Impact Of The UAE Corporate Tax Law On M&A And Restructuring – Tax Authorities

On 9 December 2022, the UAE released the Corporate Tax (CT) law
through Federal Decree No.47 of 2022 (CT law). Our alert issued in
January, 2023 provided an overview into the key areas of the CT law
relevant for businesses. This alert seeks to discuss in detail the
impact of UAE CT law on M&A transactions and restructuring.

Historically, M&A transactions involving UAE Targets did not
require a significant amount of due diligence or acquisition
structuring due to the absence of federal corporate tax. Following
the introduction of VAT in 2018 and Economic Substance Regulations
in 2019, limited scope due diligences started to be undertaken.
However, with the advent of VAT audits and its related
controversies coupled with the introduction of the UAE CT law, it
is critical to discuss tax planning for M&A involving UAE
Targets (including those with downstream non-UAE investments).

This alert aims to discuss the following key aspects of the UAE
CT law, that are likely to impact deals going forward along with
the steps that companies should undertake through the different
life cycles of a transaction.

Summary of Issues Covered in This Alert

A. Tax Due Diligence

For acquirers looking at investing in UAE Targets, there is
expected to be limited historical risks as the UAE CT law is likely
to apply (for most businesses) from 1 January 2024, with first tax
return filing not due until nine months from the end of the year
(i.e. 30 September 2025 in case of a calendar year end). However,
it is crucial that the acquirer should consider a proforma
review of the UAE Target entities from a UAE CT law
standpoint – under the hypothesis that if UAE CT law were to apply,
what could be the potential impact or exposures. Certain areas that
can be analysed within this review can include the following:

• Free Zone entities eligible for the potential 0% tax rate and
  satisfaction of mandatory conditions, i.e. qualifying income,
  substance, transfer pricing compliances;




• Inter-company transactions and transfer pricing
  considerations;




• Tax grouping and loss transfer shareholding thresholds;




• Tax attributes such as tax losses and interest limitation;




• Foreign tax exposures such as permanent establishment, entities
  deemed to be UAE residents based on control and management,
  withholding taxes and their creditability on payments received from
  non-UAE entities;




• Impact of accounting on future taxes including unrealized gains
  / losses, provision for expenses and their write back, revaluation,
  etc.

Understandably, recourse for exposures identified in a tax due
diligence may generally include an indemnity or a valuation
adjustment depending on the level of risk and amount. Given the
nascency of UAE CT law and absence of material historical returns
to review as a part of a deal (since the first tax return may only
be filed on 30 September 2025 for companies following a calendar
year), there might not be a material recourse with respect to
indemnity or valuation adjustments in the immediate future.

However, a proforma review as discussed above may enable
acquirers to identify exposures that may arise immediately post
acquisition and potentially discuss any restructuring /
documentation that the sellers / Target may need to put into place
prior to the deal. Such areas can form a part of the mandatory
conditions to close a deal and can be included as a part of the
transaction documentation to provide additional protection to the
acquirer.

B. Structuring considerations

An acquirer / acquirer group can consider various options to
acquire a potential Target, i.e. direct share acquisition from the
seller (secondary transfer) in exchange for cash or shares,
infusing equity/ debt into the Target (primary infusion) or
business transfer. Each of these modes should have considerations
under the UAE CT law. Unlike a due diligence exercise that is aimed
at identifying historical exposures, acquisition structuring could
have an immediate impact on areas such as modes of acquisition,
inclusion of leverage (debt) to undertake the acquisition,
acquiring entity jurisdiction and the post-acquisition structure.
Some areas that may merit consideration as a part of acquisition
structuring include:

Participation Exemption:

• Primary Tests: Under Article 23 of the UAE CT
  law, Participation Exemption is provided for dividends and capital
  gains earned by a UAE resident from participating interests. Whilst
  dividends received from UAE companies are automatically exempt, for
  capital gains on sale of shares (UAE and non-UAE) and dividends
  received from foreign entities, the Participation first needs to
  meet the three primary tests, i.e. 5% minimum shareholding, minimum
  holding period of 12 months and the Participation should be subject
  to corporate tax in its home jurisdiction at a rate not less than
  9%.







• Relaxation for holding companies from meeting a primary
  test: Further, Article 23(3) of the UAE CT law mentions
  that a Participation will be deemed to have met the minimum 9%
  corporate tax test if a) its principle objective and activity is
  the acquisition and holding of shares / equitable interests (that
  in turn meet the above-mentioned conditions) and b) the
  Participation’s income substantially consists of income from
  its participating interests. Further, this relaxation is also
  extended under Article 23(4) of the UAE CT law to Participations
  that qualify as a Qualifying Free Zone Person or an Exempt Person
  which ordinarily may not be subject to tax at 9% under UAE CT law
  (subject to conditions). Therefore, this condition seeks to extend
  the Participation Exemption in case of Intermediate Hold Co.
  structures in countries such as BVI, Cayman, etc and at the same
  time for Intermediate Hold Cos. located in a UAE Free Zone (subject
  to conditions).







• Additional conditions in case of muti-tiered
  investments: For structures involving multiple layers of
  investments (i.e. indirect subsidiaries), the UAE CT law also
  provides an additional condition under Article 23(2) (d) in order
  to qualify for Participation Exemption – i.e. not more than
  50% of the direct and indirect assets of the Participation
  should consist of ownership interests that would
  not have qualified for an exemption from CT if they were
  held directly by the Taxable Person. Hence, in cases where the
  value of ownership interests in stepdown subsidiaries held by a
  Participation fails to meet the three primary tests and such value
  exceeds 50% of its total assets, the Participation Exemption should
  not be available.

To test this additional condition, the below steps may be
followed:

• At the outset, the Participation (direct holding) in question
  should satisfy the primary 3 tests mentioned above i.e. 5% minimum
  shareholding, minimum holding period of 12 months and the
  Participation being subject to a CT rate of at least 9% in its home
  jurisdiction;




• Once the above tests are satisfied, the total value of assets
  (including the investment made by the Participation in each direct
  / indirect subsidiary) of the Participation should be determined -
  it is currently unclear whether book value or fair value will need
  to be taken;




• Next, each direct / indirect subsidiary should be tested
  against the aforementioned 3 primary tests, assuming that they were
  held directly by the Taxable Person (and not by the Participation);
  and




• The value of all the direct / indirect subsidiaries
  failing the conditions (in step one) should be
  added up – e.g. an indirect subsidiary in Bahrain (where no CT
  applies), ownership of less than 5% by the Participation in a
  subsidiary

If the value of the investment determined in step four does not
exceed 50% of the value of the total assets of the Participation
(in all direct / indirect subsidiaries), then the additional
condition in Article 23(2)(d) of the UAE CT law is satisfied and
the Taxable Person (i.e. the recipient of dividend / capital gains)
would be eligible to claim the Participation Exemption for
dividends and gains received from the Participation. It is to be
noted that this evaluation is only relevant for analysing the
dividend / capital gains flowing directly from the Participation to
the Taxable Person; the condition has no bearing on dividends /
capital gains flowing from the indirect subsidiaries to the
Participation. Further, this condition holds relevance for
multi-tiered structures primarily because one may have to evaluate
the lowest level of indirect assets / subsidiaries held by the
Participation (Investee company) along with their values.

Treatment of hybrid instruments: As per Article
23(6)(a) of the UAE CT law, it is prescribed that the Participation
Exemption will not be available where the Participation claims a
tax deduction for the distributions / dividends in its home country
tax return, even if all the conditions mentioned above are met
(e.g. in case of hybrid instruments). Therefore, this results in an
additional area to be looked at in the M&A context, in addition
to the prescribed conditions.

Evaluation of the fulfilment of Participation Exemption
conditions to a proposed acquisition is not only important from a
Target’s standpoint but also post integration of the Target
into the acquirer’s structure. The acquirer should evaluate the
fulfilment of conditions and the potential tax leakages, if any, on
dividend/ profit distributions through the structure. This review
will also potentially provide an insight on exit taxes on future
sale or any interim sale of a portion of the business/ certain
geographies.

Debt push-down: Article 30 of the UAE CT law,
in line with OECD’s BEPS Action Plan 4, has introduced interest
limitation rules wherein interest expenses are limited to the
higher of 30% of the Taxable Person’s EBITDA as per books or a
specific amount (yet to be prescribed). Any excess interest (above
the allowance) is disallowed in such tax period but can be carried
over for 10 years to be utilized as a deduction from future
year’s taxable income (subject to conditions).

The relevance of the interest limitation rules for M&A is
bi-fold. Firstly, as discussed above, its impact on taxable income
for the UAE Target entity / group in terms of tax deductible
expenses should be evaluated. Secondly, a critical area for
consideration is expected to be in cases where leveraged
acquisitions are carried out. Article 31 of the UAE CT law
additionally clarifies that interest obtained from related parties
(as defined under transfer pricing provisions) will be disallowed
if i) the loan is used for one of the prohibited end-uses such as
dividend payments, redemption / repurchase of shares of a related
party, capital contribution to a related party or acquisition of an
ownership where such investee company becomes a related party post
the transaction; and ii) the purpose of the loan is not to obtain a
CT advantage, which is deemed not to arise if the lender is taxed
on the interest at least at 9%. Interestingly, the additional
restrictions on related party loans throws up many interesting
issues such as:

• Deductibility of interest used to acquire minority stake;




• Jurisdiction of the lender given the deeming fiction for the
  condition relating to obtaining a tax advantage – such as loans
  from BVI, Cayman or European entities that follow hybrid structures
  for certain types of convertible debt;




• Applicability of the prohibited end-uses to asset acquisitions
  or business transfers.

Given the above, the debt push-down provisions may limit
deduction for borrowing costs, depending on the structure adopted.
Thus, in a jurisdiction like UAE where debt push-downs were not
relevant from a tax standpoint, stakeholders participating in
M&A should review the impact of leveraged buy-outs for
potential tax breaks and future impact on effective tax rates.

C. Restructuring and group transfers

The UAE CT law provides explicit exemptions for certain
qualifying group transfers and business restructuring transactions.
Whilst the latter might be another mode of acquiring a Target
business, the former enables existing groups to restructure in a
tax efficient manner either in a non-M&A context or potentially
in preparation of a sale (either fully or hiving off a separate
vertical).

The Business Restructuring Relief under Article 27 of the UAE CT
law provides an exemption for transfer of business between Taxable
Persons under the UAE CT law if the transfer is undertaken in
exchange for ownership interest for the transferor, i.e., shares in
the transferee entity. In such a case, the assets and liabilities
are deemed to have been transferred at book value and the
transferor / transferee has a lock in period of 2 years to avoid
claw back of the exempted business transfer. Thus, in a case
wherein the shares are sold to a person that is not a member of the
‘Qualifying Group’ to which the Taxable Persons belong, or
the business in question is transferred / disposed of within two
years of the acquisition, the exemption will be revoked and the
business transfer will be deemed to have been carried out at market
value at the date of transfer, and will be taxed accordingly.
Interestingly, the business restructuring relief provisions also
have an inter-linkage to Participation Exemption provisions. These
provisions require that the ownership of the transferor post
transaction (exempted under Article 27 of the UAE CT law) must be
held for at least two years to avail Participation Exemption on
such ownership. A similar requirement also exists for certain
specified shareswap transactions.

Akin to the relief on business transfers, Article 26 of the UAE
CT law also provides an exemption on transfer of assets between
members of a ‘Qualifying Group’, subject to conditions.
Amongst others, the main condition of a Qualifying Group is that
the transferor and transferee should have common ownership of 75%
or more or own 75% or more of either (transferor in transferee or
transferee in transferor). Further, neither the transferor or
transferee can be an Exempt Person (e.g. – Government Entity,
Government Controlled Entity, Qualifying Public Benefit Entity,
Qualifying Investment Fund, etc) or claiming benefits of the 0% tax
rate for Free Zone entities. If the conditions are satisfied, the
assets transferred between such entities are considered to take
place at book value, thus not triggering a gain under UAE CT law.
Conditions relating to claw back period and implications on claw
back are similar to that of business restructuring.

As a separate note, Article 38 of the UAE CT law also contains
provisions to transfer tax losses between members of a Qualifying
Group as long as the tax loss offset related conditions are met.
Some areas of consideration under these provisions include:

• Limitation on the overall tax loss that can be set off (75% of
  the taxable income of the entity);




• Inter-play of tax losses available with a group company prior
  to transfer – can be transferred for set off only after the
  transferee’s tax losses have been set off and subject to the
  75% limitation;




• Requirement to be members of the Qualifying Group from the
  period of the loss being incurred by the transferor to the period
  in which it is offset by the transferee;




• Requirement for the loss-making entity to carry on same or
  similar business following a change in ownership of more than
  50%.

The above amplifies the need to not only meet prescribed
conditions at the time of effecting a business / asset transfer but
also highlights the importance of keeping track of the claw-back
conditions. Considerations that apply may include taxability of
future exits and corresponding impact on books along with
depreciation / amortization thereon. As a part of a proposed
acquisition, whilst transactions carried out prior to the
Target’s first year of UAE CT law applicability is expected to
be grandfathered, the review of such transactions post trigger of
UAE CT law will be very relevant.

D. Others

There are some other areas that also merit consideration as the
UAE CT law comes into play within the next 12 months and M&A
deals being actively pursued in the region.

Deemed residency:

As per Article 11(3)(b) of the UAE CT law, non-UAE entities that
are effectively controlled and managed from the UAE are deemed to
be UAE tax residents for the purposes of UAE CT law. It is expected
that the location for effective management and control may depend
on where the key managerial personnel or board of directors are
located along with the location where where the key decisions are
taken by such individuals/ group of individuals. In the M&A
context, for Targets with non-UAE operations being acquired by a
UAE group/ fund, these provisions may need careful analysis. In
cases where the seller is also a UAE headquartered group and the
effective management and control of its non-UAE entities are from
the UAE, the acquirer should review these provisions appropriately
or have the seller put in place certain procedures through closing
conditions in transaction documents. This is critical as it can
increase the potential in-scope entities for UAE CT resulting in
added compliances and possibly, complex tax filings (to take into
account foreign tax credits, where applicable).

Tax models and effective tax rates:

This is an equally important area for concluded deals, ongoing
transactions and prospective ones. It is possible that acquirers
have factored an internal rate of return (IRR) from a prior M&A
deal based on the non-applicability of UAE CT law. However, this
might need to be revisited for transactions that have not been
exited from, as the potential UAE CT may have an impact on the free
cash flows available for distribution on account of tax payments in
the UAE. Therefore, all M&A transactions require a detailed
review of financial models for tax purposes and verification of the
effective tax rate along with the availability of tax attributes
(such as losses, credits, interest allowances). There may be
structuring avenues available under the UAE CT law to optimize the
effective tax rate and especially bridge any gaps between the
factored/ proposed IRR and any potential reduction due to UAE CT
law.

Documentation and insurance:

Increasingly, a tax review of the share purchase/ asset purchase
agreement will find more importance on analysis of deal
documentation. Areas such as tax indemnities, period of coverage
(given statute of limitations under UAE CT law), de-minimis and tax
indemnity caps may need more detailed consideration than earlier on
deals involving UAE Targets. Also, the insurance coverage on deals
may now need to include tax within their discussion with
representations and warranties insurers; this results in tax due
diligences or proforma reviews being very relevant. It is also
imperative to review deals that are in the transitory phase of
signing and closing where the transaction documentation has been
concluded albeit the deal has not closed (due to completion of
conditions or regulatory reasons) – if aspects discussed in this
alert need additional evaluation pre-closing given the advent of
UAE CT, its impact on the deal documentation should be
reviewed.

VAT Considerations on M&A Transactions

The implications of VAT on involving mergers and acquisitions
depend upon the specifics of each transaction, including the nature
of transfer, the type of assets / liabilities being transferred,
and whether the parties involved are registered under the UAE VAT
law.

For VAT purposes, the transaction is considered to have been
carried out in different modes – through purchase of shares or
through an asset purchase (further split into business transfer or
individual asset transfers).

The UAE VAT law provides that the transfer of business through
purchase of shares should be exempt from VAT. However, the transfer
of business as a going-concern should be considered as outside the
scope of the UAE VAT law only if following conditions are complied
with:

• There must be a transfer of the whole or a part of the
  business;




• The transfer must be made to a Taxable Person; and




• The acquirer intends to continue the business, part or
  otherwise, which is being transferred.

On the other hand, transfer of assets on a piecemeal basis
should attract VAT at the rate of 5%.

It is pertinent to note that transactions involving mergers and
acquisitions could be multifaceted and the sale and purchase
agreements must be carefully examined to arrive at the appropriate
treatment under the UAE VAT law.

Furthermore, companies involved in the transaction would have to
obtain, cancel and/or amend their VAT registrations and conform to
the procedural and compliance requirements within the prescribed
time limit failing which penalties could also be imposed. The most
important challenge here is to ensure business continuity and
issuance of tax invoices, tax credit notes etc. while the entities
being acquired are de-registered by the transferor and registered
by the transferee, either on a standalone basis or added to the
existing VAT groups – as the ‘Tax Registration Number’ of
the transferee needs to be mentioned on the tax invoices post the
effective date. Hence, the cancellation, amendment etc. of VAT
registrations need to be planned in a manner which causes minimum
or no disruption to the ongoing operations.

Key Takeaways

As it may be appreciated, the deal environment surrounding taxes
in the UAE is set to undergo a paradigm shift. The time is now to
start talking about tax early in the deal (possibly, as early as at
the time of preparing initial models for reviewing a Target and
adequately scoping of work for tax DD). Whilst the first tax return
may have over two years to be filed and hence historical reviews
may realistically start only after that period, the key is for
acquirers to be ahead of the curve in terms of identifying key
issues that may have an impact after the deal. Companies looking to
sell their businesses or potentially IPO a specific hived off
vertical will also need to factor in restructuring and asset
transfer related provisions along with other applicable ones. All
in all, the changes will broaden the team involved in M&A and
restructuring transactions, with tax now having a material impact
on the deal (even before the law comes into effect) in the
following ways:

Acquirers

• Proforma tax diligence;




• Review own structure and integration of Target structure
  including the impact of the Target joining the acquirer’s tax
  group, if any;




• Tax impact on the financial model and related IRR
  considerations;




• Taxes on exit and repatriation through the holding
  structure;




• Protection for any risks in transaction documentation.

Sellers

• Evaluate potential taxes ontransfer;




• Hive off considerations pre-sale including group restructuring
  reliefs;




• Health check of the Target’s tax affairs impending a
  deal;




• Ability to provide indemnities – period and amount;




• Existing transfer pricing considerations and compliance
  relating to inter-company transactions, if any

Group Restructuring

• Adherence to conditions for group transfer reliefs;




• Impact of existing intercompany transactions and operating
  model post restructuring;




• Accounting considerations of restructuring and related tax
  impact;




• Optimisation of tax losses and its transfer within the
  group;




• Monitoring claw back conditions and related tax implications on
  Business Restructuring and Qualifying Group transfers.

FTI Consulting’s Middle East Tax and Transaction Team has
significant experience of advising on tax issues pertaining to
M&A taxes including due diligence, structuring, vendor
assistance, tax model reviews and transaction documentation
assistance. The tax team works closely with our M&A team
specializing in financial due diligence, restructuring and
valuations. The FTI Consulting M&A team is suitably placed to
provide support through the entire M&A deal life-cycle.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.