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Friday, May 17, 2024

Is participating interest revenue tax-exempt for Corporations

The taxable individual might possess investments in the share capital of both resident and nonresident legal entities. When this investment constitutes a minimum of five percent or four million dirhams in the legal entity’s capital, it’s termed as participation.

The gains from participation can manifest as dividends, profit distribution, gains/losses on investment disposal, impairment gains or losses, and foreign exchange gains or losses.

Under UAE corporate tax law, income from participation can either be tax-exempt or taxable. Dividends and profit distribution from resident legal entities are tax-exempt as per Article 22(1) of the law.

The tax status of other related income originating from legal entities (both resident and nonresident) is contingent on specific criteria outlined in Article 23(2) of the law.

Income from participation is exempt from corporate tax if the following conditions are fulfilled. If not, corporate tax applies to the relevant income:

  1. Article 23(2)(a) necessitates a minimum 5% ownership interest or an uninterrupted investment of four million dirhams in the capital or equity of the legal entity for twelve months. This can include ordinary shares, preference shares, redeemable debentures, or any other instrument entitling profit and liquidation proceeds. Different ownership interests by the taxable person in the same entity or by members of a qualifying group are consolidated for threshold calculation.
  2. Article 23(2)(b) stipulates that foreign legal entities require a minimum of nine percent corporate tax in their jurisdiction. This entity should also be a tax resident throughout the tax period. The effective tax rate should meet the nine percent criterion. Taxation should apply to income, equity, net worth, or a combination, with a minimum effective rate of nine percent.
  3. Article 23(2)(c) demands a right to receive at least five percent of available profits for distribution, or five percent or more of liquidation proceeds in case of company dissolution.
  4. Article 23(2)(d) limits participation assets to a maximum of 50% ownership or entitlements.

Certain scenarios restrict exemption: deductions claimed for distribution, recognition of impairment losses before meeting exemption criteria, or deductible impairment losses on a loan receivable.

If the taxable person’s ownership interest drops below the threshold, previously untaxed income will be considered taxable in the relevant tax period.

Expenditure related to acquiring, selling, transferring, or disposing of participating interest isn’t deductible, as untaxed income is involved. Interest expenditure is deductible subject to interest limitations rules.

Assessing the investment’s status is crucial for adopting the right tax position and taxing related income accordingly.

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