proofs include official receipt issued by the foreign tax authorities, a certificate of deduction of withholding tax, copy of tax return files in foreign jurisdiction along with workings, a letter from relevant foreign tax authority stating receipt of the taxes due etc.

1. Closing comments

   Navigating the UAE Foreign Tax Credit landscape requires a thorough understanding of the eligibility criteria, exclusions, and documentation requirements. It is crucial for businesses and individuals engaged in financial transactions globally, to be aware of the available benefits under the UAE CT Law for claiming relief from double taxation of the foreign incomes, satisfactory discharge of compliance obligations and ensuring fair taxation and avoiding unnecessary financial burdens.