Welcome to the 10th installment of our series offering comprehensive insights into UAE corporate tax. Corporate taxation plays a pivotal role in the financial landscape of businesses operating in the United Arab Emirates (UAE). One crucial aspect of corporate taxation is the determination of taxable income, which involves identifying deductible expenditures and understanding the limitations imposed on such deductions. In this comprehensive guide, we will delve into the intricacies of corporate tax deductions in the UAE, covering various aspects from deductible expenditures to interest expenditure deduction limitations.
If you’re just joining us, we recommend starting from the beginning of our series to get a full grasp of the insights we’ve shared so far. You can find the first blog post here.
Deductible Expenditures
In accordance with the UAE Corporate Tax Law, business expenses incurred to derive taxable income are generally deductible. These expenses include costs directly related to conducting business operations, such as salaries, rent, utilities, and advertising. However, exceptions and restrictions exist, as outlined in the Corporate Tax Law.
The timing of deduction varies for different types of expenses and the accounting methods applied.
Typically, businesses recognize expenditure on capital assets by deducting depreciation or amortization over the economic life of the asset or benefit. Expenditure with a dual purpose, such as expenses incurred for both personal and business purposes, requires apportionment, with the relevant portion treated as incurred exclusively for the purpose of the business.
Furthermore, Article 33 of the UAE Corporate Tax Law lists specific expenses for which it does not allow deductions, including bribes, fines, and penalties.
Moreover, a taxable person cannot deduct expenditure incurred in deriving income exempt from corporate tax or losses not connected with or arising out of their business.
Interest Expenditure Deduction Limitations
Interest expenditure deduction is subject to specific limitations aimed at discouraging excessive debt financing and ensuring the validity of intra-group transactions. The General Interest Deduction Limitation Rule stipulates that businesses with net interest expenditure above a certain threshold must adhere to certain restrictions.
For example, businesses that exceed AED 12 million in net interest expenditure can deduct a portion of their interest expenditure, up to the greater of 30% of adjusted earnings before interest, tax, depreciation, and amortization (EBITDA) or AED 12 million. They can carry forward any net interest expenditure exceeding this limit for utilization in subsequent tax periods.
Additionally, specific interest deduction limitation rules apply when a loan is obtained from a related party to finance income exempt from corporate tax. In such cases, interest on the related party loan is not deductible unless the taxpayer can demonstrate a valid commercial reason for obtaining the loan and conducting the transaction.
Moreover, Islamic Financial Instruments are subject to scrutiny under the General Interest Deduction Limitation Rules. If an Islamic Financial Instrument includes an interest-equivalent component, it will be treated as economically equivalent to interest and subject to the same limitations.
Other Deductions and Considerations
Various other deductions and considerations impact taxable income calculation. Dividends paid by UAE companies are not deductible for corporate tax purposes. However, the payment of royalties to foreign group companies is generally deductible if deemed necessary business expenses and at arm’s length rates.
Remuneration paid to management is usually deductible, with exceptions for payments exceeding market rates or paid to related parties. Transfer pricing rules apply when a company pays a management fee to its parent or any other related party, ensuring that the fee is at arm’s length.
Value-added tax (VAT) paid may be deductible for corporate tax purposes, but only irrecoverable input VAT qualifies for deduction. Similarly, doubtful debts are allowed as deductible expenditure following International Financial Reporting Standards (IFRS).
Application and Calculation Examples
To illustrate the application of deduction rules and limitations, consider the case of Company X, which incurs net interest expenditure of AED 14 million in a tax period. Assuming an adjusted EBITDA of AED 30 million, Company X can deduct AED 12 million of net interest expenditure, with the remaining AED 2 million carried forward for utilization in subsequent tax periods.
Special Cases and Exemptions
Certain entities and transactions enjoy exemptions from general interest deduction limitations. Banks, insurance providers, and natural persons are excluded from the scope of the General Interest Deduction Limitation Rule. Additionally, certain long-term infrastructure projects may qualify for exemption from the rule.
A grandfathering rule also exists for loan agreements entered into before December 9, 2022, preserving the terms of interest payments under those agreements from the limitations imposed by subsequent regulations.
In conclusion, understanding corporate tax deductions is crucial for businesses operating in the UAE. By navigating the intricacies of deductible expenditures and limitations, businesses can optimize their tax positions while ensuring compliance with relevant laws and regulations. As the corporate tax landscape evolves, staying informed and proactive in tax planning is essential for financial sustainability and growth.
By incorporating these guidelines into their tax strategies, businesses can maximize deductions, minimize tax liabilities, and maintain compliance with the UAE Corporate Tax Law. With careful consideration and adherence to regulations, businesses can navigate the complex terrain of corporate taxation in the UAE effectively.
To stay updated with Corporate Tax Law and related implementing decisions you can visit this link.
