The UAE has given a sweet tax perk to investors by way of the ‘participation exemption’ regime in the corporate tax law.
Intending to eliminate double taxation of corporate profits, this regime exempts foreign dividends, capital gains, foreign exchange gains, and impairment gains (and therefore, forget consequent losses) from investments. We refer to these as 'participation'.
Constructive dividends
The Federal Tax Authority’s (FTA) guide alludes to this concept as certain payments/benefits received by a shareholder without a formal distribution. For example, compensation for services exceeding fair value/arm’s length from a subsidiary will be treated as a dividend, and the subsidiary will have a tax disallowance. Thereby, taxpayers should referee fair play in their related party transactions.
Cocktail instruments are welcome
Income from debt instruments that are classified as equity interests (e.g. profit-participating loans, Tier 1 securities, etc) as per accounting standards benefits from the participation exemption regime.
This should benefit hybrid instrument-based investment structures to investors. A word of caution – merely because payment on certain instruments such as bonds or debentures is contingent upon profits would not make such payments entitled to the regime.
One key condition is that the participation be subject to tax at 9 per cent. There’s good news for UAE investors going global - recalculating foreign subsidiary taxes to match UAE rules isn't needed if their statutory tax rate is at least 9 per cent.
Even for lower rates or alternative tax regimes, the benefit can apply if you can show an effective 9 per cent tax is paid. Increasing its charm further, the regime benefits extend to participation by qualifying free zone persons, exempt persons, etc., even if they are taxed at less than 9 per cent.
Investment-based ownership test
While normally you'd need a 5 per cent ownership interest in a company, investing at least Dh4 can still qualify you for the regime. On reading the available material, there seems to be a catch - the test of a minimum 5 per cent entitlement to distributable profits and liquidation proceeds still applies.
Therefore, the investment-based relaxation helps situations where ownership will eventually reach 5 per cent when the participation is sold.
12-month holding period test
Income (say dividends) from participation before completing a 12-month holding can still benefit so long as you intend to hold for at least 12 months. A longer two-year waiting period applies in situations such as capital gains income and a participation acquired through exempt transfers (qualifying group or business restructuring relief), or against an existing participation that itself did not qualify.
Free zones – a safety net
While free zones are a subject in itself, an interesting point to note here is that investments by qualifying free zone persons are entitled to 0 per cent tax, without needing to specifically test participation exemption conditions. Therefore, we’ve seen many businesses explore free zones commercially for holding investments.
Multi-layer holding structure
Intended to prevent misuse of the regime, if one is using an intermediary holding company, the law requires that at least 50 per cent of the underlying assets (of the intermediary) qualify for the regime (if held directly).
The regime restrains corresponding deductions too. Expenses linked to exempt income, like losses from selling these assets, are not tax-deductible. Similarly, costs of acquiring, selling or transferring the participation are capitalized (irrespective of accounting treatment) and therefore, not deductible against usual income.
For management and common expenses, one may come across situations where no significant time/costs are incurred to earn a passive income like dividends and, therefore, expect no disallowance. While the argument seems compelling, a careful review is necessary.
There's a sweet spot - interest expenses specifically linked to earning participation-exempt income can be deducted, subject to interest limitations rules.
The UAE’s participation exemption regime is truly flexible and investor-friendly. Just plan well and play fair.
