Adjusting for unrealized gains and losses is a crucial step in accounting for profits. Under the UAE CT law, Article 20(3), individuals subject to taxation can opt to account for gains and losses based on when they are realized for assets and liabilities that are subject to fair value or impairment accounting under applicable accounting standards, or for all assets and liabilities held on capital account at the end of a tax period.
The UAE Corporate Tax law mandates that taxpayers must use an indirect approach to calculate their taxable profits. This involves creating financial statements based on the applicable accounting standards, and then adjusting the accounting profits to determine the taxable profits. The adjustments usually require adding back non-deductible expenses, subtracting expenses not recognized in accounting profits, excluding income not subject to UAE CT law, and including taxable income that is not part of accounting profits.
One of the most critical adjustments to accounting profits is the adjustment of unrealised gains and losses. According to Article 20(3) of the UAE CT law, taxable persons can choose to account for gains and losses on a realisation basis for all assets and liabilities subject to fair value or impairment accounting under applicable accounting standards, or all assets and liabilities held on capital account at the end of a tax period. However, the gain or loss on all assets and liabilities held in the revenue account will be considered on an unrealised basis, as provided for in clause 20(3)(b) of the UAE CT law. Taxable persons may opt to be taxed on a gain or allowed a loss on a realisation basis only for the assets and liabilities subject to fair value or impairment accounting or held on capital account. This applies to all assets and liabilities of the respective category.
Assets and liabilities subject to fair value generally include financial assets, financial liabilities, investment property, biological assets measured at fair value less cost to sell, and intangible assets acquired in a business combination. Assets subject to impairment accounting include property, plant, and equipment (PPE), goodwill, intangible assets not acquired in a business combination, investments in equity instruments that are not held for trading, and others.
“Assets and liabilities are considered to be held on capital account when they are not expected to be sold or traded with during the regular course of the business operation.”
Required Adjustments to the Financial Statements: The corporate tax legislation in the UAE mandates that the accounting net profit (or loss) must be modified to account for various items specified in the law, which include:
1. Unrealised profits or losses (depending on how the realisation principle is applied)
2. Income that is exempt, such as dividends
3. Transfers between companies within the same group
4. Deductions that are not permitted for tax purposes
5. Adjustments for transactions with related parties and connected individuals
6. Any tax incentives or relief provided by the government
7. Any other modifications specified by the Minister.
How CT Treats Unrealised Gains and Losses:
Generally, assets and liabilities are considered to be held on capital account when they are not expected to be sold or traded with during the regular course of the business operation. Where a business prepares their financial statements on an accruals basis, it has the following options in respect of the UAE CT treatment of unrealised accounting gains and losses:
- The taxpayer can elect to recognise gains and losses on a ‘realisation basis’ for UAE CT purposes for all assets and liabilities – that is, any and all unrealised gains would not be taxable (and conversely, any and all unrealised losses would not be deductible) until they are realised;
- The taxpayer can elect to recognise gains and losses on a ‘realisation basis’ for UAE CT purposes for assets and liabilities held on capital account only – that is, only unrealised gains and losses in respect of assets and liabilities held on capital account would not be taxable or deductible, respectively, until they are realised. Unrealised gains and losses arising from assets and liabilities held on revenue account, on the other hand, would continue to be included in taxable income on a current basis.
“Taxpayers in the UAE can use the realization principle to determine their taxable income under the country’s CT system.”
Realisation Principle:
Similar to other Corporate Tax systems, the UAE’s CT system permits taxpayers to use the “realisation principle” to ascertain their taxable income. In other words, income will only be subject to tax, and deductions may only be taken, when a gain or loss is realised, such as when the related asset is sold or terminated. The application of the realisation principle means that any gains or losses on assets or liabilities that are subject to fair value or impairment accounting will not be included in the taxable income for each Tax Period.
Taxable Income for UAE CT:
The taxable income for a Tax Period will be the accounting net profit (or loss) of the business, after making adjustments for certain items specified in the Corporate Tax Law.
The accounting net profit (or loss) of a business is the amount reported in its financial statements prepared in accordance with internationally acceptable accounting standards.
Adjustments to the accounting net profit (or loss) will need to be made for the following items:
1. Unrealised gains and losses (subject to the election made regarding the application of the realisation principle);
2. Exempt income such as qualifying dividends and capital gains;
3. Income arising on intra-group transfers;
4. Deductions which are not allowable for tax purposes;
5. Transactions with Related Parties and Connected Persons;
6. Transfers of tax losses within the group where relevant;
7. Incentives or tax reliefs; and
8. Any other adjustments as specified by the Minister.