Understanding which expenses qualify as tax-deductible is essential for businesses under the new UAE corporate tax regime. These expenses, which can be subtracted from a company’s gross income to calculate taxable income, help reduce overall tax liability. The UAE corporate tax law specifies criteria for deductible expenses, emphasizing that they must be incurred to generate taxable income.
As businesses adapt to this new tax framework, they need to identify what qualifies as a deductible expense to ensure compliance and optimize their tax positions. The UAE corporate tax system provides detailed guidelines for correctly identifying and classifying these expenses.
What Is a Tax-Deductible Expense?
In the UAE corporate tax context, a tax-deductible expense is typically a non-capital outlay incurred solely for business purposes. These expenses are subtracted from gross income to determine taxable income, thereby lowering the tax bill. Only expenses incurred to generate taxable income qualify for deduction, preventing misuse or excessive claims unrelated to income production.
The Difference Between Deductions, Credits, and Exemptions
Understanding the distinction between tax write-offs, credits, and exemptions is crucial for managing tax obligations effectively:
- Tax Deduct: Lower the total income subject to tax by subtracting eligible business expenses.
- Tax Credits: Directly reduce the tax owed but are not part of the UAE corporate tax system.
- Exemptions: Amounts excluded from taxable income, though UAE law primarily utilizes deductions.
Specific Expenses
The UAE corporate tax law allows for deducting expenses that are clearly identifiable as being incurred exclusively to earn taxable income. For expenses serving multiple purposes, only the portion directly related to income generation can be deducted. A fair and reasonable proportion may be claimed for expenses that cannot be easily segregated.
It’s also important to note that EBITDA calculations are adjusted for certain items, with any negative EBITDA resulting in a zero value for the 30% limit. Debt instruments agreed upon before a specified date and certain regulated financial entities are exempt from interest-capping rules.
Tax-Deductible Expenses Under the New UAE Corporate Tax Law
The law permits the carryforward of disallowed net interest expense (NIE) amounts for deduction over the next ten levy periods. However, deductions are not allowed for interest on loans from related parties in specific situations, such as those involving dividends or profit distribution.
The UAE corporate tax law explicitly disallows certain expenses from subtraction. These include bribes, fines, and penalties not related to contract damages, corporate tax, recoverable VAT, taxes imposed outside the UAE, and dividends or profit distributions. Additionally, only 50% of entertainment expenses related to business contacts are deductible. Donations are deductible only if made to qualifying public benefit entities.
The law also provides for offsetting tax losses against future taxable income, with a set-off limit of 75% of the taxable income for any given tax period. Tax losses can be carried forward indefinitely, but restrictions apply. Losses incurred before the UAE corporate tax regime starts or from exempt activities cannot be carried forward.
Moreover, tax losses can be transferred between group entities under certain conditions, including a common ownership threshold and business continuity requirements. Additional rules prevent the manipulation of tax losses through changes in ownership for entities not listed on a recognized stock exchange.
Levy subtraction for Businesses in the UAE
Interest Expenses
The broad definition of interest includes costs related to raising finance, interest on Islamic financial instruments, and the finance element of lease payments. EBITDA calculations exclude interest related to financial assets or liabilities held before December 9, 2022. Financial institutions such as banks, insurance companies, and certain other financial entities are not subject to interest capping rules. Excess interest expenses can be carried forward for future deduction. Interest on loans from related parties is not deductible when related to certain transactions.
Charitable Contributions
Only contributions to qualifying public benefit entities are deductible, ensuring that donations serving the public good and related to the business’s purpose are considered for tax relief.
Entertainment Expenses
Companies can deduct up to 50% of entertainment expenses, recognizing the role of hospitality in business while preventing excessive claims.
Fines and Penalties
Fines and penalties not related to contract damages, as well as bribes or illicit payments, are non-deductible. Corporate tax, recoverable VAT, taxes imposed outside the UAE, dividends, profit distributions, and other specified expenses are also non-deductible.
Net Operating Losses
Group entities with at least 75% common ownership can transfer tax losses, provided they meet certain conditions such as having the same financial year and accounting standards. To prevent manipulation of tax losses through ownership changes, the law requires at least 50% continuous ownership from the time the loss was incurred to the time it is offset. The business must continue to operate in a similar manner after any ownership change.
For non-listed entities, the carryforward and use of tax losses require maintaining at least a 50% interest from the tax period in which the loss was incurred to the end of the tax period in which the loss is offset.
Other Non-Deductible Expenses
- Donations to non-qualifying public benefit entities
- Entertainment expenses beyond 50%
- Corporate tax
- Recoverable VAT
- Taxes imposed outside the UAE
- Dividends, profit distributions, and other specified expenses
For expenses serving multiple purposes, only the portion clearly identified as generating taxable income is deductible. If an expense cannot be distinctly attributed to taxable income production, a fair and reasonable proportion, determined on a justifiable basis, may be claimed as a deduction. Foreign exchange gains are treated as interest for these limitations.
Certain exemptions apply to the general interest limitation rule, such as NIE attributed to debt instruments agreed upon before December 9, 2022, and NIE incurred by qualifying infrastructure project persons. Interest capping rules do not apply to banks, insurance businesses, other regulated financial entities, or businesses conducted by natural persons or entities specified by a Cabinet decision.
If NIE is disallowed under interest capping rules, it can be carried forward and deducted in the subsequent ten tax periods. However, no deduction is allowed for interest on loans from related parties if the loan pertains to certain transactions, such as dividends or profit distribution, share capital transactions, or acquisition of ownership interest.
Maximizing Your Tax Reduction
Maintaining precise and comprehensive records is crucial for ensuring all eligible tax allowances are captured. A detailed recording system is necessary to substantiate all eligible expenses.
For expenses with mixed purposes, a justified method must be used to determine the deductible portion for corporate tax (CT) purposes.
Itemized vs. Standard Deductions
Unlike some systems, the UAE doesn’t offer a choice between itemized and standard deductions. Each expense must be assessed for eligibility based on its direct relevance to business operations and its non-capital nature.
Strategic Timing of Deductible Expenses
Strategically timing deductible expenses can affect your tax liability. If your net interest expense is below $3,267,172.80 (AED 12 million), you can deduct the entire amount. Exceeding this threshold allows a deduction of either the threshold amount or 30% of your EBITDA, whichever is higher. A negative EBITDA sets the deductible limit at AED 0. Carrying forward disallowed net interest expense for up to ten tax periods aligns finance-related expenses with future tax liabilities.
Contributions to Retirement Accounts and Tax Implications
Although the CT regime doesn’t specify the treatment of retirement account contributions, understanding their impact on taxable income is crucial. Losses can offset future taxable income, subject to a 75% cap per tax period, with continuity of ownership and business operation conditions after any ownership changes.
Effective Navigation of Deductions
As the UAE corporate tax landscape evolves, understanding deductible expenses and their specific conditions is vital for efficient tax planning. The distinction between deductible and non-deductible expenses can significantly affect corporate tax liability. Maintaining accurate records and understanding the rules are crucial for maximizing tax benefits while ensuring compliance.
Remember, diligent record-keeping and adherence to UAE corporate tax law guidelines are essential for optimizing your financial strategy. Armed with this knowledge, you can confidently navigate the complexities of tax deductible, ensuring compliance and safeguarding your company’s financial health.
