Background

The United Arab Emirates’ (“UAE”) Ministry of Finance (“MoF”) issued the Federal Decree-Law No. 47 of 2022 (“CT Law”) on the taxation of Corporations and businesses.

As per Article 23 of CT Law, income from "Participating Interest" is exempt from Corporate Tax subject to the relevant conditions. Participating interest means a 5% or more ownership interest in the shares or capital of a juridical person.

Recently, the MOF has issued Ministerial Decisions (“the Decision”) No. 116 of 2023, which deals with Participation Exemption under UAE CT Law. This is a very detailed decision and includes clarifications on the various conditions of a participating interest.

Key highlights

• 1.

• Ownership interest includes various forms such as ordinary equity shares, preference shares, redeemable shares, and membership and partner interests.

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  • Must be classified as equity interest under the applicable accounting standard.
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  • Holding ownership interest implies when controlled by the taxable person and with right to economic benefits under the accounting standards. This may suggest giving consideration to the beneficial ownership.
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  • % of ownership will be with reference to total paid-up capital or total equity interest contribution.

• 2.

• For evaluating the 5% threshold, all types of above ownership interests will be aggregated including interests held by the members of the qualifying group.

• 3.

• Where the original ownership interest has been exchanged and for it to be treated as a continuous ownership interest, relevant conditions need to be met such as that exchange is as per the business restructuring relief provisions of Article 27 of CT law and that ownership interest constitutes a participating interest.

• 4.

• If a debt instrument is categorized as equity interest in accordance with the relevant accounting standard, any income generated from it would be treated as income from participating interest. This also stresses the importance of equity interest classification as per accounting standard.

• 5.

• The entity in which the ownership interest is held must be subjected to a minimum tax rate of 9% in its relevant jurisdiction. There has been further clarification provided on meeting the “subject to tax” criteria such as:

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  • In certain cases, tax will not be considered as similar nature to Corporate tax if its only applied to selected activities or tax paid is refunded at time of profits distribution or tax due only in the event of profits distribution.
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  • Subject to tax test would be considered as satisfied if 9% effective tax rate (ETR) is applied or 9% ETR is arrived if recalculated based on UAE CT law provisions.

• 6.

• Article 23(3) of UAE CT law allows exception to the 9% tax rate condition mentioned above if:.

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  • the participation is a Holding company and is directed and managed in foreign country, comply with the documentation requirements in that country, have adequate substance and does not conduct any other activity other than ancillary to holding the shares; and
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  • Income of the participation derived during relevant tax period substantially consists of income from participating interests.

• 7.

• Minimum acquisition cost - If the acquisition cost of the ownership interest is equal to or exceeds AED 4 million, meeting the 5% threshold is not necessary for the investment to qualify as participating interest.

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  • Applicable exchange rate at the date of acquisition to be considered.
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  • Where this minimum acquisition cost threshold is not met for a period of 12 months, any income previously not taken into account as per participation exemption shall be included in the taxable income in the tax period in which the threshold is not met.

• 8.

• As per one of the conditions of participation exemption, Article 23(2)(d) of the CT law mentions that not more than 50% of the assets (direct or indirect) of the participation should consist of ownership interests or entitlements that would not qualify for participation exemption if these assets are directly held by taxable person. The decision clarifies that this should be determined on the basis of carrying value of assets in the consolidated balance sheet of the participation; or market value of direct and indirect ownership interests and other assets.

• 9.

• Non-deductible expenditure – expenditure related to acquisition and disposal of participating interest e.g. due diligence costs, litigation costs, valuation, stamp duty costs etc. shall not be deductible as it relates to exempt income. These expenses will be capitalized as part of participating interest acquisition cost. However, interest expenditure incurred in relation to acquisition and subsequent holding of participating interest will be deductible as per specific and general interest deduction rules of CT law.

• 10.

• Participation exemption will only apply if a taxable person receives it in capacity as owner of ownership interest in participation and not in any other capacity.

• 11.

• Article 23(8) of CT law provides that participation exemption does not apply to a loss realized on the liquidation of a participation. The decision provides clarity on the calculation of liquidation loss and also mentions certain adjustments to be done to the same.

• 12.

• Foreign permanent establishment (“PE”) tax losses – Where a tax loss incurred in a foreign PE is utilized by a taxable person, that tax loss must be fully offset by taxable income from PE in future periods before

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  • Taxable person can elect to apply foreign PE exemption as per Article 24 of CT law ; or
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  • Any income arising upon or following incorporation of the Foreign PE can benefit from participation exemption provisions of CT law.

This decision is one of the key decisions on an important provision of Participation exemption of UAE CT law. It stresses and clarifies significant points on:

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• Importance of equity interest under applicable accounting standard.

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• Aggregation of ownership interests

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• Satisfying the criteria of the minimum 9% tax rate in foreign jurisdiction and definition of “subject to tax” conditions

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• Holding company exclusion

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• Minimum acquisition cost threshold etc.