The UAE’s Ministry of Finance (MOF) recently announced the implementation of a federal corporate tax in the country. The term ‘Corporate Tax’ refers to a type of direct tax levied on a corporation’s or business entity’s net income or profit. Today, we will take a look at taxable profits in the UAE.
In this article, we will look at how to calculate taxable profits in the UAE. There are two methods for calculating taxable profits: direct method and indirect method.
- Methods for calculating taxable profits
- Equation
- Taxable expenses
- Accounting profit and taxable profit: Are there differences?
- What is the impact of the corporate tax?
- Frequently asked questions about corporate tax
- How can Connect FZ help you learn more about taxable profits in the UAE?
1. Methods for calculating taxable profits
We can calculate taxable profits directly using the direct method by deducting the cost of:
- Goods sold.
- Tax allowable expenses.
- And other allowable deductions from the corporations’ gross income.
They would add taxable income, if any, to the taxable profits to arrive at the taxable profits. As a result, we can say:
“Taxable Profits = Gross Income – Cost of goods sold – Tax allowable expenses and deductions + Other taxable income.”
This is a simple method of calculating taxable profits, and it would be very effective if corporations did not prepare financial statements regularly. However, if you need further assistance, you can count on Connect FZ’s services. Not only do we offer company formation services in the UAE’s free zones or Mainland, but also services such as tax and accounting solutions.
2. Equation
Using accounting profits as a base, add back all disallowable expenses, deduct tax allowable expenses, add taxable other income, and subtract non-taxable other income to calculate taxable profit. For example, consider the following equation:
- Accounting Profit as per IFRS XXXX
- Add: Disallowable expenses XXXX
- Less: Tax allowable expenses XXXX
- Add: Other taxable income XXXX
- Less: Other nontaxable income XXXX
- Taxable profits XXXX
Companies and tax authorities prefer to calculate taxable income in this manner. This is a very effective and dependable method of calculating corporate tax where corporations prepare financial statements regularly; they audited these financial statements by external auditors.
Furthermore, calculating taxable profit is simple because they take accounting profits from audited financials, and the breakdown of other numbers is available in the notes to the financial statements.
3. Taxable expenses
They determine taxable expenses and income using the principles and rules outlined in the corporate tax law and related regulations in both of the preceding methods.
For example, ABC company earns AED 30 million per year and has a cost of goods sold of 18 million. Accounting depreciation is 0.05 million, while tax depreciation is 0.07 million. Provision for doubtful debts is 0.1 million, while actual debts of 1.2 million have been written off. Bank charges are 0.05 million, audit fee is 0.10 million, utilities are 0.05 million, penalties are 0.15 million, and other expenses are 6.5 million.
The company profited AED 0.15 million from the sale of a machine. ABC earned 0.5 million in dividend income. ABC’s interest expense is 1 million, while the actual interest payment is 1.75.
Solution: According to the diagram, the accounting profit before tax is AED 4.65 million, while the taxable profit is 2.28 million under both methods. As a result, the tax payable would be 0.21 million [AED 2.28*9%].
3.1. More details
They have allowed tax depreciation and bad debts written off for tax purposes instead of accounting depreciation and provision for doubtful debts, which are not allowed for tax purposes when calculating taxable profits.
Penalties are not deductible as an expense for tax purposes. They have disallowed interest expenses for tax purposes; however, they have allowed interest payments. Dividend income and capital gains (gains on the sale of fixed assets) are not subject to tax, hence they are not taxable income.
Dividend income, capital gains on fixed-asset sales, and penalties have all resulted in long-term differences. This means that they will have an effect in the current period but will have no effect in the subsequent period.
Depreciation, bad debt provision, and interest have all resulted in temporary differences that will be offset in the next period. They have accepted bank charges, audit fees, utilities, and other expenses as allowable expenses by both administrations.
The preceding understanding is based on global practices and press releases issued by the UAE’s Ministry of Corporate Taxation. Once implemented by the UAE government, the law and related regulations would provide a clear foundation for calculating corporate taxes.
4. Accounting profit and taxable profit: Are there differences?
Profit computation principles and guidelines under IFRS and GAAP differ from the basis outlined in the new UAE’s corporate tax law and related laws; so, it results in significant differences in profits and their computation methods. Let’s look at how the two terms differ, even though they are both referred to as “profit” for businesses:
4.1. Accrual basis of accounting
To begin with, they compute accounting profits using the accrual basis of accounting; as opposed to taxable profits, where they compute them using both the accrual and cash basis. To better understand the distinction, the former shows the accounts receivable once he has made the sale.
This is even if money is not always received from the customer; cash is recorded only when it is exchanged or received from the customer to the company, not only at the time of recognition; this in the case of taxable profits.
4.2. IFRS or GAAP
Accounting profits in Dubai, UAE are calculated by the applicable IFRS or GAAP; whereas taxable profits are calculated following the guidelines outlined in the UAE’s corporate tax law and related regulations.
4.3. Accounting profit
Accounting profit, also known as bookkeeping profit, is the net income that results from deducting all explicit costs; such as raw material costs, labor costs, distribution costs, and other production costs/expenses, from the organization’s total revenue, as defined by accounting standards or GAAP.
Taxable profit, on the other hand, takes into account tax liabilities such as accounting profits and other costs and refers to profit that is taxable under income tax guidelines or the income tax act.
4.4. Computation
Accounting profit computation is a continuous process that takes into account payments and receivables. Taxable profit, on the other hand, is a one-time tax that they calculate after all amounts have been received and paid.
4.5. Uses
They use accounting profit to recognize a company’s overall profitability; whereas taxable profit is used to calculate the company’s tax liability.
4.6. Reporting
Accounting profit remains within the scope of financial reporting; whereas they let the extent of taxable profit or income to tax reporting.
4.7. Definition
They define accounting profit as financial gains after deducting all costs, whereas taxable profit is profit on which taxes are paid.
4.8. Methods
Accounting profit uses the straight-line method for depreciation calculations, whereas taxable profit uses the double-declining depreciation method.
4.9. FIFO and LIFO
They calculate accounting profit using the FIFO (First In First Out) inventory valuation method; whereas taxable profit is calculated using the LIFO (Last In First Out) inventory valuation method.
4.10. What does determine each one?
Accounting profits indicate whether a company’s financial performance is positive or negative, whereas taxable profits in the UAE determine the organization’s tax liability.
4.11. Financial years
And last but not least, for the calculation of accounting profits, they consider the current financial year while income from the previous year is taken into consideration in case of taxable profits that matter. For example, when the assessment year is 2023-2024, the previous year will be then 2022-2023.
5. What is the impact of the corporate tax?
The UAE corporate tax will apply to all business and commercial activities in the UAE, except natural resource extraction; they will continue to tax it according to the emirate’s specific taxation.
They will levy the corporate tax on ‘taxable income,’ which is the accounting net profit of a given business after adjusting for certain items (deductibles), as defined later in the UAE corporate tax law.
Commercial activities, which include all types of business activities carried out in the country under a trade license or permit, as well as income earned under freelancer permits (provided taxable income exceeds AED 375,000), are included within the scope of the corporate tax regime’s applicability.
5.1. Key points
The following are the key parameters of the new UAE’s federal corporate law:
- Corporate tax will be levied on taxable income of more than AED 375,000. Thus, the applicable corporate tax will be 0% for taxable income up to AED 375,000.
- Corporate tax rates for income above AED 375,000 are as follows: 9 percent for taxable income above AED 375,000; and a different tax rate for large multinational corporations that meet certain specific criteria.
- The new tax regime will take effect for the first time in the fiscal year beginning 1 July 2023 and ending 30 June 2024. However, a business with a fiscal year beginning on 1 January 2023 and ending on 31 December 2023 will be subject to UAE corporate tax beginning on 1 January 2024.
- The Federal Tax Authority (FTA), which was established in 2016, will be the government entity in charge of the administration, collection, and enforcement of the UAE’s corporate tax regime. Furthermore, the Ministry of Finance will continue to be the competent authority for an international tax agreements, treaties, and other similar agreements, including the exchange of information for tax purposes.
5.2. Exemptions
Individual salaries and employment income are exempt from taxation under the UAE Corporate Tax regime for both public and private sector employees.
Individuals who invest in real estate or receive capital gains from personal investments made through shares or debentures in the form of dividends or investment returns are not subject to tax as long as they do so in their capacity.
Businesses registered in the UAE’s free zones will be subject to the UAE corporate tax regime, but only to the extent that they conduct their operations within the territory. The corporate tax exemption granted to such business entities for activities conducted outside the country will be honored under the new corporate tax regime as well.
6. Frequently asked questions about corporate tax
6.1. What exactly is corporate tax?
Corporate tax is a type of direct tax levied on corporations and other businesses’ net income or profit. In other jurisdictions, “Corporate Income Tax” or “Business Profits Tax” are also ways to call it.
6.2. Why is the UAE implementing CT?
A competitive CT regime based on international best practices will solidify the UAE’s position as a leading global hub for business and investment; as well as accelerate the UAE’s development and transformation to meet its strategic goals.
The implementation of a CT regime reaffirms the UAE’s commitment to meeting international tax transparency standards and preventing harmful tax practices.
6.3. Is the UAE the first to implement CT?
The majority of countries in the world, including the majority of GCC members, have a comprehensive CT regime.
6.4. When will the UAE CT regime go into effect?
The UAE CT regime will go into effect for fiscal years beginning on or after June 1, 2023. Check out the following examples:
- A company with a fiscal year beginning on 1 July 2023 and ending on 30 June 2024 will be subject to UAE CT beginning on 1 July 2023.
- A company with a fiscal year beginning on January 1, 2023, and ending on December 31, 2023, will be subject to UAE CT beginning January 1, 2024.
7. How can Connect FZ help you learn more about taxable profits in the UAE?
Emirates such as Abu Dhabi, Dubai, and Ras al Khaimah, besides Ajman, Sharjah, and Umm Al Quwain, aim to implement international best practices in creating a leading global center for investment and business. This will be by introducing the new corporate tax regime in the country. In the meantime, they are also accelerating the country’s strategic objectives for further advancement.
Hence, the new amendments also reaffirm the country’s commitment to meeting international standards for tax transparency and limiting negative tax practices. Additionally, if you do not know how to calculate taxable profits in the UAE, we can help you and do it for you. In this way, we invite you to learn more about our value added services!
Would you like to contact us at Connect FZ to get the best accounting and tax consultancy services in the UAE? If you would like to speak to one of our experts about taxable profits in the UAE, feel free to call us at +971 43 316 688. Also, write us an email to contact@connectfz.com if you wish. With us, you can even refer a friend and receive cash rewards!
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