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Chapter 11: Exempt Income & Participation Exemption | Articles 22 & 23 | UAE Corporate Tax
Firoz
Overview
This video explains the concept of exempt income under UAE Corporate Tax law, differentiating it from exempt persons. It details Article 22 and Article 23 of the UAE Corporate Tax Law, focusing on exempt income and participation exemption, respectively. The discussion covers conditions for exemption, including shareholding percentages, holding periods, and subject-to-tax requirements, with specific examples illustrating complex scenarios like capital gains and foreign dividends. The video also touches upon ministerial decisions and guides that provide further clarification on these exemptions.
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Chapters
- Taxable income differs from accounting income due to necessary adjustments.
- An exempt person is entirely outside the scope of UAE corporate tax.
- Exempt income applies to taxable persons, where specific income streams are excluded from corporate tax calculation.
- Article 22 of the UAE Corporate Tax Law outlines exempt income, while Article 23 addresses participation exemption.
Distinguishing between exempt persons and exempt income is crucial for accurate corporate tax calculation and compliance, preventing misapplication of tax rules.
A taxable company receives dividends from another UAE company; this dividend is exempt income, reducing the taxable company's overall tax liability, whereas an exempt person would not be subject to tax at all.
- Exempt income categories include local dividends, participation interest exemptions, and income related to non-resident aircraft/ship operations.
- Article 22 covers general exempt income, Article 23 focuses on participation exemption, Article 24 on foreign permanent establishment exemption, and Article 25 on non-resident aircraft/ship income.
- Ministerial Decision 302 of 2024 is the current governing regulation, superseding earlier decisions.
- Guides like CTG EX1 (Exempt Income) and CTG FSI1 (Foreign Source Income) provide further explanations.
Understanding the specific articles and ministerial decisions governing exemptions ensures that businesses correctly identify and claim all eligible income exclusions.
Local dividends received by a UAE company from another UAE company are exempt from corporate tax without any conditions.
- Participation exemption covers dividends from foreign companies, capital gains from UAE shares, and capital gains from foreign shares.
- Unlike local dividends, these exemptions are subject to specific conditions.
- For capital gains on UAE shares, exemption applies if the conditions for participation exemption are met.
- Foreign dividends are also eligible for exemption, provided certain conditions are satisfied.
This section clarifies the conditions under which significant income streams like foreign dividends and capital gains can be shielded from UAE corporate tax.
A UAE company selling shares of its UK subsidiary may be eligible for capital gains exemption under participation exemption rules, provided specific conditions are met.
- Condition 1: Minimum 5% shareholding in the participation, eligibility for 5% profit, and entitlement to 5% liquidation proceeds.
- Alternatively, if the 5% shareholding is not met, the acquisition cost of the shares must be at least AED 4 million.
- Condition 2: The shares must be held for a minimum uninterrupted period of 12 months, or there must be an intention to hold for this period.
- The 12-month holding period can be satisfied by demonstrating an intention to hold, even if the tax return is filed before the full period is completed.
These holding requirements ensure that participation exemptions are not used for short-term tax avoidance schemes but rather for genuine, long-term investments.
A UAE company invested AED 10 million for a 3% stake in another company. Although below the 5% threshold, the investment value exceeding AED 4 million allows it to potentially qualify for participation exemption.
- Condition 3: The Subject to Tax (ST) test requires that the income (dividend or capital gain) originates from a jurisdiction where it has been taxed at a minimum rate of 9%.
- Several exceptions to the ST test exist, particularly for capital gains on UAE shares if the subsidiary is a qualifying free zone person, elects small business relief, is an exempt person, or has taxable income below AED 375,000.
- Condition 4: The Bad Asset test is applied if the foreign investment constitutes more than 50% of the total assets of the intermediary company.
- The Bad Asset test is only required if the foreign investment is considered a 'related party' based on control thresholds.
These tests prevent the artificial routing of income through low-tax jurisdictions to claim exemptions, ensuring the integrity of the tax system.
A UAE company receives a dividend from a Cayman Islands company. Since the Cayman Islands has no corporate tax, the ST test would typically fail, unless the Cayman entity is a pure holding company whose underlying income is already taxed above 9%.
- Participation exemption is an automatic entitlement if conditions are met; it does not require a specific election or application.
- If any condition for exemption is violated in a subsequent year, the previously exempted income becomes taxable in the year of violation.
- Other types of income that can fall under participation exemption include foreign exchange gains/losses and impairment gains/losses related to the participation.
- The exemption applies to qualifying dividends and capital gains, but not necessarily to all forms of income from a participation.
Understanding that exemptions are automatic but can be reversed upon violation emphasizes the importance of ongoing compliance and monitoring.
A UAE company claimed exemption based on the intention to hold shares for 12 months but sold them after 9 months. The exemption claimed in the prior tax return must be reversed and taxed in the year the intention was broken.
Key takeaways
- Exempt income is a reduction applied to accounting income when calculating taxable income for a tax-paying entity, distinct from an exempt person who is outside the tax net.
- Local dividends received by a UAE company from another UAE company are exempt without any conditions.
- Participation exemption for foreign dividends and capital gains requires meeting specific criteria related to shareholding, holding period, subject-to-tax, and bad asset tests.
- The AED 4 million acquisition cost can substitute the 5% shareholding requirement for participation exemption.
- An intention to hold shares for 12 months can satisfy the holding period requirement, but violating this intention later can lead to the reversal of exemptions.
- The Subject to Tax test is crucial for foreign income, ensuring the income has been taxed at a minimum rate in its source country, with specific exceptions for UAE-based transactions.
- The Bad Asset test scrutinizes the balance sheet of the intermediary foreign company to prevent layering of structures solely to avoid taxes.
- Participation exemption is an automatic right upon meeting conditions, not an elective process.
Key terms
Exempt IncomeExempt PersonParticipation ExemptionSubject to Tax TestBad Asset TestHolding PeriodAcquisition CostQualifying Free Zone PersonSmall Business ReliefRelated Party
Test your understanding
- What is the fundamental difference between an exempt person and exempt income under UAE Corporate Tax law?
- Under what conditions can a UAE company claim exemption on dividends received from another UAE company?
- Explain the 'holding period' condition for participation exemption and how an 'intention to hold' can satisfy it.
- How does the 'Subject to Tax' test ensure that foreign income is genuinely taxed before being considered for exemption in the UAE?
- Describe the purpose of the 'Bad Asset' test and in which scenarios it is applicable for participation exemption claims.