The United Arab Emirates (UAE) boasts a robust corporate tax regime to foster economic growth and eliminate double taxation. In this comprehensive newsletter article, we’ll delve into the complexities of the UAE’s Corporate Tax Law, particularly focusing on exemptions related to dividends, participation interests, and various types of income and losses..
Dividends and Profit Distributions
When received from Resident Persons, dividends are generally tax-exempt. However, even dividends from Non-Resident-Persons can be exempt under specific conditions detailed in the Participation Exemption to prevent double taxation.
Dividends cover various forms of income, including regular dividends, in-kind dividends like bonus shares, and other distributions related to shares. Additionally, payments not conducted at arm’s length can be considered as dividends. These ordinary dividends apply to payments associated with shares or participation rights in a company. Moreover, “Other rights to participate in profits” encompass instruments like partnership interests and trust units that confer profit participation rights.
It’s important to highlight that payments or benefits “in respect of” shares or rights to profit are categorized as dividends unless they relate to debt claims. The definition covers distributions arising from share buybacks, redemption, cancellation, or other ownership interest terminations. Even constructive dividends, arising when shareholders receive excessive compensation from related or connected entities, fall under this category.
Personal investment income, when received by natural persons, remains non-taxable for Corporate Tax. Dividends from Resident Persons are always tax-exempt. Dividends from Non-Resident Persons can also enjoy a tax exemption, provided they meet the stringent conditions stipulated in the Participation Exemption. However, they are included in the Taxable Income if they fail to meet these conditions. For non-resident entities, foreign Dividends are subject to Corporate Tax if linked to a Permanent Establishment in the UAE. Yet, they can still be tax-exempt if the Participation Exemption conditions are satisfied.
The Participation Exemption in Depth
The Participation Exemption plays a pivotal role in the UAE’s Corporate Tax regime, preventing double taxation and offering significant tax benefits for specific income derived from a Participating Interest. This exemption is available to both Resident and non-resident entities with a UAE Permanent Establishment, contingent upon meeting specific criteria.
To qualify for this exemption, the ownership interest must meet several criteria, including a minimum ownership percentage, acquisition cost threshold, and a holding period. The exempt income encompasses dividends, capital gains or losses, foreign exchange gains or losses, and impairment gains or losses from Participating Interests. Expenditure related to exempt income is typically not deductible, except for Interest expenses.
The Participation Exemption is automatic, meaning there’s no need for a formal election. This exemption is available to both Resident and Non-Resident Persons, provided the specified conditions are met.
Eligibility and Criteria
The Participation Exemption’s eligibility criteria revolve around the concept of an “ownership interest.” An ownership interest is defined as any equity or similar interest that entitles the holder to profits and liquidation proceeds of the Participation, as defined by Accounting Standards. This can include various types of ownership interests, such as ordinary shares, preferred shares, redeemable shares, membership and partner interests, Islamic financial instruments, and other equity-like instruments.
However, certain instruments, such as debt instruments and options (call or put), do not qualify as ownership interests. The recipient of the income must be the true “owner” of the ownership interest, meaning they control the interest and have the right to economic benefits as defined by Accounting Standards. Economic ownership implies having rights to profits, liquidation proceeds, and voting in respect of the Participation.
The minimum ownership percentage requirement for the Participation Exemption mandates that a Participating Interest must represent a 5% or greater ownership of the shares or capital of a juridical person. However, if ownership falls below 5%, it can still qualify if it meets the minimum acquisition cost test. Additionally, ownership interests held by members of a Qualifying Group are aggregated for this test.
The holding period test stipulates that a Participating Interest must be held or intended to be held for at least 12 continuous months to prevent short-term investments for tax benefits. The intention to hold for 12 months is tested when income is derived and can be inferred from various factors.
Moreover, different ownership interests held by a Taxable Person in a single juridical person are aggregated for the holding period test. This test applies to the Participation as a whole, not individual ownership interests. In cases of ownership interest exchange arising due to the business restructuring relief, the period of ownership is treated as continuous if both interests qualify as Participating Interests.
In cases where the minimum ownership percentage is not met, the minimum acquisition cost test offers an alternative. To qualify under this test, a Taxable Person can be considered to have a Participating Interest if the acquisition cost is equal to or exceeds AED 4 million. This threshold simplifies the administrative process, assuming that a significant investment signifies a long-term commitment and influence over the entity.
Aggregation of acquisition costs is allowed for different ownership interests in the same juridical person held by the Taxable Person. This test also applies to ownership interests held by members of a Qualifying Group in which the Taxable Person in a member, and the combined acquisition cost should exceed AED 4 million. Intra-group transfers within a Qualifying Group do not affect the minimum acquisition cost test.
The Subject to Tax Test
The Participation Exemption is subject to the “subject to tax” test, ensuring that Participating Interests are adequately taxed, either through UAE Corporate Tax or a similar foreign tax at a rate of at least 9%. This test aims to prevent income shifting to low-tax jurisdictions to inappropriately benefit from the Participation Exemption.
To meet this test, the Participation must be subject to an adequate level of taxation, meaning that it should be subject to UAE Corporate Tax or a similar tax in its country of residence at a rate of at least 9%. Exclusions and various scenarios are also considered, including income from subsidiaries in no or low-tax jurisdictions, different aspects of foreign jurisdiction’s tax systems, and the tax rate requirement.
These exceptions provide clarity on when Participations are considered to meet the subject to tax test, even if they are not taxed or are taxed at a rate below 9%. Qualifying Free Zone Persons, Exempt Persons, holding companies, and entities that elect Small Business Relief are some of the scenarios that can meet this requirement.
Entitlement to Profits and Liquidation Proceeds Test
This test mandates that the ownership interest in the Participation must have an entitlement to at least 5% of both the profits available for distribution and the liquidation proceeds. The ownership interest refers to the legal and beneficial ownership of shares or other ownership interests. Profits available for distribution are determined based on the relevant corporate or other legislation governing the formation of the Participating Interest.
Profit allocation can vary based on factors like shareholder agreements, company bylaws, or specific arrangements among shareholders or members, allowing for different profit-sharing ratios regardless of the ownership interest percentage. The key factor is the actual percentage of entitlement to profits available for distribution and liquidation proceeds, irrespective of the ownership percentage.
The Asset Test
The Participation Exemption also features the asset test, ensuring that more than 50% of the direct and indirect assets within the Participation consist of ownership interests or entitlements that would qualify for the Participation Exemption if held directly by the Taxable Person. This test prevents potential abuse where significant non-qualifying Participations are held through an intermediary entity to benefit from the Participation Exemption.
The asset test calculation can be based on the consolidated balance sheet of the Participation and the accounting asset values or a Market Value valuation of the assets. The valuation should not be older than 12 months. The asset test must be met throughout the entire Tax Period in which income from the Participation is received, without interruption. In the case of a disposal of the Participation, the asset test must be satisfied until the date of the disposal.
Exempt Income and Losses in Detail
Dividends and other profit distributions received from a foreign participation interest are exempt from taxation. The exemption applies upon actual receipt, which is significant for taxpayers following the Accrual Basis of Accounting.
In the case of resident persons, dividends or profit distributions from them are already excluded from taxable income, without additional conditions.
Capital Gains and Losses
Gains from the sale, transfer, or other disposal of a participation interest after a 12-month holding period are exempt from corporate tax. However, capital losses are not deductible for corporate tax purposes.
Foreign Exchange Gains or Losses in Relation to Participation Interests
Foreign exchange gains related to a participation interest are exempt from taxation, while foreign exchange losses in connection with a participation interest are not tax-deductible.
Impairment Gains or Losses
Income or gains resulting from the reversal of impairments on a participation interest are typically exempt from corporate tax under the participation exemption. However, if an impairment loss had been previously deducted from taxable income, any subsequent income that qualifies for the participation exemption is not exempt up to the amount of the previously deducted impairment loss.
The interaction between the participation exemption and the foreign permanent establishment exemption hinges on whether the taxable entity chooses to apply the foreign permanent establishment exemption. If a resident entity with a foreign permanent establishment opts not to include the income, losses, and associated expenses of the permanent establishment in its taxable income, the income from a participation interest linked to the foreign permanent establishment is also excluded from the taxable income calculation. Essentially, the income and expenses of the foreign permanent establishment are not factored into the determination of taxable income.
On the other hand, if the resident entity does not select the foreign permanent establishment exemption, income derived from a participation interest associated with a foreign permanent establishment can qualify for the participation exemption, provided it meets the necessary conditions. The impact of foreign permanent establishment tax losses is also considered in this context.
How TME Legal Consultants Can Support Your Business
The UAE’s corporate tax regime offers specific tax treatments for exempt income and losses related to participation interests. Understanding these details is crucial for businesses to optimize their tax strategies, ensure compliance with the law, and promote economic growth in the UAE.
TME Legal Consultants is a team of 45 professionals in the field of legal-, tax-, accounting and compliance with over 18 years of experience. We advised a significant number of SMEs in the context of the implementation of the tax framework in the UAE and KSA over the last decade to make sure that our clients are well oriented in the new and fast evolving tax landscape and to reduce the legal liability of managers which may arise in connection with non-compliance.
