May 12, 2022

INTRODUCTION OF CORPORATE TAX IN THE UAE

To Our Clients and Friends:

On January 31, 2022 the Ministry of Finance of the United Arab Emirates (UAE) announced the
introduction of a federal Corporate Tax (“CT”) on business profits, effective from the financial year
beginning June 1, 2023. Pursuant to the aforementioned announcement, the Ministry of Finance
published a consultation document to collect and appraise the responses of stakeholders (“Consultation
Document”) with regards to the most prominent features of the legislation and its implementation, ahead
of the release of the draft CT legislation. The formal responses to the Consultation Document should be
submitted using this form by May 19, 2022. The Consultation Document can be viewed here.

In this client alert, we provide a summary of the key policy drivers, the key features of the proposed
regime, and high level commentary contextualising the potential effects of the legislative reforms on our
clients.

Background

The UAE currently does not have a federal CT regime. CT is determined at an Emirate level through
tax decrees. Currently, at an Emirate level, the UAE only levies corporate tax on oil and gas companies
and branches of foreign banks. Furthermore, the UAE benefits from the presence of more than 40 free
zones, which have their own rules and regulations. Such zones generally afford companies incorporated
therein significant tax benefits, making the UAE an attractive jurisdiction from a tax
perspective. Additionally, the UAE does not levy income tax on employment-based income.

Key Policy Drivers

The UAE, as a member of the OECD inclusive framework, is introducing the federal CT regime as a
stepping stone to the execution of its commitment to the global minimum effective tax rate concept
proposed by Pillar II of the OECD Base Erosion and Profit Shifting project (“OECD BEPS”).[1] The
responsible body of oversight has been designated as the Federal Tax Authority (“FTA”). In introducing
CT, the UAE aims to further its objectives of accelerating its development and transformation by
introducing “a competitive CT regime that adheres to international standards, together with the UAE’s
extensive network of double tax treaties, [which] will cement the UAE’s position as a leading jurisdiction
for business and investment”.[2] The introduction of CT is also perceived as an important step in
diversifying the UAE Government’s budget revenue away from revenues that today are mainly generated
from the hydrocarbon industry. The Consultation Document offers assurances that the CT regime will
build on international best practices as opposed to introducing new concepts, in order to ensure the
seamless integration and cooperation of the regime with existing international frameworks.
The Consultation Document indicates that the UAE Government has been guided by a set of key
principles in its legislative undertaking. Such principles include: (1) flexibility and alignment with
modern business practices, ensuring adaptability to changing socio-economic circumstances;
(2) certainty and simplicity of the tax rules to support businesses’ accurate decision-making and cost-
effective operation; (3) neutrality and equity, ensuring fair taxation treatment to different types of
businesses; and (4) transparency.

The Consultation Document heavily emphasises the UAE’s ongoing commitment to execute BEPS 2.0,
noting that “further announcements on how the Pillar Two rules will be embedded into the UAE CT
regime will be made in due course.”[3] No further practical guidance is otherwise offered in the
Consultation Document. In this regard, international entities which may be subject to Pillar II are
advised to keep a close eye on developments in the law that are likely to apply to them, to the extent they
are taxable entities subject to the UAE CT regime.

Key Features of the Corporate Tax Regime

Taxable Persons

Subject to certain exemptions discussed below, CT will be levied on UAE-incorporated companies such
as LLCs, PSCs, PJSCs, and any other legal entities with a distinct legal personality, including, for
example, LLPs and partnerships limited by shares.

In line with tax measures in other jurisdictions, CT will be levied on foreign legal entities: (1) with a
permanent establishment (“PE”) in the UAE, and that earn UAE sourced income, or (2) that are tax
resident by way of management and control in the UAE.

Unincorporated partnerships and other unincorporated ventures will be deemed ‘transparent’ for UAE
CT purposes. Income of such entities may be taxed in the hands of their partners or members. Helpfully,
in order to tackle the discrepancies in the classification of partnerships (transparent vs opaque) in
different jurisdictions, the UAE CT treatment of foreign unincorporated partnerships will defer to the
tax treatment of the partnership in the relevant foreign jurisdiction.

Companies and branches registered in free zones will also fall within the scope of the CT regime, and
will be subject to tax return filing requirements. In order to honour existing tax arrangements within
free zones, such entities will be subject to a 0% CT rate provided that they maintain adequate substance
and comply with all regulatory requirements. A free zone person with a branch in mainland UAE will
be taxed at a regular CT rate on mainland source income while continuing to benefit from the 0% CT
rate on its “other income”. Where a free zone person transacts with mainland UAE but does not have a
mainland branch, the free zone person can continue to benefit from the 0% CT rate if its income from
mainland UAE is limited to ‘passive’ income (meaning interest and royalties, and dividends and capital
gains from owning shares in mainland UAE companies). The 0% CT rate will also apply to any
transactions between free zone entities and their group companies in mainland UAE. However,
payments made to free zone entities by a mainland group company will not be tax
deductible. Furthermore, the Consultation Document notes that, to prevent free zone businesses from
gaining an unfair competitive advantage compared to businesses established in mainland UAE, any other

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mainland sourced income will disqualify a free zone person from the 0% CT regime in respect of all
their income. Once the draft law is released, we expect that free zone registered entities will need to
evaluate their existing position and whether they will continue to benefit from the tax exemptions, or
whether their position will change in light of the CT law.

Income tax will not be payable by natural persons, provided that they do not engage in business or
commercial activity in the UAE. Taxable natural persons operating through sole establishments or
proprietorships or as individual partners in an unincorporated partnership, conducting business in the
UAE, will be subject to the CT regime. The Consultation Document indicates that it remains to be the
case that employment based income obtained in the UAE will not be subject to income tax.

Applicable Rates

CT will be charged on the annual taxable income of a business as follows:

• 0%, for taxable income not exceeding AED 375,000;

• 9%, for taxable income exceeding AED 375,000; and

• a different tax rate (not yet specified) for large multinationals that meet specific criteria set with
reference to Pillar II of the OECD BEPS.[4] In light of the Consultation Document’s emphasis
on the UAE’s commitment to implementing the BEPS 2.0 measures, we expect that the rate will
be fixed with reference to the rate finally determined by the OECD.

Exempt Entities

The following list of entities will be exempt from CT, either automatically or by way of application (the
method is still undetermined):

1. the federal UAE Government and Emirate Governments and their departments, authorities and
other public institutions;

2. wholly Government-owned UAE companies that carry out a sovereign or mandated activity, and
that are listed in a cabinet decision;

3. businesses engaged in the extraction and exploitation of UAE natural resources that are subject
to Emirate-level taxation (e.g. upstream oil and gas companies);

4. charities and other public benefit organisations that are listed in a Cabinet Decision issued at the
request of the Ministry of Finance, upon application of the relevant entity;

5. public and regulated private social security and retirement pension funds; and

6. investment funds, as they are typically organised as ‘flow-through’ limited partnerships.

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Residency

As previously indicated, tax residency is a pivotal factor in determining whether business profits will be
subject to CT in the UAE. In furtherance of its objective of achieving certainty, the UAE relies on
international principles in determining tax residency.

The Consultation Document notes that a legal person that is incorporated in the UAE will automatically
be considered a ‘resident’ person for UAE CT purposes. Equally, any natural person who is engaged in
a business or commercial activity in the UAE, either in their own name or through an unincorporated
partnership, will also be considered a resident person for purposes of the UAE CT regime. A foreign
company may be treated as a resident person if it is effectively “managed and controlled” in the
UAE. This will be a question of fact, but the Consultation Document indicates this would “typically
look at where the directors or other decision makers of the company make the key management and
commercial decisions”.[6]

UAE resident legal persons will be taxed in the UAE on their worldwide income. Natural persons will
only be taxed on income earned from their business activities carried out in the UAE. However, certain
income earned from overseas will be exempt from CT, including income from foreign branches and
qualifying foreign shareholdings. Where income earned from abroad is not exempt, income taxes paid
in the foreign jurisdiction can be credited against the CT payable in the UAE on the relevant income to
prevent double taxation.

Non-Residents

Non-residents will be subject to UAE CT on taxable income (1) from a PE in the UAE, and (2) which is
sourced in the UAE. The Consultation Document indicates that the law is to refer to the definition of
PE outlined in Article 5 of the OECD Model Tax Convention, and the intention is for foreign companies
and advisors to be entitled to rely on OECD Commentary when assessing whether they have a PE in the
UAE. Thus, the existence of a PE in the UAE will be determined by reference to whether either there is
a “fixed place of business” of, or a “dependent agent” habitually exercising the authority to conclude
contracts on behalf of, the non-resident person in the UAE.

Significantly, the Consultation Document notes that the UAE CT regime will allow regulated UAE
investment managers to provide discretionary investment management services to foreign customers
without triggering a UAE PE for the foreign investor or the foreign investment fund – this investment
management exemption will “be subject to conditions that are comparable to similar regimes in leading
financial centres”.[7]

Calculating Taxable Income

The UAE CT regime proposes to use the accounting net profit (or loss) position in the financial
statements of a business as the starting point for determining taxable income. IFRS standards are
typically used by businesses in the UAE and will form the basis for such assessment, but the CT law will
allow for alternative financial reporting standards.

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Exemptions & Deductions

The CT law will include a participation exemption from CT on dividends received, and capital gains
earned from the sale of shares of a subsidiary company. The UAE CT regime will exempt all domestic
dividends earned from UAE companies, including dividends paid by a free zone registered entity
benefitting from the 0% CT regime. The main condition to benefit from the participation exemption is
that the UAE shareholder company must own at least 5% of the shares of the subsidiary company. This
participation requirement remains competitive in comparison with other jurisdictions. For example, the
participation exemption in the UK (the “substantial shareholding exemption”) requires (amongst other
things) the shareholder to own at least 10% of the ordinary shares in the subsidiary for a consecutive
period of at least 12 months.

In order to remain an attractive tax jurisdiction for international businesses, the UAE will allow for
foreign branches of UAE companies (subject to certain conditions) to either (i) claim a foreign tax credit
for taxes paid in the foreign branch country, or (ii) elect to claim an irrevocable exemption for their
foreign branch profits.

Interest and other financing costs will be deductible for CT purposes. However, the deductibility of
interest will be capped at 30% of a business’ earnings before interest, tax, depreciation, and amortisation
(EBITDA), in line with Action 4 of the OECD BEPS project, in order to disincentivise businesses from
using excessive levels of debt financing (as opposed to equity financing) in pursuance of a tax
benefit. Interest capping rules will not apply to banks, insurance business and other financial services
entities.

Losses

In line with international best practices, a business will be able to offset a loss incurred in one period
against the taxable income of future periods, up to a maximum of 75% of the taxable income in each of
those future periods.

Tax losses will be able to be carried forward indefinitely provided the same shareholders hold at least
50% of the share capital from the start of the period when a loss is incurred to the end of the period in
which a loss is offset against the taxable income.

Groups

A UAE resident group of companies will be able to elect to form a tax group, capable of being treated
as a single taxable person (or a fiscal unity) if the parent company holds at least 95% of the share capital
and voting rights of its subsidiaries. To form a tax group, neither the parent company nor any of the
subsidiaries can be an exempt person or a free zone entity benefitting from the 0% CT rate, and all group
members must use the same financial year. For other groups of companies which do not meet the 95%
threshold, the CT regime will allow the transfer of losses between group companies, provided that they
are at least 75% commonly owned.

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Whilst no clear indications are given as to the features of the proposed law in respect of business
reorganisations, the Consultation Document asserts that such reorganisations are to be undertaken on a
tax neutral basis.[8] Intra-group transfer relief will be available for transfers of assets and liabilities
between UAE resident companies that are at least 75% commonly owned, provided the assets and/or
liabilities being transferred remain within the same group for a minimum of three years.

To further facilitate corporate restructuring transactions, the UAE CT regime will exempt or allow for a
deferral of taxation where a whole business, or independent parts of a business, are transferred in
exchange for shares or other ownership interests.

Such features are positive and welcome additions to the CT rules, particularly if other aspects of the CT
regime prompt corporate restructurings (please see below with regards to transfer pricing). Furthermore,
group relief is often sought to assist the financing of further mergers and acquisitions, potentially leading
to increased activity in the UAE.

Transfer Pricing

Transfer pricing rules are expected to apply to transactions between related and connected persons, in
accordance with the principles of the OECD Transfer Pricing Rules. Therefore, transactions between
related or connected parties must be conducted on an arm’s-length basis.

Large business groups, particularly family-owned conglomerates with cross-border operations may need
to rethink their group structures and assess their intra-group transactions from a transfer pricing
perspective, to ensure that their transactions are indeed conducted on an arm’s-length basis.

Tax Credits

As noted above, UAE resident companies will be subject to UAE CT on their worldwide income, which
includes foreign sourced income that may have been subject to tax of a similar nature to CT in another
country. To avoid double taxation, the UAE CT regime will allow a credit for a foreign tax paid in a
foreign jurisdiction against the UAE CT liability on the foreign-sourced income that has not been
otherwise exempted.

Administrative Aspects

A business subject to CT will need to register with the FTA and obtain a tax registration number within
a period of time to be prescribed in the law. The FTA can also automatically register a business for CT
purposes if the person does not voluntarily do so. Businesses can also deregister if they cease to be
subject to CT. To reduce administrative efforts and costs, businesses will only need to prepare and file
one tax return (and other related supporting schedules) with the FTA for each tax period. A CT return
must be filed, and any CT payment made, within nine months of the end of the relevant tax period.

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Conclusion

The introduction of CT in the UAE logically follows from the UAE’s role as a member of the OECD
inclusive framework, particularly in light of discussions on the global minimum tax proposed by
Pillar II. The proposed tax rate of 9% still remains highly competitive in comparison to other
jurisdictions. In addition, it can be seen from the Consultation Document that the proposed CT regime
is based on well-recognised and practiced international principles, making the cost and process of
implementing the law relatively efficient for businesses subject to similar regimes in other
jurisdictions. The law will seemingly also maintain some of the most distinct tax benefits of the UAE,
for example, the tax benefits afforded to free zone registered entities. Inevitably, once the regime takes
effect, different businesses might want to reconsider their corporate structures in order to avail
themselves of the available tax benefits.

We would be happy to help clients consider and review their current corporate structures to assess the
impact of the proposed UAE CT rules, and also discuss any opportunities resulting therefrom.

___________________________

[1] For further information regarding Pillar I and Pillar II of the OECD Base Erosion and Profit Shifting
project, please refer to our UK Tax Quarterly Update – February 2022 (pp. 12-16) here.

[2] Consultation Document, ¶ 2.2.

[3] Consultation Document, Section 9.3.

[4] https://u.ae/en/information-and-services/finance-and-investment/taxation/corporate-tax.

[5] Consultation Document, Sections 3.3 and 3.7.

[6] Consultation Document, ¶ 4.4.

[7] Consultation Document, ¶ 4.21.

[8] Consultation Document, Section 6.3

The following Gibson Dunn lawyers prepared this client alert: Jeffrey Trinklein, Sandy Bhogal,
Benjamin Fryer, Hanna Chalhoub, Siham Freihat*, and William Inchbald.

Gibson Dunn’s lawyers are available to assist in addressing any questions that you may have
regarding the issues discussed in this update. For further information, please contact the Gibson
Dunn lawyer with whom you usually work, any member of the firm’s Tax or Corporate practice
groups, or the following authors:

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 Jeffrey M. Trinklein – London/New York (+44 (0) 20 7071 4224 /+1 212-351-2344),
[email protected])

Sandy Bhogal – London (+44 (0) 20 7071 4266, [email protected])

Benjamin Fryer – London (+44 (0) 20 7071 4232, [email protected])

Hanna Chalhoub – Dubai (+971 (0) 4 318 4634, [email protected])

William Inchbald – London (+44 (0) 20 7071 4264, [email protected])

* Siham Freihat is a trainee solicitor in Gibson Dunn's London office.

© 2022 Gibson, Dunn & Crutcher LLP

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