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simply put:
- The impact of the UAE corporate tax will affect most of the local business community.
- Tax preparation requires a well-thought-out implementation plan that businesses should proactively develop based on published information and best practice principles to identify tax impact categories that go beyond the basic requirements for filing tax returns.
- In particular, the corporate structures of free zone and mainland entities should be reviewed immediately for proper planning and implementation of tax optimization and/or tax reduction strategies.
Body
While we await the release of the details of the new UAE tax law, certain actions can be taken immediately based on the information provided to date by the Ministry of Finance and the Federal Tax Authority. Based on generally accepted principles, the guidance provided and assumptions about the broad application of corporate tax will help businesses prepare for the start date of the new rules.
A fit-for-purpose legal structure is mandatory for any business, however, the appropriateness of any legal structure may change over time, given the development of applicable laws and regulations. Therefore, we strongly recommend reviewing the legal structure before corporate tax laws are enacted.
We already know that the UAE intends to honour free zone corporate tax holidays and tax holidays, so now is the right time for a legal and strategic review of business operations.
If you have any questions or concerns about any of the issues below, we may take immediate action 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 free zone work? Is your business limited to international/offshore or UAE based free zone transactions? Do you do or plan to do business with the UAE mainland? Do you operate a tax “group” or have transactions with related parties? Do you meet other regulatory requirements? Can you maintain your free zone tax holiday? Alternatively, can you separate out part of your mainland business for free zone exemption?
Free Zone/Continental Structure
The public consultation paper on corporate tax in the UAE provides some guidance on free zone entities and income. For example, it is clear that “Free Zone Personnel” includes companies and branches registered in the Free Zone.
Remaining eligible for the 0% corporate tax rate would require free zone income to be unpolluted. That is, income can only come from a foreign jurisdiction or the same or other free zone 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 owning a UAE mainland entity).
Additionally, transactions between Free Zone personnel and their respective UAE Continental Group entities will be subject to a 0% corporate tax rate. However, in order to maintain tax neutrality and fairness, payments made by UAE mainland entities to free zone persons will not be tax-deductible.
Likewise, free zone persons with a UAE mainland branch will only be taxed on mainland-sourced income, while continuing to maintain a 0% corporate tax rate on their free zone/offshore income.
Businesses must comply with laws and regulations to qualify for free zone business tax exemption. For example, businesses should only carry out activities permitted by the trade license and maintain correct economic substance disclosures.
act now
Essentially, this means that, with a proper corporate structure, it should be possible for free zone businesses to maintain their tax-free status. However, depending on the complexity of business operations, this may require planning and we recommend getting started right away.
Once the corporate tax-related income year begins (ie the first financial year commencing on or after 1 June 2023), it may be too late to restructure as free zone income may already be tainted. In addition, free zone individuals or groups with entities in the UAE mainland need to review not only the legal structure of the company, but also the legal agreements that support transactions between these entities.
If a free zone person (part of a business or group structure) currently receives or expects to receive any income from the mainland, an immediate review is recommended to determine the adequacy of the corporate structure. Forming a mainland branch or entity, especially given the recent relaxation of onshore ownership, may prove to be wise tax planning for the future. Likewise, mainland entities with significant free zone or offshore revenue streams may consider spinning off some of their operations to free zone entities.
Transfer Pricing, Financial Statements and Good Governance
Another important announcement is that transfer pricing (TP) requirements will be aligned with the Organisation for Economic Co-operation and Development (OECD) transfer pricing guidelines. This, combined with the requirement to maintain audited financial statements for Free Zone entities intending to benefit from the 0% corporate tax incentive, means that planning around TP should also be addressed in a timely manner.
The Transfer Pricing Guidelines and the OECD Model Tax Treaty require “related persons” (often referred to as related parties) to deal with each other on an arm’s length basis. While the conditions required to form a tax group under local rules (base case 95% common group ownership) may have some impact on transfer pricing effects, in general the related party measure can be interpreted in a broader perspective .
In addition, many of the transactions the TP rules seek to manage may already be embedded in the business. The onus is on the taxpayer to demonstrate that arm’s length practices are being followed, which can involve extensive documentation, which always begins with the contractual terms of the arrangement. Where intra-group transactions of goods and services are not already supported by contractual agreements, such gaps should be addressed to help manage tax risk. This includes internal 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 anything that other entities would have to procure for themselves if not provided by an affiliate should be backed by a written agreement. These agreements are designed to document the legal origin and terms of a transaction, similar to how a tax invoice proves the purchase of goods or services. However, unlike invoices from third parties, the invoicing of intra-group transactions is often not sufficient evidence for an audit by tax authorities, as the TP questions the appropriateness of the transaction value. Unless the group is able to address these considerations through appropriate documentation, the tax authorities may adjust the tax liability accordingly.
Another requirement of the new tax law is audited financial statements. This is especially true for people in free zones who wish to enjoy the relevant tax relief and will therefore be the best practice for future business in the UAE. Audited financial statements prepared in accordance with International Financial Standards, together with documented support for intra-group transactions and tax adjustments appropriately calculated and prepared, will assist management in making operational and risk-based decisions on internal tax matters. This, in turn, would be the best preparation for potential future tax audits and well-documented corporate governance policies covering tax-related matters.
Conclusions and Recommendations
UAE lawmakers will seek to balance the expected simplicity needed to minimise compliance burdens with sufficient complexity to provide certainty to taxpayers.
New laws always cause adaptation periods and the need for interpretation. However, this adaptation period can also be used as an opportunity to review the legal, financial, governance and risk aspects of the business, as these may influence management decisions and financial outcomes. Under the new tax law, all areas of structuring, contracting, commercial and employment arrangements may need to be reviewed and updated. In addition, transaction processes and financial matters, governance and policies should be revisited to ensure tax readiness.
The announcement on corporate tax gives UAE businesses time to prepare for the changes. If tax planning has not yet begun, we recommend taking action now.
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