Exempt Income in UAE Corporate Tax

The UAE Corporate Tax regime includes several exemptions to prevent double taxation and align with international tax practices. These exemptions are designed to ensure fairness and simplicity while maintaining compliance with global standards.

Purpose of Exemption

1. Preventing Double Taxation
   Exemptions are designed to exclude income and capital gains from taxable income if they originate from another juridical person or a foreign branch that has already been subject to tax.
   
2. Aligning with Global Standards
   The UAE’s exemptions reflect international practices, especially concerning income derived from activities like international transportation.

Symmetry in Tax Treatment

Exemptions come with symmetrical rules to ensure consistency:

• Non-Deductibility of Related Expenses – Any expenses incurred to generate exempt income cannot be deducted for Corporate Tax purposes.
• Apportioning Mixed Expenses – If expenses relate to both taxable and exempt income, only the portion directly tied to taxable income can be deducted.

Fair and Reasonable Apportionment

If it’s not clear how to split expenses between taxable and exempt income, an appropriate proportion must be determined based on a ‘fair and reasonable’ approach, which:

• Considers the specific circumstances and relevant facts.
• Can use different methods, as long as the chosen method accurately reflects the activity and is straightforward to justify.
• Should not impose unnecessary complexity or burden on the taxpayer or the Federal Tax Authority (FTA) in terms of review or explanation.

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Key Categories of Exempt Income

1. Domestic Dividends

Dividends and other profit distributions received from a UAE Resident Person are exempt from Corporate Tax.

This exemption is straightforward and does not require the recipient to meet additional conditions.

The rationale is simple, profits distributed as dividends have already been taxed at the corporate level. Therefore, taxing them again would result in double taxation. This exemption also extends to distributions made by a Resident Free Zone entity (whether qualifying or not) to another UAE Resident Person.

Under the UAE Corporate Tax regime, dividends and other profit distributions received from a UAE Resident Person are exempt from Corporate Tax. This exemption is straightforward and does not require the recipient to meet additional conditions.

The rationale is simple: profits distributed as dividends have already been taxed at the corporate level. Therefore, taxing them again would result in double taxation. This exemption also extends to distributions made by a Resident Free Zone entity (whether qualifying or not) to another UAE Resident Person.

2. Income Exempt Under the Participation Exemption

The UAE Corporate Tax regime provides a participation exemption to ensure that income and gains derived from significant ownership interests in other entities, known as “Participating Interests,” are not taxed again at the recipient level.

This exemption applies to both dividends and other income derived from Participating Interests, subject to specific conditions.

2.1 Distributions Received from Foreign Juridical Persons

Dividends and other profit distributions received from foreign juridical persons are exempt from Corporate Tax if the recipient holds a Participating Interest in the foreign entity. A Participating Interest reflects a significant, long-term ownership interest that allows the owner to exert some level of control or influence over the entity’s activities.

To qualify for the exemption, all the following conditions must be met:

1. The Taxable Person must hold at least 5% ownership interest in the shares or capital of the foreign entity, and this interest must be held or intended to be held for at least 12 months.
2. The Taxable Person must be entitled to at least 5% of distributable profits and 5% of liquidation proceeds of the entity.
3. No more than 50% of the entity’s assets can consist of ownership interests that would not qualify for an exemption if directly held by the Taxable Person.
4. The entity must be subject to a Corporate Tax, or a similar tax, in its home jurisdiction at a rate of at least 9%.

The “subject to tax” condition is considered met if the foreign jurisdiction has a headline statutory tax rate of at least 9%, or the entity can demonstrate it is effectively taxed at a rate of 9% or more on profits, income, or equity.

The exemption applies to various forms of ownership, including ordinary shares, preferred shares, redeemable shares, membership interests, partner interests, and other financial instruments that entitle the holder to profits or liquidation proceeds. Additionally, an ownership interest with a historical acquisition cost of AED 4,000,000 or more can qualify for the exemption.

However, the participation exemption does not apply if the foreign jurisdiction allows the entity to claim a deduction for dividends or distributions paid to the Taxable Person.

2.2 Distributions Received from Foreign Juridical Persons

The participation exemption also applies to other types of income and gains derived from Participating Interests. This includes holdings in both Resident and Non-Resident entities. The requirements for a Participating Interest remain the same, with the additional provision that Participating Interests in Qualifying Free Zone Persons or Exempt Persons are also considered to meet the “subject to tax” condition.

Income exempt from Corporate Tax includes:

• Gains or losses from the transfer, sale, or disposal of the Participating Interest, whether partial or full.
• Foreign exchange gains or losses related to the Participating Interest.
• Impairment gains or losses related to the Participating Interest.

However, expenses incurred in relation to acquiring, transferring, selling, or disposing of the Participating Interest are not deductible for Corporate Tax purposes. This includes professional fees, due diligence costs, litigation expenses, commissions, brokerage fees, and other related costs.

It’s important to note that only income received in the capacity of a shareholder (e.g., dividends or liquidation proceeds) qualifies for the exemption. Income earned through other relationships, such as debtor-creditor (e.g., interest income) or buyer-seller (e.g., service fees), remains subject to Corporate Tax.

3. Income Exempt Under the Participation Exemption

To address or reduce potential double taxation on international income, the UAE Corporate Tax regime allows a Resident Person to elect to exempt income derived from their Foreign Permanent Establishments (PEs) from Corporate Tax in the UAE. This election ensures that income from foreign operations is not taxed twice—once in the foreign country and again in the UAE.

When a Resident Person elects to apply this exemption, the following items from their Foreign Permanent Establishments are excluded from their taxable income in the UAE:

1. Income and associated expenditure generated by the Foreign PE.
2. Losses incurred by the Foreign PE.

However, it is important to note that if the election is made, any Foreign Tax Credit that would have been available for offsetting UAE Corporate Tax will no longer apply.

To qualify for the Foreign Permanent Establishment exemption:

1. The income, expenditure, and losses of the Foreign PE must be treated as if they are derived from a separate and independent business.
2. Any transactions between the Resident Person and the Foreign PE must be conducted at Market Value and comply with arm’s length principles.
3. The exemption only applies to Foreign PEs that are subject to a Corporate Tax, or a tax of a similar nature, in their home country at a rate of at least 9% (the “subject to tax requirement”).

The election to apply the exemption is comprehensive. This means that it must cover all Foreign Permanent Establishments meeting the subject to tax requirement. A Resident Person cannot selectively apply the exemption to specific PEs—it’s either all qualifying PEs or none.

4. Income from operating aircraft or ships in international transportation

Recognizing the UAE’s role as a global logistics and transportation hub, the Corporate Tax regime exempts income earned by Non-Resident Persons from operating aircraft or ships in international transportation, provided specific conditions are met. This exemption reflects the UAE’s alignment with international norms for taxing cross-border transportation activities.

To qualify, the Non-Resident Person must be engaged in one or more of the following activities:

1. International Transport: Carrying passengers, livestock, mail, parcels, merchandise, or goods by air or sea.
2. Leasing or Chartering: Providing aircraft or ships for international transportation purposes.
3. Leasing Essential Equipment: Renting equipment integral to the seaworthiness of ships or airworthiness of aircraft used in international transportation.
4. The exemption applies only if the Non-Resident Person’s home country offers a similar tax exemption to UAE Resident Persons engaged in operating aircraft or ships in international transportation. This principle, known as reciprocity, ensures a balanced and fair treatment between nations in the taxation of international transportation activities.

These exemptions ensure the UAE Corporate Tax system aligns with international practices, avoids double taxation, and supports economic competitiveness.

Source: Corporate Tax Guide | CTGGCT1 | September 2023