Deductible and Non-deductible Expenditure under UAE Corporate Tax Law

In this article we will discuss about Deductible and Non-deductible Expenditure under UAE Corporate Tax Law. A Taxable Person, under the recently announced UAE Corporate Tax Law, has been provided with certain tax deductions from their Taxable Income that are incurred by the Person during the relevant Tax Period.

Distinguishing Deductible and Non-deductible Expenses in Accordance with UAE Corporate Tax Law

Within the confines of this article, we shall delve into the distinctions between deductible and non-deductible expenses as delineated by UAE Corporate Tax Law. The newly unveiled UAE Corporate Tax Law extends specific provisions for tax deductions on a Taxable Person’s incurred expenses during the relevant Tax Period.

Defining Tax Deductions

As per the UAE CT Law, tax deductions encompass expenses that can be subtracted from a Taxable Person’s total Taxable Income during tax liability calculations. These deductions effectively diminish a Taxable Person’s Taxable Income, consequently reducing their tax liability. These deductions are legally sanctioned incentives, meticulously detailed within the law, and are subject to deduction by taxpayers.

Expenditures Solely Allocated for Business Purposes

Under the UAE Corporate Tax Law, deductions are granted for expenditures that are deemed to be incurred “wholly and exclusively” for business purposes by the Taxable Person. In essence, any expenditure that is legitimate in nature and is incurred in the regular course of business operations, aimed at generating Taxable Income, is eligible for deduction in accordance with the UAE Corporate Tax Law. Such expenditures are deductible within the Tax Period in which they are expended.

Exception – Non-Deductible Capital Expenditures

Expenses categorized as “capital nature,” incurred during the course of business, do not qualify as deductible expenditures for the purpose of calculating Taxable Income.

Expenditures with Dual Purposes

There may arise scenarios where expenditures serve dual purposes, catering to both business and personal needs. Under UAE Corporate Tax Law, deductions are permissible for such expenses if they meet the following criteria:

1. Any identifiable portion or component of the expenditure that is entirely and exclusively incurred to generate Taxable Income.
2. An equitable portion of any indistinct or unidentifiable segment of the expenditure, which has been allocated on a fair and rational basis, taking into consideration the pertinent facts and circumstances related to the Taxable Person’s business.

 

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Expenditure Excluded from Deductions in Accordance with UAE Corporate Tax Law

Under the purview of UAE Corporate Tax Law, certain expenditures cannot be claimed as deductions from the Taxable Income accrued by a Taxable Person during a given Taxable Period. These include:

1. Expenditures unrelated to the Taxable Person’s Business.
2. Expenditures incurred in the pursuit of Exempt Income.
3. Losses not stemming from or associated with the Taxable Person’s Business.
4. Any additional expenditures that may be specified through a Cabinet decision subsequent to a Minister’s proposal.

Interest Expenditure Regulation

Interest expenses are frequently exploited as a mechanism for base erosion and profit shifting (BEPS), often resulting in tax avoidance. Entities claim interest deductions by overleveraging through debt financing in intra-group or Related Party transactions, thereby reducing their Taxable Income and evading taxes.

To ensure responsible debt financing and the execution of genuine commercial transactions, the UAE Government, in alignment with the OECD’s BEPS Action Plan 4 – Interest Capping Rules, has introduced limitations on the deduction of interest expenditure, capping it at 30%.

Deductibility of Interest Expenditure:

Interest expenditure shall be eligible for deduction in the Tax Period in which it is incurred.

However, these deductions are subject to the following regulations:

1. General Interest Deduction Limitation Rule
2. Specific Interest Deduction Limitation Rule

General Interest Deduction Limitation Rule

Article 30 of the UAE Corporate Tax Law outlines the Limitation Rules for General Interest Deduction. A Taxable Person can claim General Interest Deduction by deducting up to 30% of their earnings before EBITDA as Net Interest Expenditure. To elucidate further:

What constitutes the Net Interest Expenditure of a Taxable Person?

The Net Interest Expenditure of a Taxable Person for a given Tax Period is the disparity between the Interest expenditure incurred during that period and the Taxable Interest income received during the same period, encompassing any carried-forward Net Interest Expenditure.

It’s important to note that the calculation of Net Interest Expenditure shall exclude any Interest expenditure disallowed by any other provision of the UAE Corporate Tax Law.

Limitations on Deducting Net Interest Expenditure for Taxable Persons

Taxable Persons are subject to limitations when deducting their Net Interest Expenditure, which is capped at 30% of their Accounting Earnings before Interest, Tax Depreciation, and Amortization (EBITDA) for the relevant Tax Period. This deduction is calculated excluding any income classified as Exempt Income according to Article 22 of the UAE Corporate Tax Law.

Threshold for Exemption from the General Interest Deduction Limitation Rule

If a Taxable Person’s Net Interest Expenditure for the Tax Period falls below a specific threshold determined by the Minister, they are exempt from the General Interest Deduction Limitation Rule.

Carry Forward of Disallowed Net Interest Expenditure

Any Net Interest Expenditure that cannot be deducted during a particular period may be carried forward and claimed as deductions in the subsequent ten (10) Tax Periods, following the order in which the expenditure was incurred.

Exemption from Interest Capping Rules

The rules governing the calculation of Net Interest Expenditure and its deduction to reduce Taxable Income do not apply to the following categories of Taxable Persons:

1. Banks.
2. Insurance Providers.
3. Natural persons engaged in Business or Business activities within the State.
4. Any other individuals or entities designated by the Minister.

Applicability to Associated Persons

In cases where a Taxable Person is associated with one or more entities through ownership or control and is required to consolidate its financial statements as per relevant accounting standards, the Minister may issue a decision to specify the applicability of the provisions related to Net Interest Expenditure deduction for such Taxable Person.

Specific Limitations on Interest Deduction for Related Party Transactions

Distinct provisions exist within the UAE Corporate Tax Law concerning the deduction of Interest Expenditure incurred by a Taxable Person when obtaining a loan from a Related Party.

Exception for Deduction in Related Party Transactions:

No deduction is allowed for Interest expenditure incurred by a Taxable Person on loans obtained from Related Parties, whether directly or indirectly connected to the Taxable Person, for the following transactions:

1. Payment of profits or dividends to a Related Party.
2. Transfer of shares to a Related Party for redemption, repurchase, capital reduction, or return of share capital.
3. Capital contributions to a Related Party.
4. Acquisition of ownership in a Person who is, or becomes, a Related Party after the acquisition.

Note: A Taxable Person may, however, be permitted to deduct interest expenditure in the above cases if they can demonstrate that such transactions were not conducted with the intention of obtaining a Corporate Tax Advantage.

In instances where foreign jurisdictions impose taxes on such Interest at a rate of not less than 9%, such tax liability shall not be considered a Corporate Tax advantage under this Law.

 

Entertainment Expenditure

Entertainment Expenditure encompasses the costs associated with hosting and entertaining individuals such as clients, shareholders, suppliers, or other business associates of the Taxable Person. These expenses go beyond merely covering:

1. Meals.
2. Accommodation.
3. Transportation.
4. Admission fees.
5. Facilities and equipment used for entertainment, amusement, or recreation.
6. Any additional expenses specified by the Minister.

Limitations on Deducting Entertainment Expenditure:

Tax deductions for Entertainment Expenditure are subject to certain limitations. A Taxable Person can claim a deduction of up to 50% (fifty percent) for expenses incurred in:

1. Entertainment.
2. Amusement.
3. Recreation during a Tax Period,

This is contingent upon compliance with Article 28 of the UAE Corporate Tax Law, which pertains to Deductible Expenditure.

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Non-deductible Expenditure

Non-Deductible Expenditures are certain specific expenditures for which deductions from Taxable Income of a Taxable Person are not allowed. The following expenditures incurred by the Taxable Person are barred from being claimed as deductions:

  1. Donations are given to a corporate entity but not a Qualifying Public Benefit Entity.
  2. Grants are given to a corporate entity but not a Qualifying Public Benefit Entity.
  3. Gifts are given to a corporate entity but not a Qualifying Public Benefit Entity.
  4. Penalties and fines are other than those that are paid as damages or for contract violations.
  5. Bribes, and illegal payments
  6. Payments made to the owner of the Taxable Person in the form of dividends, profit distributions, or similar advantages.
  7. Sums are withdrawn by a natural person who is a Taxable Person as defined in Clause 3 of Article 11 of the UAE Corporate Tax Law or a partner in an Unincorporated Partnership from the business.
  8. Corporate Tax levied by the UAE Corporate Tax Law on a Taxable Person.
  9. Input Value Added Tax paid by a Taxable Person and eligible for reimbursement under the Federal Decree-Law No. (8) of 2017 mentioned in the preamble.
  10. The tax is imposed on the income of a Taxable Person outside the UAE.
  11. Any other expenditure that is prescribed by the Cabinet on the Minister’s recommendation.

 

 

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FAQs

1.  What is a deduction in UAE Corporate Tax Law?

In UAE Corporate Tax Law, a deduction refers to an allowable expense or loss that can be subtracted from a company’s total Taxable Income, effectively reducing its tax liability.

2. Can a company deduct foreign expenses under the UAE Corporate Tax Law?

Yes, a company can deduct foreign expenses under UAE Corporate Tax Law if these expenses were incurred for income generation within the UAE and were subject to taxation in the foreign jurisdiction.

3. Can a company carry forward losses under the UAE Corporate Tax Law?

Companies are allowed to carry forward losses for a period of up to five years in accordance with UAE Corporate Tax Law.

4. What are the types of deductions available under the UAE Corporate Tax Law?

UAE Corporate Tax Law offers deductions for expenses incurred solely for income generation. These expenses encompass various categories such as salaries, rent, repairs, provisions for bad debts, impairment losses, and contributions to government-approved charitable organizations.

5. Can a company deduct depreciation expenses under the UAE Corporate Tax Law?

Indeed, a company can deduct depreciation expenses under UAE Corporate Tax Law, albeit subject to specific regulations governing the calculation of depreciation.

6. Are there any restrictions on the deductibility of expenses under the UAE Corporate Tax Law?

Certain restrictions apply to the deductibility of expenses, including fines and penalties, contributions to non-approved charitable organizations, and expenses related to non-business activities.

7. Can a company deduct expenses related to illegal activities under the UAE Corporate Tax Law?

Expenses linked to illegal activities cannot be deducted under UAE Corporate Tax Law.

8. What is the deadline for claiming deductions under the UAE Corporate Tax Law?

The deadline for claiming deductions coincides with the Tax Return filing deadline, which is typically within six months following the end of the financial year.

9. What is the penalty for claiming incorrect deductions under the UAE Corporate Tax Law?

Claiming incorrect deductions can result in penalties amounting to 50% of the tax underpaid or unpaid due to the erroneous deduction, in addition to accrued interest.