For years, investors were free to pay corporate taxes in the UAE, however, times have changed. Hence, companies will have to pay corporate taxes in 2023. Thus, it is important that you are aware of deferred tax liabilities.
In this article, you will learn everything about deferred tax liabilities. Let us observe:
- The United Arab Emirates’ tax system
- Federal taxes in the UAE
- Foreign direct investment
- Free zones
- Corporate transactions
- Rates suggestions
- CIT is exempt from income
- Additional features
- What is deferred tax liabilities?
- International Financial Reporting Standards (IFRS)
- How can Connect FZ help you?
1. The United Arab Emirates’ tax system
The tax system in the UAE is one of the main draws for many ex-pats to the region. Employees, for example, pay no income tax, and there was no system for corporate or inheritance taxes, among other things.
There was also no VAT until January 2018. This tax on the sale of goods and services was implemented at a low rate of 5%. There is also an excise tax levied on specific products deemed harmful to human health or the environment by the government, such as energy drinks and tobacco.
Additionally, you can learn about the UAE corporate tax and tax penalties with us. This will help you avoid trouble and ensure the smooth running of your business.
2. Federal taxes in the UAE
2.1. Taxation on earnings
The UAE does not levy an income tax. As a result, there is no need to file an income tax return in the UAE because there is no applicable individual tax in the country. The same is true for freelancers and self-employed individuals who live in the UAE.
2.2. Individual taxation
Employees in the UAE who are GCC nationals (including the UAE) are subject to a 17.5 percent social security regime. Those who are UAE nationals pay 5% (via automatic deduction from their paycheck) and the employer pays the remaining 12.5%.
Additionally, employees of companies and branches registered in a free trade zone are also subject to social security obligations. Furthermore, residents of other GCC countries may be subject to different social security contributions than residents of their home country. However, UAE’s social security does not cover non-GCC nationals.
2.3. Corporate taxation
In the UAE, corporate taxes are only levied on oil companies and foreign banks. However, the country has 45 free zones; businesses registered in the UAE do not have to pay tax for an extended period. There are no capital gains taxes unless the company is subject to another type of income tax.
Note that corporate tax rules are set to change on 1 June 2023; when a federal corporate tax of 9% will be implemented for businesses with net profits of AED 375,000 or more.
2.4. Double taxation
To encourage strategic global partnerships, the UAE is expanding its network of Double Taxation Agreements (DTAs) and Bilateral Investment Treaties (BITs). The UAE has signed approximately 193 DTAs and BITs with the goal of exempting or reducing direct and indirect taxes on investments and profits.
3. Foreign direct investment
The UAE’s corporate tax rate will be among the lowest in the world, making it appealing for inward investment. The Ministry of Finance also confirms that they will not apply any withholding tax in the UAE:
- And other similar payments.
The local government has strategically positioned the implementation of corporate tax; this is to ensure that the UAE remains an appealing destination for foreign direct investment for many years to come.
The UAE will also continue to attract highly qualified individuals because employment income (whether received from the public or private sector) will remain tax-free, and no tax will be levied on income or gains derived from personal investments.
4. Free zones
According to the Ministry of Finance announcement, free zone businesses will be subject to corporate tax and they will have to file corporate tax returns. The Ministry of Finance, on the other hand, has stated that the new regime will honor the tax breaks currently available to FZ establishments; as long as they comply with applicable regulatory requirements and do not conduct business in the UAE.
It is not uncommon for businesses to operate from a free zone, with a portion of their revenue coming from onshore sales of goods or services. According to the announcement, this portion of their revenue may be subject to corporate tax. This makes sense because otherwise, establishing a free zone business would be an obvious tax mitigation option.
Although we have not seen the Law or Implementing Regulations detailing the impact on free zone businesses; there will likely be increased administrative requirements to account for their onshore derived revenues.
With the relaxation of foreign ownership restrictions and increased real estate options onshore; businesses based in free zones may decide whether to establish an onshore presence.
4.1. The impact of corporate tax
The application of corporate tax in the UAE will have a significant impact on decisions regarding market entry strategies and corporate structuring. Businesses operating in the UAE must consider the impact of corporate tax on their:
- Existing structures.
- Shareholding arrangements.
- Group company agreements.
- Their ability to maximize the use of losses or other corporate tax reliefs.
- And whether any proposed reorganizations or disposals will qualify for corporate tax reliefs (such as qualifying intra-group transactions or disposals of qualifying holdings) or may trigger unexpected repercussions.
International companies with marketing or so-called “rep-offices” in the UAE must also consider whether these will now be treated as taxable permanent establishments and whether the FTA will seek to attribute significant taxable profits to the operations of such offices.
5. Corporate transactions
The introduction of corporate tax will have an impact on the M&A market. Investors will be relieved to learn that dividends and capital gains from a qualifying shareholding will be tax-free. However, higher due diligence costs are likely to be incurred to ensure a thorough understanding of the corporate tax liabilities being acquired.
We may see an increase in the flow of asset sales rather than share sales, allowing buyers to better control the tax liabilities they acquire. They will have to strengthen contracts to include more comprehensive tax guarantees and indemnities.
We may also see increased interest in warranty and indemnity insurance coverage to protect against unexpected tax liabilities and penalties. This may be especially true in the first few years of the new corporate tax regime when they are integrating the system and its requirements into organizational processes.
6. Rates suggestions
They propose to use the following corporate income tax rates:
- 0 percent rate on taxable income up to AED 375,000 (approximately US$ 102,000);
- 9 percent rate on taxable income above AED 375,000;
- A different rate for large multinationals with consolidated global revenues exceeding EUR 750 million (approximately AED 3.15 billion.
7. CIT is exempt from income
According to the MOF, the following types of income will be exempt from the CIT regime:
- Dividends and capital gains earned by a UAE business from qualifying shareholdings. For example, an ownership interest in a UAE or foreign company that meets certain conditions specified in the UAE CIT law.
- Qualifying intra-group transactions and reorganizations subject to certain conditions specified in the UAE CIT law.
- Foreign entities and individuals who do not conduct a trade or business in the UAE.
8. Additional features
8.1. Credits for foreign taxes
Foreign CIT paid on taxable income in the UAE will be able to be credited against CIT payable in the UAE. It is worth noting in this context that the UAE has signed over 130 double tax treaties; this will aid in the proper operation of the tax system in the context of cross-border trade and ownership relationships both before and after the implementation of UAE CIT.
Businesses will be able to use losses incurred (as of the CIT regime’s implementation) to reduce taxable income for subsequent fiscal periods under the CIR regime.
8.3. Tax groups
Groups of taxation UAE groups of companies will be able to form a tax group and be taxed as a single entity; subject to certain conditions specified in the UAE CIT law. A tax group in the UAE will be able to file a single tax return on behalf of the entire group.
8.4. Pricing for the transfer
Transfer pricing rules and documentation requirements based on the OECD transfer pricing guidelines will also apply to UAE businesses.
9. What is deferred tax liabilities?
Deferred tax liabilities are the amounts of corporate taxes that you must pay in future periods; this is a result of the following factors:
- Because of taxable temporary differences, taxable revenue is lower than accounting revenue.
- Because of taxable temporary differences, taxable expenses exceed accounting expenses.
9.1. More details about deferred tax liabilities
The tax authorities may permit businesses to pay income tax; that is less than the income recorded in the statement of comprehensive income, resulting in lower taxable profits. Hence, like interest of AED 50,000 accrued by an LTD on fixed-term deposits, which will be received at the end of the five-year deposit term.
Tax authorities will not consider this accrued interest as income when calculating current-period taxable profits, and the taxable temporary difference will arise as a result of this interest income.
Prepayments, such as three years’ rent of AED 120,000 paid in advance, are common examples of taxable expenses exceeding accounting expenses. They will amortize it over three years at a rate of AED 40,000 per year in the accounting books; whereas tax authorities in various jurisdictions may follow a cash basis and ask the registered business to treat the full rental payment of AED 120,000 as allowable tax expense in the first year.
As a result, taxable expenses in the current period would be AED 80,000 higher due to prepaid rent.
10. International Financial Reporting Standards (IFRS)
Temporary differences are differences between assets or liability’s carrying amount in the statement of financial position and its tax base. They refer to the amount attributed to an asset or liability for tax purposes as its tax base.
Therefore, temporary differences are going to result in taxable amounts in determining taxable profit (tax loss) in future periods. This is when the carrying amount of the asset or liability is recovered or settled are referred to as taxable temporary differences.
Using the above definition of IFRS, the interest of AED 50,000 and the rent of AED80,000 in the preceding examples are taxable temporary differences. Because of these taxable temporary differences, the registered business will pay less tax in the current period.
Note that they will consider these amounts in the future to determine the taxable profits for the relevant period. Except for a few exceptions, IFRS requires that they record deferred tax liability on taxable temporary differences.
10.1. More details about IFRS
They recognize deferred tax liability for all taxable temporary differences, except where the deferred tax liability arises from:
- The initial acknowledgment of goodwill; or
- The initial recognition of an asset or liability in a transaction that: (I) is not a business combination; and (ii) affects neither accounting profit nor taxable profit (tax loss) at the time of the transaction.
Because the taxable temporary differences are AED 130,000 [50,000+80,000], the registered business will record a deferred tax liability of AED 11,700 [130,000*9% (applicable corporate tax rate)].
In the period when taxable temporary differences exceed deductible temporary differences, tax expense exceeds tax liability, and the difference is recorded as deferred tax liability. When deductible temporary differences exceed taxable temporary differences, tax expense will be lower than the tax liability, and they will record the difference as a deferred tax asset in the statement of financial position, as discussed in our previous article.
The preceding understanding is based on global practices and IFRS 12 requirements. When the UAE government enacts corporate law, it will establish a firm foundation for calculating corporate taxes.
11. How can Connect FZ help you?
Now you know what deferred tax liabilities are about. The country is making big changes in its economy to improve it. There is no doubt that the UAE is always thinking about making investors’ lives easier.
Nevertheless, you do not have to worry about deferred tax liabilities as we are here to assist you. We have the expertise to help you in a variety of tax-related matters such as VAT, and more. Our specialists are ready to take your business to the next level as you take care of its commercial activities.
Would you like to contact Connect FZ to obtain more information on any tax-related matter? If you have any questions, call us at +971 43 316 688. Also, you can email us at firstname.lastname@example.org. We are the best partners for your business!