FTA Guide on Determination of Taxable Income

A taxable person following IFRS accounting will likely have unrealized gains and losses in the profit and loss account, resulting from mark to market adjustments, revaluation of assets, and other adjustments to the cost of an asset in accordance with IFRS. Article 20 of the UAE CT Law provides an option to such a person to recognize such gains and losses only when they are realized. The election can be made for all specified assets and liabilities or limited to those held on capital account. 

The guide clarifies that non-exercise of the election for first tax year will be deemed an irrevocable election in itself for taxation of such gains and losses in accordance with their accounting treatment. Consequently, the said treatment will have to be followed for subsequent years too. The case study exemplifies that unrealized loss on inventory would be admissible while an unrealized loss on land would not be deductible where the election has been made for taxation of gains/losses on assets and liabilities held on capital account. In any case, unrealized losses on investments eligible for participation exemption would be inadmissible irrespective of election, given that income from such investments is tax exempt.

The guide reinforces that only those expenses are deductible that are wholly and exclusively incurred for the purposes of taxable business, and expenses common to any other objective will require apportionment. The allocation keys used should be reasonable in view of the facts and circumstances and should result in a fair apportionment. While revenue could be an allocation key in some situations, other factors such as benefit derived also need to be taken into account for determining the suitable allocation key. The method should be consistently used for each tax period unless there is a change in business facts requiring change of methodology.

Further, unreimbursed expenses incurred for subsidiary’s business will not qualify as deductible expenses against parent company’s income. In addition, depreciation and amortization on expenses capitalized but otherwise inadmissible under another provision of the UAE CT law, will also be disallowed. This would also be the case with fines and penalties, or payments made to related parties in excess of the fair market price.  

Similarly, gifts made to a person other than a qualifying public benefit entity are inadmissible, including gifts to individuals who are business partners. Entertainment expenses for employees, including staff parties, are fully admissible, entertainment for business partners is admissible at 50% thereof, whereas any entertainment for the private benefit of shareholders or their families is inadmissible in its entirety. 

As a general rule, employee benefit costs are deductible irrespective of payment in cash or kind. This covers benefits provided for employee's spouse and dependents, such as medical insurance or flight allowance.

Reimbursement of employees' home office expenses such as home office setup, and a reasonable apportionment of utility bills are also considered as incurred for the purpose of business and hence deductible. 

Contribution to a private pension fund is admissible up to 15% of the employee’s salary and is allowed only when paid, as opposed to other employee benefits which are admissible on accrual basis as per IFRS. 

In terms of Article 31 of the UAE CT Law, interest on a loan obtained from a related party, that is used for payment of dividend or profit distribution to another related party, is inadmissible where the party receiving interest is not subject to corporate tax at 9%. Any other interest expense is subject to limit of AED 12 million or 30% of earnings before interest, taxes, depreciation, and amortization (EBIDTA), whichever is higher; however, interest on loan agreements signed prior to 09 December 2022 or where interest is disallowed under any other provision of CT Law, is excluded from this general limitation. 

The guide clarifies that specific interest deduction limitation rule will be looked into first, before applying the general rule. The case study practically demonstrates this by means of an example whereby interest charge on loan obtained from a foreign subsidiary in a low tax jurisdiction and used to pay dividend to the parent company, is disallowed in entirety, and the rest of the interest expense, excluding on loans signed prior to 09 December 2022, is subject to test for admissibility under the general limitation rule. The expense exceeding the limit of 30% of EBIDTA is allowed to be carried forward to next 10 years and can be adjusted against taxable income, subject to total charge staying within general limitation as computed for that year. 

Pre-Incorporation Expenses: Pre-incorporation expenses, such as registration fees and feasibility studies, are deductible in the first tax period if they are not capital in nature and are recorded in the financial statements in accordance with the applicable accounting standards.

Pre-trade expenses: Expenses incurred after business setup but before revenue generation, such as product development costs, are deductible in the tax period in which they are incurred, provided they are recorded in the financial statements.

The guidance is in Iine with the general principle for admissibility of expenses: these costs recorded in the books of account as per the applicable accounting standards. 

Article 24 of the UAE CT Law allows a taxable person to opt for the exemption of income relating to its foreign PE where such PE is subject to tax in the source country at tax rate of 9% or above. The guide exemplifies the computation for claiming this exemption and emphasizes that income attributable to the foreign PE must be computed using the transfer pricing principles and ‘separate entity approach’. Further, where such an election has been made, no credit can be claimed for foreign tax paid with respect to such PE. 

However, where no such election is made, the income of the PE will be subject to UAE tax, and foreign tax credit will be admissible up to the UAE tax liability on such income. The credit will be allowed irrespective of the existence of a double tax treaty between the source country and the UAE.

 The guide emphasizes the ‘separate entity approach’ for computation of taxable income of PE in the UAE of a non-resident person, and specifically mentions of admissibility of common head office costs insofar as they are reasonably attributable to such PE and incurred for its business, using a suitable allocation key.  

Tax loss relief comes into play once accounting income for the year has been adjusted and the effect of all exclusions/additions has been accounted for. If the result is positive, the taxpayer can adjust prior year’s tax losses up to 75% of the taxable income for the year. This is however not relevant for the first taxable year, as losses incurred prior thereto are not admissible for tax loss relief. 

However, within a qualifying group, tax loss relief can be availed by offsetting tax loss of one company against taxable income of another, up to 75% of such income, and subject to specified conditions relating to ownership and continuity of business.