UAE companies need to take a closer look at the ‘outlying areas’ of the corporate tax system

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Jaffa cakes are cookie-sized orange cakes covered in chocolate. I see them now on the shelves of supermarkets in Dubai. What is the connection between the Jaffa cake and taxes?

To learn this, you have to go back to a true story from the 1990s. The elaborate UK VAT rules require cakes and biscuits to be taxed at zero rate because they are considered essential items. However, chocolate covered cookies are considered a luxury and are therefore taxed at the standard rate of 20 percent (previously 17 percent).

McVities, a key producer of Jaffa Cake, treated Jaffa Cake as zero-rated for VAT purposes. However, HMRC, the UK tax authority, argued that the Jaffa cake should be considered chocolate covered biscuits and taxed at the standard rate. The case eventually ended up in court, which then had the daunting task of deciding whether Jaffa’s cake is a cake or a cookie.

The court considered all aspects such as name, texture, size, ingredients, cooking method, consumer attitude and location in the supermarket aisle when making its decision. Believe it or not, one of the most pressing arguments was about what happens when Jaffa’s cake goes stale. The court found that Jaffa’s stale cake was hard like a stale cake and not soft like a stale biscuit. McVities won the suit.

This curious story is often cited as an example of the complexity and absurdity of taxation. Tax rules, like all rules, attempt to create a sense of black and white by setting the scope around the rules. Life sometimes gets in the way of all its glorious shades of gray.

Circumstances exist or inevitably arise which fall, or could be construed to fall, on both sides of a line drawn by the tax administration. These border areas attract all sorts of judgments and complexities.

A recurring theme in the UAE’s corporate tax announcement was that the Ministry of Finance intends to keep it simple. Indeed, we have already seen this desire materialize in the UAE’s VAT regime and in the detailed announcements on corporate taxation, in particular evidenced by the application of a single tax rate as opposed to the multiple rates that we see in many other jurisdictions.

But the Ministry of Finance also expressly recognizes that a certain level of complexity in CT is unavoidable.

Although there are also marginal areas of judgment in UAE VAT, there is a very important distinction between VAT and corporate taxation. In terms of VAT, companies simply play the role of tax collector on behalf of the Federal Tax Authority (AFC). While this has an impact on the company’s cash flow, there is often very little, if any, impact on its bottom line. (Just to be clear, I’m not talking about penalties here).

A direct impact on the bottom line

The story of corporation tax, however, is totally different. Accountability directly affects the bottom line, which is the profit that business owners can take home. Therefore, the stakes are much higher.

Marginal complexities can arise in a number of areas. The public consultation paper recently released by the Department of Finance gives us definitive indications of where things are headed and what challenges we can expect.

The first key question will be whether you are subject to corporation tax. The basic rule is that all businesses in the UAE are subject to tax, while individuals living in the UAE are not. For the vast majority, a decision on its position in this regard will be relatively simple. However, complexities can arise for:

  • Individuals and unincorporated partnerships doing business;
  • Foreign entities doing business in the UAE;
  • UAE entities doing business in foreign countries;
  • Companies subject to certain taxes already existing in the UAE; and
  • Charities, government agencies, etc.

Given the tax incentives promised in UAE Free Zones, companies connected to a Free Zone will also require a detailed assessment of their CT obligations and exemptions. Additionally, where business relationships involve multiple related entities and individuals – a common practice in the UAE, even for small businesses – the tax pooling and transfer pricing rules and their implications will require careful assessment.

Complexities can also arise when determining the amount of profits subject to tax. IFRS are widely used in the UAE for the preparation of financial statements. While this brings a certain level of uniformity across the country, we must remember that accounting standards quite often require judgments, some of which have a significant impact on reported earnings.

Options to IFRS

In addition, official announcements suggest that accounting standards other than IFRS may be acceptable. Although accounting profit is the basis for calculating taxable profit, tax rules will exempt the inclusion of certain income and prohibit the deduction of certain expenses, which will inevitably lead to judgments on items that are at or around the limit. .

All transactions between those who are taxed and those who are not will be particularly subject to specific rules and control in terms of tax evasion. All of this means that a clever game between the different accounting and tax rules can allow for some flexibility as to the amount of taxable profit recognized and tax paid in a year, provided that this game is acceptable to the FISC administration.

However, such a “range of acceptability” will be a key judgment that companies may need to make in a number of areas. While we await more information from the Ministry of Finance and the FTA, identifying and resolving these marginal areas of complexity should be a key objective as companies prepare for the introduction of CT.

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