On 16 October 2023, the UAE Federal Tax Authority (“FTA”) released a Corporate Tax (“CT”) Guide on “Exempt Income: Dividends and Participation Exemption”.
This CT guide aims to provide in depth guidance on the exemption granted under UAE Corporate Tax for dividends and other profit distributions. The purpose of this exemption is to prevent dividends and other profit distributions from potentially being subject to double taxation.
This Guide aims to covers the following important topics:–
- Definitions of dividends and profit distributions.
- Eligible income and expenditure under the participation exemption.
- Eligibility criteria for persons seeking exemption under this guide
- Functioning of the participation exemption.
- Related implications for tax groups.
Unincorporated partnerships are not specifically addressed in the Guide
As regards dividends, the Guide explains that dividends received from a juridical person who is a resident person are always exempt with no additional condition. While, foreign dividends are exempt if the conditions of the participation exemption are satisfied.
As regards the participation exemption, the Guide focuses on the definition of participating interest, exempt income and losses, as well as expenditure related to exempt income. The treatment of Income from a participating interest within and outside a tax group is also analysed.
Below are some of the key highlights of the Guide-
- A Dividend is not defined in the Corporate Tax Law. However, Ministerial Decision No. 116 of 2023 provides a definition of “Dividend”. Further, as per the Guide, the scope of dividend has been expanded to include the following under the preview of dividend :
- Ordinary Dividend
- Dividend in Kind
- Other distribution
- Non-arm length payment to shareholders
- Issuance of bonus shares are in effect payment out of company profit to its shareholders, would cover under the definition of dividend.
- Payment or benefit made in connection with the following would be considered a Dividend to the extent it constitutes, in substance, a distribution of profit to the extent of accumulated profits (or retained earnings) balance:
- The acquisition by a company of its own shares (buy-back of shares);
- The redemption of shares;
- The cancellation of shares (capital reduction); or
- The termination of other ownership interests or rights.
- In case of natural person (resident or non-resident) deriving dividend from Foreign juridical person (Non-resident person), then said foreign dividend will be subject to Corporate Tax if it is attributed to a Business or Business activity and does not represent Personal Investment Income. Exemption can be availed subject to Participation exemption conditions.
- A Participating Interest is a significant, long-term ownership interest in a juridical person (the “Participation”) that suggests some degree of control or influence over the Participation.
- Minimum Ownership Test – A Participating Interest represents a 5% or greater ownership interest in a Participation. Following aspect should be taken into account while determining Minimum Ownership Test :
- A holding can qualify as an ownership interest only if it is treated as an equity interest under the Accounting Standards in the Financials.
- A debt instrument (including those convertible into equity) is treated as an ownership interest if it is classified as an equity interest under the Accounting Standards applied by the Taxable Person. Accordingly, income from convertible debentures or bonds cannot be considered a dividend, until and unless the instruments are actually converted into shares.
- The holding of an option would not be considered as holding an ownership interest.
- The person receiving the income must be the economic owner of the ownership interest. If a person holds the ownership interest in the capacity of an agent, nominee, fiduciary or administrator, they will not be entitled to the Participation Exemption with respect to income from the Participation.
- Minimum Acquisition Cost Test –
- Acquisition cost of different types of ownership interests held by a Taxable Person in the same juridical person are aggregated.
- Alternatively, the minimum acquisition cost test is met if the aggregate acquisition cost of ownership interests together exceeds the threshold of AED 4 million.
- Holding Period Test –
- Income received before the minimum holding period is completed can also benefit from the Participation Exemption, as long as the Taxable Person has the intention to hold the Participating Interest for at least 12 months, indicating that it is not merely a short-term investment
- Where a Taxable Person benefits from the Participation Exemption on the basis of an intention to meet the 12-month holding period, but subsequently does not achieve that condition, then income previously not taken into account in determining Taxable Income must be included in the calculation of Taxable Income in the Tax Period where the condition is breached.
- However, there are two exceptions when the intention is not sufficient, and in such cases the Participation Exemption only applies after the relevant holding period requirement of 12 months has actually been met-
- In case of Capital Gains or Losses
- Participation Exemption does not apply for a period of two years where the Participation is acquired under specific circumstances
- Subject to Tax Test – The entity in which ownership interest is held should be subject to a minimum tax rate of 9% in its home country. There are conditions provided to satisfy subject to tax conditions and in some cases, there is a provision to compute “Effective tax rate” and even payments like Zakat could qualify provided effective tax rates is reaching to 9% level.
- The Participation Exemption applies the same treatment to both gains and losses. Thus, no deduction for Corporate Tax is allowed for capital losses, foreign exchange losses or impairment losses where the conditions for a Participating Interest are met.
- Expenditure incurred in relation to Exempt Income (eg litigation cost, professional fees, commission brokerage etc.), which includes where the Participation Exemption applies, is not deductible for Corporate Tax purposes, except for Interest expense. Instead, it should be capitalised for Corporate Tax purposes, even if such expenses are not capitalised in the Financial Statements.
- In case of common expenses towards earning Exempt Income and Taxable Income. the share of expenses relating to Exempt Income, as apportioned on a fair and reasonable basis, will be non-deductible.
- The Participation Exemption applies without the need for the Taxable Person to make an election or file an application with the FTA.
- Any Taxable Person, Resident or Non-Resident Persons, can benefit from the Participation Exemption in respect of relevant income if the conditions are satisfied.
- The Participation Exemption in respect of Dividends and other profit distributions does not apply if the Participation can claim a deduction for Dividends or other profit distributions
- Where a Participating Interest is wholly or partially transferred to a Related Party by way of a non-arm’s length transaction, the Taxable Income of the transferor needs to be adjusted to take into account market value as Sale consideration and accordingly Participation Exemption would equally apply to the adjusted income.
- Gains in respect of the liquidation of a Participating Interest are exempt from Corporate Tax. As an exception to the general rule, losses realised on the liquidation of a Participating Interest are not exempt, but rather they are deductible from Taxable Income.
- Where a member of a Tax Group receives income from the disposal of a Participating Interest that is a member of the same Tax Group, the application of the Participation Exemption is not required since those transactions will generally be eliminated when the Parent Company prepares its consolidated Financial Statements for Corporate Tax purposes. Where a member of a Tax Group disposes of a Participating Interest in an entity that is not a member of the Tax Group, the Participation Exemption may be available.
- Any income or gain resulting from the reversal of impairments in respect of a Participating Interest would also fall under the Participation Exemption and, therefore, be treated as exempt from Corporate Tax. However, if an impairment loss recognised in relation to a Participating Interest was deductible from Taxable Income (i.e. prior to the ownership interest becoming a qualifying Participating Interest, as otherwise it would not have been deductible), Article 23(6)(b) of the Corporate Tax Law provides that any subsequent income that would otherwise be exempt under the Participating Exemption will not be considered as exempt, up to the amount of the impairment loss that was treated as deductible for Corporate Tax.