How will the newly introduced 9% Corporate Tax impact the UAE’s Entrepreneurial Ecosystem?
March 8, 2022
On 31 January 2022, the Ministry of Finance (MoF) announced that the United Arab Emirates (UAE) will introduce a federal Corporate Tax (CT) on business profits that will be effective for financial years starting on or after 1 June 2023.
The UAE Corporate Tax regime has been designed to incorporate best practices globally and minimize the compliance burden on businesses. Corporate Tax will be payable on the profits of UAE businesses as reported in their financial statements prepared in accordance with international accounting standards, with minimal exceptions and adjustments.
- There will be a progressive rate applicable as follows:
- 0% for taxable income up to AED 375,000;
- 9% for taxable income above AED 375,000; and
- A different tax rate might apply for large multinationals that meet specific criteria set with reference to 'Pillar Two' of the Organization for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting project.
This corporate tax will also apply to businesses registered within UAE free zones, and it will extend to individuals on a freelance visa who meet the same threshold of annual taxable income sourced through their commercial freelancing activities.
- Dividends and capital gains of qualifying shareholding will be exempt from tax. A qualifying shareholding refers to an ownership interest in a UAE or foreign company that meets certain conditions.
- Qualifying intra-group transactions and reorganizations will not be subject to CT.
- Information on other UAE CT exemptions and exclusions will be provided.
Other elements of the CT system
- Relief of double taxation: Foreign taxes will be allowed to be credited against the UAE Corporate Tax payable.
- Transfer Pricing (TP): Transfer Pricing and documentation requirements will apply to UAE businesses with reference to the OECD Transfer Pricing guidelines.
- Fiscal unity and loss relief: A UAE group can elect to form a tax group and be treated as a single taxable person provided certain conditions are met. In this case, only one single tax return will need to be filed per group. The FTA has clarified that tax losses may be offset between group companies, provided certain conditions are met.
Administrative and compliance
- The Federal Tax Authority (FTA) will be the responsible institution for the administration, collection and enforcement of the CT. The MoF will remain the “competent authority” for exchange of information and bilateral/multilateral agreements.
- Businesses will need to register and file a CT return.
- The FTA has clarified that the CT return will need to be filed electronically per financial year.
- No advanced or provisional CT filings are required.
- The FTA will provide further information on applicable penalties.
To evaluate the impact of this new tax structure on UAE's competitive entrepreneurship positioning, it is important to understand the key decision making criteria for entrepreneurs and SMEs in selecting a strategic location for their business.
The question thus becomes: what can small businesses and startups expect to reap in benefits as a result of the introduction of corporate tax?
1. The concept of free zones in the UAE will continue to protect current entrepreneurs, while inviting new ones with amore attractive packaging and pricing structure.
The corporate tax announcement underlined that free zone businesses can continue to benefit from corporate tax incentives, as long as they comply with the necessary requirements. Free zones were established to attract innovation to the UAE and house entrepreneurs. Consequently, they have underlying legal foundations that allow their registered businesses to enjoy tax exemptions for the duration of the free zone laws. Companies registered in the Dubai International Financial Centre (DIFC),for example, will remain subject to 0% tax until 2071.
In a positive twist for entrepreneurs and other free zone-registered companies, a new trend that is likely to arise is increased competition amongst free zones, as they try to retain their current customer base and attract new ones. In light of the new financial burden, entrepreneurs will consider switching free zones if they do not get a financially attractive package from the free zone jurisdiction they are currently a part of. Ultimately, this will drive the numerous free zones to revise their packaging and pricing structure to become more competitive. We predict that this might lead to the reduction of annual license fees, or additional inclusions and free add-ons to be introduced to support entrepreneurs.
2. Corporate tax will drive up in-flowing investments, and incentivize small businesses and startups to self-invest.
Companies in the UAE can expect to rate one of three routes in reacting to corporate tax:
- accept that their net profits will decrease by 9% - which nobody prefers
- or, increase prices to achieve the same “after tax” profit
- or, increase their investments(i.e. increase their costs) to lower the tax burden.
Small businesses and startups are thus well-positioned to reap the benefits of an increased economic appetite in investment, as bigger companies attempt to reduce their tax burden. Additionally, corporate tax will push most companies to further invest in their own growth. Our latest study shows that the percentage of net profits invested in research and development (R&D) in the GCC is amongst one of the lowest in the world. Along this line, we can expect an increase in R&D investment in the UAE for both established mid-to-enterprise businesses as well as small businesses and startups, ultimately driving innovation and growth up within the entrepreneurship ecosystem.
3. The UAE government will likely ramp up even further on incentive programs and entrepreneurship ecosystem-building
Entrepreneurship is treated as a priority in the UAE. From governmental project tendering process perks, to quotas on awarding a minimum of 15-20% of contracts to startups, we can expect UAE to amplify the volume of support it provides small business and startups with to ensure the sustainability of the sector. Entrepreneurs will be able to benefit from expanding incubation programs that equip promising startups with strategic partners, advisors, and investors. This is exemplified by the recently announced Area 2071 ecosystem, overseen by Dubai Future Foundation, as well as other government-run or sponsored business incubators and accelerators.
Do we feel that this measure will discourage foreign companies from moving to the UAE? Not at all. The new tax rate will be the second lowest in the Gulf, after Bahrain. Major global economies have much higher corporate taxes, with the United States imposing a 27% rate and the European Union an average of 20.7%.The UAE's competitive advantage remains intact.
Looking at how the UAE has addressed transitioning into new legislation and business practices, it is without doubt that international best practices in entrepreneurship support and nurturing will be introduced to soften the impact of corporate tax on this segment, and we expect to see more details on tax exemption, relief applications, and subsidies as more information will be available ahead of June 2023.
For now, businesses should gain a good understanding of the proposed changes to fully assess the implications. The changes may have implications on, or require changes to, the legal structure, business model, contracting and (transfer) pricing, accounting, profit, systems
and data and organizational structure.
For any advice related to the implementation of corporate tax, please contact us!