UAE to Launch Corporate Income Tax – Main Impacts for Projects – Corporate Tax

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Imminent tax reform means additional costs and complications for energy and infrastructure projects in the Gulf state

On January 31, 2022, the UAE Ministry of Finance announced that the Federal Corporate Income Tax (IRS) would be introduced in a major change for the Middle Eastern state. The decision came after similar moves by neighboring Gulf states, the United Arab Emirates keen to comply with international tax standards. Although the detailed policies remain unknown, the CITs will impact businesses across a range of industries. In this article, we look at its potential impact on projects in the UAE.

EXISTING PROJECTS

  • Although the impact of the CIT on existing projects is significant, it is anticipated that these project companies would be entitled to claim increased costs under typical law change provisions in the concession/levy agreement. This should be assessed on a case-by-case basis, with careful consideration of the relevant provisions to verify whether relief is available and to ensure that all requirements are met (such as notification and claim thresholds).

  • Parties involved in projects need to consider how to manage accounting requirements so that arrangements can be put in place to capture all relevant income, expenses and deductions under the corporation tax regime.

UPCOMING PROJECTS

  • For future projects, the CIT will have an impact on the internal rate of return (IRR) of the sponsors. The treatment of expenses and allowable deductions under the CIT regime will be an important consideration, particularly given that project companies are generally thinly capitalized and subject to debt service payments.

  • Experience from other jurisdictions suggests that there should be detailed provisions explaining the deductions permitted under the CIT regime, including specific provisions detailing the treatment of interest payments and small capitalization entities.

  • Given the impact on profits, the CIT will have to be taken into account in the financial models. We expect rates submitted in bids to increase accordingly, especially for projects where the RFP or RFP requires a minimum IRR of projected equity.

  • Although the details are not yet known, it appears that dividends and capital gains from certain qualifying holdings may be exempt from CIT. Entities that are part of large multinational corporate groups will also need to consider the availability of tax group structures, as well as interaction with the Organization for Economic Co-operation and Development Pillar Two regime, which outlines the implementation of a minimum tax rate of 15% for multinational companies. The adoption of tax groups can make it possible to offset the losses of one project against the profits of another project and possibly to simplify administration by allowing the filing of group declarations rather than individual declarations for each entity.

LENDERS

  • It is expected that the CIT will not impact the ability of project companies to service their debt under project finance, particularly where the debt service is within a typical cash cascade. However, this will be taken into account once the details of the CIT are announced. For example, to determine how reserved amounts and subordinate operating and maintenance (O&M) costs are handled.

  • The impact of the CIT on foreign banks is likely to be less significant, as UAE branches of foreign banks are already subject to a 20% corporation tax under each emirate’s respective banking decrees. It’s unclear how the bank decrees will interact with the proposed new CIT, but that will likely be answered in the bill, as well as any applicable transitional provisions.

  • UAE banking decrees do not apply to banks in the UAE, so the impact of the CIT on those banks is likely to be greater.

EPC AND O&M CONTRACTORS

  • From the perspective of engineering, procurement and construction (EPC) and O&M contractors, any income they earn for services provided or work performed in projects located in the UAE will be subject to CIT. This will impact the potential profitability of projects for contractors and will need to be factored into revenue streams.

  • Contractors will also need to carefully consider how payments and expenses are calculated, apportioned and paid under the project documents, as this will impact the respective responsibilities of the parties under the CIT regime. For example, whether an allowance applied to a payment for services is treated as a reduction in revenue or as an expense could affect an O&M contractor’s tax exposure.

  • For existing projects, contractors should consider whether provisions for legislative changes in the relevant project contracts will mitigate changes that were not known at the time of contract signing.

  • To the extent that a free zone (where 100% foreign ownership of companies is permitted) operates in the mainland UAE, it will be subject to corporation tax. As such, any entrepreneur incorporated in a free zone but operating onshore through a local branch is unlikely to benefit from the corporate tax incentives offered to free zone companies, with respect to corporation tax.

NEXT STEPS

While the specific details of the proposed corporate tax regime remain unknown, the impact of this new tax will be significant for infrastructure and energy projects in the UAE. We suggest that all parties involved in the projects start considering the implications now so that they can undertake the necessary preparations before its implementation.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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