UAE Domestic Minimum Top-up Tax

The UAE has implemented Pillar Two rules, which aim to establish a global minimum tax rate of 15% for multinational enterprises (MNEs).

Introduction:

This post provides a detailed overview of the UAE's Corporate Tax Law (Federal Decree-Law No. 47 of 2022), its implementation guide, and the Pillar Two rules adopted by the UAE, drawing from the provided sources. This briefing will cover key definitions, taxable entities, income sourcing, permanent establishment rules, deductible expenses, and the nuances of the Pillar Two global minimum tax.

I. Core Definitions & Concepts

• Taxable Person: The core concept is centered around who is subject to the Corporate Tax. A “Taxable Person” is any person (natural or juridical) subject to the Corporate Tax Law. This is broadly applied.

• Business & Business Activity: A "Business" is defined broadly as "any activity conducted regularly, on an ongoing and independent basis by any Person and in any location." A "Business Activity" is wider, encompassing "any transaction or activity, or series of transactions or series of activities conducted by a Person in the course of its Business." Essentially, any activity with the intention of generating revenue can be considered a business. The law applies to both commercial and non-commercial activity.

• The guide clarifies this further: "For the application of the Corporate Tax Law to companies and other juridical persons, all activities conducted and assets used or held will generally be considered activities conducted, and assets used or held, for the purposes of a Business or Business Activity."

• Government Entities & Controlled Entities: "Government Entity" includes the Federal Government and each of the Local Governments, along with their ministries, departments, authorities, and agencies. "Government Controlled Entity" requires being listed in a Cabinet Decision.

• Crucially, any licensed business activity of a government entity is treated as a separate, independent business subject to corporate tax, with separate financial statements required.

• "Where a Government Entity conducts a licensed Business or Business Activity, such activity will be treated as a separate and independent Business for Corporate Tax purposes. The Government Entity must maintain financial statements for this Business, separate from its other activities."

• Natural Resources: This is defined as "Water, oil, gas, coal, naturally formed minerals, and other non-renewable, non-living natural resources that may be extracted from the State’s Territory."

• "Extractive Business" refers to exploring and exploiting natural resources, while "Non-Extractive Natural Resource Business" encompasses related activities like processing, storing, and transporting these resources.

• Each Emirate is responsible for regulating the exploration and production of its resources, through licenses and concessions, although some aspects are federally regulated.

• Income from "Non-Extractive Natural Resource Business" might be subject to the applicable tax law of the Emirate.

• State’s Territory: The State's Territory is defined as "the State’s lands, territorial sea and airspace above it".

• Resident Person: Includes juridical persons incorporated in the UAE, foreign juridical persons effectively managed and controlled in the UAE, and natural persons conducting business in the UAE.

• Non-Resident Person: A person not considered a Resident Person, but who has a "Permanent Establishment" in the UAE, or derives "State Sourced Income," or has some other nexus in the UAE as per a Cabinet decision.

• Permanent Establishment: A Non-Resident Person has a Permanent Establishment in the UAE if:

• It has a fixed place of business in the UAE.

• A person has and habitually exercises the authority to conclude contracts on their behalf.

• Has some other form of nexus defined by a Cabinet Decision.

• A branch office is explicitly defined as a permanent establishment.

• An exception is made for activities that are exclusively preparatory or auxiliary.

• State Sourced Income: This is income derived from a Resident Person, or a Non-Resident Person attributable to their Permanent Establishment in the UAE, or income from activities, assets, or services within the UAE. Examples of State Sourced Income are the sale of goods in the UAE, and income from real estate in the UAE, services provided within the UAE, and interest from a UAE borrower.

• "Income from services would generally be considered State Sourced Income where the service is rendered in the UAE or where the ultimate recipient or beneficiary of the service is located in the UAE."

• Related Party & Connected Person: These are defined by degrees of kinship, control, and ownership. Transactions with them are subject to scrutiny and must be at "Market Value".

• Control means "the ability of a Person, whether in their own right or by agreement or otherwise to influence another Person." This could mean 50% or more of voting rights.

• "Related Party" is defined through the degree of kinship, ownership and partnership.

• "Connected Person" is defined through ownership and management roles.

• Free Zone: A designated geographic area specified by a cabinet decision

  
  

II. Taxable Entities & Scope

• Juridical Persons: All juridical persons (companies) incorporated in the UAE, along with foreign entities effectively managed in the UAE, are generally subject to Corporate Tax.

• Natural Persons: Natural persons conducting a "Business or Business Activity" in the UAE are also subject to Corporate Tax on income from the UAE or non-UAE sources insofar as it is derived from that business.

• "If a natural person carries on a wholly separate Business in a foreign jurisdiction, which is not related or connected to the Business conducted in the UAE, the income from such other Business will not be taxable in the UAE."

• Exempt Persons: Certain entities are exempt, including government entities, social security funds, regulated investment funds and charities. They are typically exempt only in relation to their core purpose.

• Wholly owned subsidiaries of exempt persons might also be exempt under certain conditions, especially if their operations are primarily ancillary to the exempt parent.

• Unincorporated Partnerships: Unless they apply to be treated as taxable in their own right, partnerships are not separate taxable entities and each partner will be taxed in their individual capacity.

• Branches: A branch of a foreign entity in the UAE is treated as the same Taxable Person as the foreign entity.

  
  

III. Income & Sourcing Rules

• State Sourced Income: A non-resident is subject to UAE CT on State Sourced Income, as defined earlier.

• "In broad terms, State Sourced Income is income derived from a Resident Person or from activities or contracts performed in the UAE, assets located in the UAE, or rights used or services performed in the UAE."

• Income from Goods: Generally sourced where the sale and transfer of title take place.

• Income from Services: Sourced where the service is rendered or the beneficiary is located.

• Property Income: Sourced where the property is located.

• Capital Gains: Sourced in the UAE where the juridical person whose capital is being disposed of is a Resident Person.

• Interest: May be sourced where the borrower is a Resident Person, a Government Entity, or the loan is secured by UAE located collateral.

• Insurance Premiums: Sourced where the insured person is a Resident Person, or the insured asset is located in the UAE, or the insured activity is performed in the UAE.

  
  

IV. Deductible Expenses

• General Principle: Expenses must be incurred “wholly and exclusively for the purposes of the Taxable Person’s Business” and cannot be capital in nature to be deductible.

• Expenditure "incurred for purposes other than for the Taxable Person’s Business, such as for a private purpose (e.g. personal consumption)" is not deductible.

• Non-Deductible Expenses: Include expenses not related to business, those related to exempt income, and other categories as determined by Cabinet Decision.

• Apportionment of Expenses: If expenditure is incurred for multiple purposes, the deductible portion must be apportioned on a “fair and reasonable basis.”

• Interest Expense: Interest expenditure is generally deductible, with restrictions for loans from related parties in specific cases (such as funding dividends). There is also a net interest expense limitation (30% of EBITDA), with certain entities exempt.

• The law limits deductibility for certain interest payments to related parties, "No deduction shall be allowed for Interest expenditure incurred on a loan obtained, directly or indirectly, from a Related Party in respect of any of the following transactions: a) A dividend or profit distribution to a Related Party; b) A redemption, repurchase, reduction or return of share capital to a Related Party".

• Transfer Pricing: Transactions with Related Parties and Connected Persons must be at arm's length "Market Value."

  
  

V. Pillar Two Implementation

• Global Minimum Tax: The UAE has implemented Pillar Two rules, which aim to establish a global minimum tax rate of 15% for multinational enterprises (MNEs).

Scope: Pillar Two applies to MNE Groups with annual revenue of EUR 750 million or more in at least two of the preceding four years. The revenue threshold is to be considered "in the ultimate parent's financial statements".

• Constituent Entities: The rules apply to each constituent entity of an MNE. These include those consolidated within the financial statements of an MNE as well as certain entities including joint ventures and partnerships.

• Income Calculation: Pillar Two income is based on the financial accounting net income or loss, adjusted for items including taxes, dividends, and certain gains. The Financial Accounting Net Income is prepared in accordance with IFRS if the Constituent Entities are in the UAE.

• "The Pillar Two Income or loss of each Constituent Entity is the Financial Accounting Net Income or Loss determined for the Constituent Entity for the Fiscal Year adjusted for the items described in Article 3.2 to Article 3.5."

• Safe Harbors: The rules may be simplified for jurisdictions using “safe harbors”, which will include a simplified revenue calculation, a simplified income calculation, and a simplified tax calculation. Safe harbours apply when the Average Pillar Two Revenue in the UAE is less than EUR 10 million, Average Pillar Two Income in the UAE is less than EUR 1 million, and the Effective Tax Rate is above 15%.

• Top-Up Tax: If the effective tax rate of a constituent entity is below 15%, a top-up tax may be payable to the UAE.

• "Top up Tax= Top up Tar x Pillar Two Income o/ the Constituent Entity/Aggregate Pillar Two Income o/ all Constituent Entities."

• Adjustments: The Pillar Two calculation has its own rules, such as for qualified shipping income, and a specific approach for asset values and calculations.

• Location of Entities: An entity is located in the jurisdiction where it is created or managed and the Permanent Establishment is located in the jurisdiction in which it is situated.

• Joint Ventures: Joint ventures are considered to be a separate MNE group for the purposes of calculating Pillar Two Tax.

  
  

VI. Key Considerations

• Licensing Authorities: Licensing Authorities play a crucial role in determining which entities conduct a Business Activity.

• Cabinet Decisions: Many aspects of the law are subject to further clarification via Cabinet Decisions, highlighting the need for ongoing monitoring.

• Transitional Reliefs: Some transitional rules apply in the initial years.

• Clarifications: A person may seek clarifications from the Authority.

  
  

VII. Conclusion:

The UAE's Corporate Tax regime is comprehensive and aims to align with international standards, including Pillar Two. The broad definitions of "Business" and "Business Activity," coupled with the distinction between Resident and Non-Resident Persons, create a complex landscape. Companies and individuals conducting business in the UAE must carefully consider the application of these rules to their specific circumstances. Particular attention should be paid to related party transactions, the sourcing of income, the application of the deductibility rules, and the implications of the Pillar Two Global Minimum Tax. It is critical to note, that some issues remain open until further clarification by Cabinet decisions.