By releasing a Public Consultation Document, the Ministry of Finance gave the general public a fantastic opportunity to weigh in on the creation and implementation of the CT regime and to assess its effects. Comments had to be sent by May 20, 2022.
The FTA released answers to some Frequently Asked Questions (FAQs) that laid down high-level thinking of the government in terms of the design of the CT regime.
Impact of Cross-Functionality on a Business
The initial implementation of the new tax system would undoubtedly necessitate a shift in the tax and finance division of any business’s mentality. From now on, it will be crucial to look at every transaction and book entry from the perspective of CT.
To some extent, businesses in the UAE generally geared up fairly robustly in the wake of the implementation of the value-added tax (VAT) and excise regimes. In turn, the government-supported businesses by showing leniency on issues relating to non-compliance, significantly reducing penalties, and extending time limits for paying those penalties.
In addition to the tax functions, the CT regime would also have an impact on the supply chain, general finance, IT, and legal functions. It will be essential for the tax functions to play an increasingly bigger role in guiding the commercial decisions of the organization. Businesses will also need to have solid record-keeping data architecture in line with best practices for managing tax data and tax risk.
It can be predicted that the UAE government would likely ensure that some of the finest tax technology-related practices from other nations are adopted from the beginning of the tax system, such as e-audits, e-compliance, e-assessments, and e-invoicing. This is vital for businesses.
As a result, organizations would need to make sure that staff members are well trained and that processes are well defined to be ready for a tax role that is enabled by technology. The most crucial thing for businesses to do is to make sure that their data management is so strong that, in the event of any regulatory change, the data can be easily shared with the FTA, preventing them from having to catch up with the new regulations.
Impact on Cost of Doing Business in UAE
In the UAE, the new headline CT rate is 9% for businesses generating a taxable income above 375,000 UAE dirham ($102,000), except for businesses located in the Free Zones that do not conduct business with the mainland. Separately, there will be another rate announced for those businesses which would fall under the scope of the OECD’s Pillar Two reforms, i.e., multinational enterprises (MNEs) with global consolidated revenues above 750 million euros ($795 million).
It must be appreciated that the 9% rate is still one of the most competitive globally. Even in the Middle East region, it is the lowest rate, not counting Bahrain which has still not introduced a CT regime.
In addition to these competitive rates, the government might also reduce or outright remove charges relating to license fees and fees for setting up companies. This would certainly reduce the impact of the tax on profit-making businesses in the UAE. It is also expected that the free zones will attract start-ups and scale-ups away from the mainland if they are profitable. This might, in turn, prompt even the free zones to drastically reduce charges like annual license fees, because of competition within the free zones to attract the maximum number of businesses.
Issues Relating to Individuals
There are also some interesting issues relating to individual taxation. One of the FAQs states:
How do you determine whether an individual has a “business” that will be within the scope of UAE CT?
This would generally be done by reference to the individual having (or being required to obtain) a business license or permit to carry out the relevant commercial, industrial, and/or professional activity in the UAE.
If an individual has or is required to have. With a business license or permit, these individuals would be placed on an equal footing as compared to legal entities performing the same activities. Further, it generally appears that if a business license or permit is not required and not possessed either, then the activity is not considered to be a business.
Turning to legal entities, the FAQ states that all activities undertaken by a legal entity will be deemed “business activities” and hence be within the scope of UAE CT.
Considering these statements, an interesting question arises. If a legal entity were, for example, engaged in the activity of trading assets—real estate, stocks, even cryptocurrency—this would be considered to be a business activity and hence, taxable. Whereas, for an individual, such activities are business activities only if the individual has, or is required to have, a license or a permit to do so.
In this situation, what happens for an individual who is trading—not investing—in the share market in their capacity?
The FAQ states that individuals will not be subject to UAE CT on dividends, capital gains, and other income earned from owning shares or other securities in their capacity.
Reading this sentence, it is clear that dividends, capital gains, or other income would not be subject to CT. In the UAE, individual trading in securities is per se not required to obtain any license or permit. What happens if such an individual is engaged in the activity of trading securities in their capacity as a means of their livelihood and is not required to obtain any permit or license?
The condition for taxability, as discussed above, generally, is concerning (having a requirement to) obtaining a permit or a license. It appears that this individual trading in securities for their livelihood would not be considered to be undertaking a “business,” even though they may have a profit motive, methodically perform the trades, operate in substantial volumes, and largely undertake the steps and processes similar to an investment firm or a wealth management firm.
This apparent asymmetry between an individual and a legal entity performing similar activities appears to be in place due to the priority of the government to ensure relative simplicity in the tax system. Comparing this system with other more complex tax systems as in the UK or India may not be fruitful. This is because those systems have, to a large extent, sacrificed simplicity in the pursuit of ensuring neutrality as to the economic effect on business activities—irrespective of corporate form—and the prevention of avoidance schemes.
Still, there is leeway for the UAE government to further clarify this position, given the words generally by reference in their FAQ (above). As the tax system matures, the FTA may provide further guidance and clarification.
Tax Grouping Implications
On the issue of tax grouping, the FAQ reads:
Will a group of UAE companies be able to form a “fiscal unity” for UAE CT purposes?
A UAE group of companies can elect to form a tax group and be treated as a single taxable person, provided certain conditions are met. A UAE tax group will only be required to file a single tax return for the entire group.
In this context, a question arises on whether domestic transactions between members of a tax group inter se would be subject to arm’s-length pricing (ALP) for these transactions. In other words, when one entity within a tax group transacts with another entity within the group, does ALP even matter? One way of thinking about this is that as the profit is just shifted between the entities that are within the same tax group, there would be no net effect on the tax-group CT.
Such an arrangement would also lead to other questions, such as whether assets could be revalued when a new entity joins the tax group, thereby affecting depreciation, thin capitalization, and related party borrowings (price and level of debt) with entities outside the tax group.
To answer the question regarding the interplay of ALP with a tax group, another FAQ is relevant:
Will intra-group transactions are exempt from UAE CT?
Qualifying intra-group transactions and reorganizations will not be subject to UAE CT provided the necessary conditions are met.
We do not yet know the necessary conditions referred to, including whether a tax group is covered in this exemption. Comparison with a couple of other countries may be helpful.
In Germany, there is a concept known as Organschaft. This applies where the parent company holds more than 50% of the voting rights of the subsidiary, and the two companies put together a court-ordered profit and loss pooling statement. The two companies are treated as an integrated fiscal unit. Here, profits and losses can be offset, but there is no provision for the elimination of intra-group tax profits from the total tax base. On the other hand, in the Netherlands, transactions between the members of the fiscal unity are completely disregarded. No profits arise until goods or services are supplied to an entity outside the fiscal unity.
Given that the UAE generally prefers simple and business-friendly tax policies, it is more likely that it will take more cues from the relatively simpler Dutch tax system, rather than the more complex German tax system. Therefore, given the information available, it may be expected that the UAE may not require domestic transactions between members of a tax grouping to be subject to ALP.
This does appear to be the intention even in the Public Consultation Document, as described in Paragraph 6.8: “To determine the taxable income of the tax group, the parent company will have to consolidate the financial accounts of each subsidiary for the relevant tax period, and eliminate transactions between the parent company and each subsidiary group member (and amongst the subsidiary group members).”
