UAE allows flexibility by not requiring separate books of account for tax purposes. Small businesses have further flexibility on which accounting standard to follow. Image Credit: Shutterstock

Unlike many other countries, the UAE corporate tax does not require companies to maintain separate books of account for tax purposes.

The taxable income for a tax period would be derived from the corresponding financial statements prepared in accordance with the accounting standards accepted in the UAE. These accounting standards should be used to prepare the financial statements:

  1. International Financial Reporting Standards (IFRS); or
  2. IFRS for SMEs if the revenue is up to Dh50 million.

The Federal Tax Authority (‘FTA’) released a guide on the interaction of accounting standards with the corporate tax. The guide mentions that failure to comply with the specified accounting standards will attract administrative penalties.

Cash basis vs accrual basis of accounting

In general, every taxable person should prepare financial statements using an accrual basis of accounting. However, an option to use cash basis is available if total receipts during the tax period does not exceed Dh3 million. The cash basis of accounting can also be used in ‘exceptional circumstances’ if the FTA approves such an application by the taxpayer.

The cash basis of accounting essentially means that the income and expenditure could be recorded on receipt/payment basis irrespective of the invoice exchange or completion of supplies. The option provides administrative convenience to small enterprises to use their bank statements and/or cash ledger instead of maintaining detailed books of account.

Small Business Relief

The UAE’s Small Business Relief allows a taxpayer to have nil tax liability - irrespective of actual profits/income – for all tax years up to the years ending December 31, 2026. This is one of the specific tax reliefs linked to the quantum of annual revenue of a taxpayer. The annual revenue for any of these years should not exceed Dh3 million.

A taxpayer could opt for IFRS, IFRS for SMEs, or cash basis of accounting to determine its eligibility for Small Business Relief irrespective of the accounting method. It provides flexibility to taxpayers to claim maximise tax reliefs.

Transactions with related parties

It is now common knowledge that the transactions and arrangements between related parties must be at arm’s length. If these are not at arm's length in the books of account, the appropriate adjustments could be made in the computation of taxable income without administrative penalties.

An accounting issue could arise if an asset or a liability is transferred between related parties at a value higher or lower than the market value i.e. arm’s length value.

To illustrate, a machine valued at Dh10 million is sold by Company A to its related party Company B at Dh15 million. The latter would capitalise the asset at Dh15 million - i.e., the transaction value and corresponding depreciation expense - in its books of account. For computing taxable profits, however, the depreciation should be done at the cost base of Dh10 million, which is the arm’s length value.

Taxpayers will need to keep a detailed reconciliation of the accounting records and the tax records of transactions that are not at arm’s length.

Realised vs unrealised gains/losses

Another typical issue between financial accounting and tax accounting relates to realised and unrealised gains or loss. Realised gains refer to those derived on completion of a transaction, such as gains on sale of property.

Unrealised gains are those not yet realised, but recorded in the books of account upon ‘fair value accounting’ at current market value. To illustrate, short-term financial instruments not yet sold, but revalued at market value as on the balance-sheet date.

The guide provides that a taxpayer may elect to reduce the unrealised gains or loss during the computation of taxable income. Such election must be made while submitting the first tax return and such decisions will be irrevocable.

The FTA guide correctly states that the starting point for calculating taxable income is the accounting income. Once the accounting income is correctly calculated, the resulting computation of taxable income could be comprehensively prepared.

Businesses should not only focus on maintaining detailed records of the accounting income but also the necessary reconciliation between accounting income and taxable income.