UAE Corporate Tax: How should businesses account for deductions?
Car rental companies could however find fines no longer come under ‘expenses’
As UAE companies prepare for corporate tax, the primary focus remains on revenue streams and on free zone tax benefits.
Any business-related expenses – generally assumed to be tax deductible – often escape a comprehensive analysis. But these expenses form an equally important aspect of determining taxable income. Any error in tax positions could result in future penalties.
Car rental industry
Another issue relates to non-deductible expenses. Any fines and penalties – otherwise claimed as an expense in the account books – should be added back to the profits to determine the taxable income. Exception applies to amounts awarded as compensation for damages or breach of contract
Such expense restriction is generally not a significant concern for most companies. The quantum of statutory penalties are generally not substantial.
The car rental industry, however, could face strong headwinds from such expense restrictions. Depending on their fleet size, rental companies regularly pay fines for traffic violations committed by their customers.
It is often claimed that the violation is committed by customers and not by the rental companies. That the rental company is only a facilitator/conduit between the customers and the authorities.
The veracity of any such claims hinges on identifying as to who is statutorily liable to pay such fines. One needs to also examine if the restriction on their deductibility is absolute or depend on the recoveries made from customers.
Product samples, gifts
A common query regarding expense deductibility relates to product samples and marketing gifts. The items could be provided to existing as well as potential customers. Except for permitted entities, the UAE tax laws restrict the expense deduction for donations, grants or gifts made to an ‘entity’.
As the law refers to ‘entity’, it is often argued – based on a literal interpretation of the tax laws - that the gifts made to individuals are not restricted for tax purposes.
I have regularly counselled that understanding the context of tax policies is important for interpreting the tax laws. The context of the corporate tax policy does not suggest that gifts to individuals should be allowed as a deductible expenditure.
Taxpayers could seek an official clarification to determine if the gifts and grants to individuals would be allowed as a deductible expenditure.
Business expenditure
Any expenditure incurred ‘wholly and exclusively’ for the purposes of a taxpayer’s business is deductible from taxable income. Having led the tax functions at a leading industry player, my first thoughts always visualise the soft-drink beverage industry.
It often operates on a two-company model – the concentrate manufacturing company and the bottling company. A substantial portion of its media ad spend expense is incurred by the concentrate manufacturer. In certain countries, the tax authorities have stressed that the advertised product – the beverage bottle - is never manufactured by the concentrate manufacturer and, axiomatically, the ad expense does not relate to their business.
In the UAE context, such an argument could also risk the ‘exclusivity’ requirement for expense deduction.
Similar tax conundrums would be faced by brand owners and marketing offices incurring marketing expenses for products never manufactured or sold by them.
Airlines
To highlight the importance of tax policy context and its understanding, the apt example would be that of the airline industry. Only 50 per cent of the expenditure incurred in connection with meals or transportation provided to its customers is deductible. It is generally referred to as ‘entertainment’ expenditure.
As the passengers are nothing but customers of airlines, would the 50 per cent restriction apply to their entire operating expenditure? Only a contextual reading would provide the correct answer to such question.
Tax laws are not written for specific industries. A perfunctory analysis of the tax laws and errors in understanding implications is likely to result in financial penalties. Business owners need to understand the importance of a comprehensive tax analysis.