- The impact of UAE corporate tax will be felt in the majority of local businesses.
- Tax preparedness requires a well-considered implementation plan which should be proactively designed by companies based on already published information and best practice principles to identify categories of tax incidences that go beyond tax. basic requirement for filing a tax return.
- In particular, the corporate structures of Free Zone and Mainland entities should be immediately reviewed, so that appropriate planning can be conducted and tax optimization and/or mitigation strategies implemented.
Pending the publication of details of the new UAE tax legislation, some action can be taken immediately, based on the information provided to date by the Ministry of Finance and the Federal Revenue Authority. The guidance provided and assumptions regarding the broad application of corporation tax, in accordance with generally accepted principles, will help prepare businesses for the effective date of the new rules.
A fit-for-purpose legal structure is mandatory for any business, however, the suitability of any legal structure may change over time also taking into account changes in applicable laws and regulations. Accordingly, we strongly recommend the review of the legal structure before the enactment of the corporate tax law.
We already know that the UAE intends to honor free zone company tax exemptions and exemptions and therefore now is the time for a legal and strategic review of business operations.
If you have any doubts or questions about any of the following issues, immediate action can be taken to prepare and optimize or mitigate certain risks that may arise.
Are you currently operating in a free zone? Do you know how the rules and regulations of your particular free zone work? Are your operations limited to international/offshore or free zone transactions based in the UAE? Do you or do you plan to do business with the United Arab Emirates? Do you operate a tax “group” or do you have related party relationships? Do you meet your other regulatory requirements? Will you be able to maintain your tax exemption in the free zone? If not, could you divest yourself of some of your mainland business to gain tax exemption from the free zone?
Free zone/continental structuring
The UAE Corporate Tax Public Consultation Paper provided guidance on Free Zone entities and income. For example, it is clear that a “free zone person” includes companies and branches that are registered in a free zone.
Eligibility for continued access to the 0% corporate tax rate will require free zone revenues to be intact. That is, income must only be received from foreign jurisdictions or from the same or other free zones within the UAE.
There are some exceptions to this requirement.
Free zone persons will also maintain a 0% corporate tax rate if mainland income is limited to passive income (interest, dividends, royalties and capital gains from ownership of the mainland UAE entity).
In addition, transactions between Free Zone Persons and their respective UAE-based group entities will benefit from the 0% corporate tax rate. However, to maintain tax neutrality and fairness, payments made by mainland UAE entities to the Free Zone Person will not be tax deductible.
Similarly, a free zone person with a mainland UAE branch will only be taxed on income originating from the mainland while continuing to maintain a 0% corporate tax rate on its free zone/offshore income.
Businesses must maintain legal and regulatory compliance in order to be eligible for free zone corporate tax exemptions. For example, companies must only conduct activities authorized by the business license and maintain the filing of correct disclosures of economic substance.
Essentially, this means that with the proper business structure, it should be possible for a free zone company to maintain tax-exempt status. However, depending on the complexity of business operations, this may require planning and we recommend this begins immediately.
Once the income year relevant for corporation tax begins (i.e. the first accounting year beginning on or after June 1, 2023), it may be too late to restructure as the income of the free zone could already be tainted. Additionally, an individual or free zone group that operates a mainland UAE entity will need to review not only the legal structure of the business, but also the legal agreements that support transactions between those entities.
If a free zone person (company or part of a group structure) currently receives or expects to receive income from the mainland, an immediate review to determine the suitability of the business structure is advised. Incorporating a mainland branch or entity, especially in light of the recent easing of onshore ownership, could prove to be sound tax planning for the future. Similarly, mainland entities with significant free zone or offshore revenue streams may consider outsourcing part of the business to a free zone entity.
Transfer Pricing, Financial Statements and Good Governance
Another important announcement is that transfer pricing (TP) requirements will be aligned with Organization for Economic Co-operation and Development (OECD) guidelines. This, in conjunction with the requirement that audited financial statements be maintained by free zone entities intending to benefit from the 0% corporate tax rate incentives, means that planning around the TP must also be quickly addressed.
Transfer Pricing Guidelines and the OECD Model Tax Convention require “associated persons”, often referred to as related parties, to deal with each other at arm’s length. Although the requirements for forming a tax group under local rules (base case of 95% common group ownership) may have some bearing on the impact of TP, the measurement of a related party is generally interpreted in much broader terms.
In addition, many of the transactions that transfer pricing rules aim to manage may already be embedded in the business. The burden on taxpayers to prove that arm’s length measures are followed can involve extensive documentation that invariably begins with the contractual terms of the arrangement. If intragroup goods and services transactions are not already supported by contractual agreements, these gaps should be filled to help manage tax risk. This includes internal intra-group support services such as IT, human resources, finance, legal and strategic management. Anything provided between group companies that would be a source of revenue if provided to a third party or that the other entity would have to source itself if not provided by the related party must be supported by a written agreement. These agreements aim to document the legal source and terms of the transaction, similar to how a tax invoice certifies the purchase of goods or services. However, unlike an invoice in the case of third parties, the issuance of an invoice for intragroup transactions is often not sufficient evidence for the purposes of tax authority checks, as TP questions the appropriateness of the value. of the transaction. Unless groups are able to address these considerations with appropriate documentation, tax authorities may adjust tax liabilities accordingly.
Another requirement of the new tax rules will be audited financial statements. This is particularly applicable to people in the free zone who wish to benefit from relevant tax relief, and will therefore be the best practice for UAE companies in the future. Audited financial statements prepared in accordance with international financial standards, together with documented support for intra-group transactions and appropriately calculated and prepared tax adjustments, will assist management in making operational and risk-based decisions regarding matters internal taxes. This, in turn, will be the best preparation for possible future tax audits, as well as well-documented corporate governance policies covering tax-related issues.
Conclusion and recommendations
UAE lawmakers will seek to balance the anticipated simplicity needed to minimize the compliance burden with sufficient complexity to provide taxpayer certainty.
New laws always give rise to a period of adaptation and a need for interpretation. However, this adjustment period can also be used as an opportunity to review the legal, financial, governance and risk aspects of businesses, as these can affect management decision-making and financial results. All areas of structuring, contracts, business and employment agreements may need to be reviewed and updated in light of new tax law. In addition, transaction flows and financial matters, governance and policy should be revisited to ensure tax readiness.
The corporate tax announcement has given UAE businesses time to prepare for the changes. If tax planning has not yet begun, we recommend that you act quickly.