Corporate Tax Guide on Determination of Taxable Income

Overview of the guide

On July 31, 2024, the Federal Tax Authority (FTA) issued Corporate Tax Guide | CTGDTI1 on the Determination of Taxable Income. This guide is designed to provide general guidance to Taxable Persons for determining their Taxable Income and calculating their Corporate Tax Payable under the Corporate Tax Law.

This guide is designed to provide general guidance to Taxable Persons for determining their Taxable Income and calculating their Corporate Tax Payable under the Corporate Tax Law.

▪ The adjustments required to be made to the Accounting Income for determining the Taxable Income under the Corporate Tax Law, and

▪ The adjustments required to be made to the Taxable Income for calculating the Corporate Tax Payable under the Corporate Tax Law.

• The Guide is also applicable to a Qualifying Free Zone Person (“QFZP”) where relevant.

• This Guide includes 9 detailed case studies to illustrate the key concepts for determination of TI. They provide specific fact patterns, illustrative extracts of f inancial information from the Financial Statements for the purposes of demonstrating the principles of the Corporate Tax Law.

1. Deductible and non-deductible expenditure - This case study covers the adjustments to be made to AI relating to deductible and non-deductible expenditure (excluding Interest deduction limitation rules). 2. Interest expenditure - This case study covers the adjustments to be made to AI relating to Interest expenditure. It covers the applicability of the General and Specific Interest Deduction Limitation Rules (i.e. deductible and non-deductible Interest expenditure and the treatment of disallowed/unutilized Net Interest Expenditure).

3. Tax Loss relief - This case study covers the adjustments to be made to AI relating to Tax Loss relief and the treatment of unutilized Tax Losses.

4. Interest expenditure and Tax Loss relief - This case study covers the adjustments to be made to AI in a situation where there is both unutilized/carried forward Net Interest Expenditure and Tax Losses.

5. Transfer of Tax Loss and limitation on Tax Loss carried forward - This case study covers the application of provisions relating to the transfer of a Tax Loss and the limitation on the use of Tax Loss carried forward.

6. Cash Basis of Accounting - This case study covers the determination of TI and calculation of CT Payable in the case of a Taxable Person having Revenue equal to or less than AED 3 million and applying the Cash Basis of Accounting.

7. Unrealised gains and losses, Exempt Income - This case study covers the adjustments to be made to AI for unrealised gains or losses, and for Exempt Income (such as Dividends, income from Participating Interest) including expenditure incurred in earning Exempt Income.

8. Foreign Permanent Establishment - This case study covers the adjustments to be made to TI in relation to the Foreign Permanent Establishment (“PE”) exemption.

9. Non-Resident Person conducting Business in the UAE through a Permanent Establishment - This case study covers the determination of TI and calculation of CT Payable in the case of a Non-Resident Person operating in the UAE through a PE.

Key takeaways

• Dividends and other profit distributions received from a Resident Person that is a juridical person are exempt from Corporate Tax.

• Dividends and other profit distributions received from foreign juridical persons are exempt from Corporate Tax if the recipient has a Participating Interest in the foreign company.

• A Participation is a juridical person in which the UAE shareholder company owns a 5% or greater ownership interest (a “Participating Interest”) for at least 12 months, and that meets the conditions of the participation exemption regime.

• Capital gains derived from the disposal of assets are included in annual taxable income in the same manner as other income from the business. Capital gains on the sale of shares may be exempt from corporate income tax, subject to meeting certain conditions, Certain other income (e.g., capital gains, foreign exchange gains / losses and impairment gains or losses) from a Participating Interest are exempt from Corporate Tax.

• The Guide clarifies that local taxes that are not in the nature of Corporate Tax, such as municipal and property taxes, will be tax deductible.

• Tax Loss relief, if any available, should be applied to the Total Income, i.e. the tax adjusted accounting income. After that, the applicable tax rates (i.e. 0% and 9%) are to be applied to the tax loss adjusted Total income.

• The Revenue threshold of AED 50 million to prepare audited Financial Statements must be considered in line with the arm’s length standard. For companies incorporated in the UAE (or operating in the UAE through a PE situated in the UAE), the audit must be performed by a UAE-registered auditor.

• The Guide clarifies that if the Taxable Person does not make the election to apply the realization basis for unrealized gains/losses in the first Tax Period, then this will be considered an irrevocable election. It is therefore important for taxpayers to determine their preferred election position as early as possible.

• Employee costs are generally considered to be wholly and exclusively incurred for Business purposes provided they are not excessive and meet the arm’s length standard (where employees are Related Parties or Connected Persons). Employee benefits other than cash salaries incurred for the wealth and benefit of the employees to retain or reward them could also be deducted in full for Corporate Tax purposes. the guide specifically mentions medical insurance, private car use, flight allowance for spouses and children, personal weekend travel, entertainment, etc. However, private pension fund unpaid contributions or excessive contributions (>15% of the employee’s total remuneration) are not claim tax deduction.

• Expenditure incurred in relation to more than one purpose if expenditure is incurred partly for Business purposes and partly for some other purpose, the amount must be apportioned so that only the part relating to the derivation of Taxable Income will be allowed as a deduction, should be allocated based on the fair and reasonable basis.

• Where non-deductible expenses are capitalized, any depreciation associated with these capitalized expenses will not be deductible for CT purposes. For example, if the cost of an asset includes capitalized expenses related to government fines or non-arm's length payments to Related Parties, the proportion of depreciation related to these costs is not deductible for CT purposes.

• pre-incorporation expenditure though incurred before the Business is officially incorporated or set-up, will be allowed as a deduction to the extent to which it is recorded in the income statement once the company is incorporated (or the Business is set up), in line with the relevant Accounting Standards, subject to meeting the general deduction criteria under the Corporate Tax Law and provided that it has not been claimed as deductible expenditure by another Taxable Person. These expenses typically occur during the pre-launch phase, when a Business is preparing to commence its commercial activities. Examples include costs associated with product development, marketing and advertising expenses, office setup costs, utilities, office equipment, expenses for hiring and training employees before the commencement of operations, etc.

• The bad debt expense will be deductible when determining Taxable Income, as long as it satisfies the requirements for deductibility of expenditure in the Corporate Tax Law. Further, if a balance which was written off in a prior Tax Period is subsequently recovered, the credit to the income statement will be taxable in the Tax Period in which it is recognized in accordance with the requirements as applicable.

• As Per the Guide, for CT purposes the accounting classification of a particular expense is not relevant when considering whether such an expense is entertainment expenditure. The Guide provides the following grouping of expenses for CT purposes:

• (i) Entertainment for employees is generally fully deductible. Examples are staff parties, off-site events/away-days (which may include spouses and children) or rewards for meeting performance targets.

• (ii) Incidental expenses for business meetings, food and refreshments in the office, complimentary drinks to customers are also generally fully deductible.

• (iii) Commercial hospitality. Where a Taxable Person provides commercial hospitality as part of its Business or Business Activity, for example in-flight entertainment, hotel’s packages or mid-week promotions, etc, this would not be considered entertainment expenditure and can be claimed as a deduction.

• (iv) Marketing or advertising. The 50% deduction restriction rule does not apply to other marketing expenditure, such as advertising, promotions, attending trade shows or direct marketing campaigns. Nevertheless, typically discretionary costs of providing hospitality at the event such as meals, a musical performance or accommodation will be subject to the 50% restriction for entertainment expenditure. While marketing related sponsorship costs (for example, sponsoring an event) will be deductible, any benefits received as part of that sponsorship used to entertain business partners and/or customers, such as tickets to a sporting event, shall be subject to the 50% limit.

• The Guide reiterates that the following will not be considered while calculating the Net Interest Expenditure for the purposes of the General Interest Deduction Limitation Rule (“GIDLR”):

• Interest expenditure that is disallowed under any other provisions of the CT Law, for example, the Specific Interest Deduction Limitation Rule (“SIDLR”) or non-arm's length amounts

• Interest income or Interest expenditure related to grandfathered debts (i.e. prior to 9 December 2022)

• Interest income and Interest expenditure in relation to Qualifying Infrastructure Projects

• Taxable Income (even if negative) before the GIDLR and Tax Loss relief is required to be increased by the following, to arrive at the “adjusted EBITDA” for the purposes of GIDLR:

• Net Interest Expenditure for the relevant Tax Period

• depreciation and amortization expenditure tax deducted for the relevant Tax Period

• any Interest income or expenditure relating to historical financial assets or liabilities held prior to 9 December 2022

• any Interest income or Interest expenditure in relation to Qualifying Infrastructure Projects.

• For the interest tax deduction calculation, the Guide has an example where interest expense on trade payables and interest income on trade receivables are part of the Net Interest Expenditure calculation.