Explained: What is corporate tax, how does it affect expats, entrepreneurs in the UAE?

stock corporate tax — Explained: What is corporate tax, how does it affect expats, entrepreneurs in the UAE? Image Credit: Shutterstock

Dubai: After the UAE finalised on Monday that it would implement corporate taxes from June next year, it's vital to understand what this form of taxation simply means, and how it affects expats and entrepreneurs in the region.

What exactly is corporate tax?

Corporate tax is a direct tax levied on the profits of business entities. Business owners, subjected to the tax, would essentially pay taxes on production, people, property and environmental impact, as well as firm's income.

How does this tax help expats, entrepreneurs?

Non-residents that conduct business in the UAE through a permanent establishment are subject to corporate tax from June next year. This is not a tax on individuals and their incomes, the UAE authorities have reaffirmed.

This means that corporate tax will not apply on an individual’s salary and other employment income (whether received from the public or private sector).

Corporate tax will also be paid by entrepreneurs or business owners in a range of industries, notably oil and banking - currently in place in several GCC countries. As a result, there are a wide range of government fees and levies imposed across all business sectors throughout the region.

Income earned from activities carried out under a freelance license/permit will be subject above the minimum threshold of Dh375,000 in annual profit. Investment in real estate by individuals in their personal capacity should not be subject if the individual is not required to obtain a commercial license/permit to carry out such activity.

Tax — Non-residents that conduct business in the UAE through a permanent establishment are subject to corporate tax from June next year.

How did this form of tax come about?

For many years, Gulf economies like the UAE have maintained low or zero taxes in order to attract foreign business owners and their investment. The UAE remains an attractive jurisdiction for foreign investment due to favourable tax regimes versus most other countries in the region.

However, a number of reforms have been underway to create new revenue streams while reducing dependence on mainstream sources of revenues in the region. Like the UAE, in several other countries in the Gulf, the value-added taxes have already been announced, while in other countries different forms of taxes are being introduced.

Why is there a rampant move in favour of taxes? Although personal income tax is still unheard of in the Gulf, many countries have introduced value added tax on consumption, with Saudi Arabia tripling the rate to 15 per cent last year.

How is corporate tax different from VAT?

Taxes are the main source of revenue for most countries globally. While taxes generally help governments to generate additional revenue and fund public expenditure, there is a major difference between direct taxes such as corporate tax and indirect taxes like VAT and excise tax.

VAT and excise tax are indirect taxes collected by businesses on behalf of the government and are intended as taxes on consumption that should be borne by the final consumer. The absence of a corporate tax is very attractive for businesses operating or seeking to invest in the country.

It is for these reasons that the implementation of VAT and excise tax was a popular choice and historically limited direct taxes on businesses.

VAT 1 — How is corporate tax different from VAT?

Corporate tax rates have been dropping around the world, from highs of over 50 per cent to around the 20 per cent range, as economies compete to attract inward foreign investment.

However, the GCC is an exception as these taxes are being introduced for the first time.

Before UAE, which other countries have this tax?

Apart from the UAE, four out of the six GCC countries have corporate tax regimes, ranging from 10 per cent in Qatar, through 15 per cent in Kuwait and Oman, to 20 per cent in Saudi Arabia. So a tax rate of 9 per cent in the UAE makes it 'among most competitive' in world, said the country's finance ministry.

When will this start affecting businesses in the UAE?

Corporate tax in the UAE will be charged on business profits on financial years starting on or after June 1, 2023.

"A business that has a financial year starting on January 1, 2023 and ending on December 31, 2023 will become subject to UAE corporate tax from January 1, 2024 - which is the beginning of the first financial year that starts on or after 1 June 2023)," said Chirag Agarwal, founder and managing director at Dubai-based Earningo Accounting & Tax Consultancy.

Why is corporate tax important for the UAE?

Corporate tax rates vary widely by country, with some countries considered to be tax havens due to their low rates. Corporate taxes can be lowered by various deductions and so the effective corporate tax rate, the rate a corporation actually pays, is usually lower than the statutory rate; the stated rate before any deductions.

Paying corporate taxes can be more beneficial for business owners than paying additional individual income tax. The money collected from corporate taxes is used as the source of revenue for a country.

"With the double tax treaty networks, UAE will be placed further at an advantageous position with a competitive corporate tax rate," said Vikas Arora, chief executive at Dubai-based service provider CXO Factor.

"This also strengthens UAE’s position in terms of transparency, implementation of Organisation for Economic Co-operation and Development (OECD) guidelines to ensure businesses operate with the correct governance and tax structure.”

UAE skyline — Why is corporate tax important for the UAE?

How do tax treaties help mitigate corporate tax for non-residents?

GCC countries have a growing double taxation treaty (DTT) network to eliminate double taxation — the UAE has treaties with 112 countries, Kuwait 82 countries, Qatar 60, Saudi Arabia 51 countries, Oman 31, and Bahrain with 44 countries.

The tax treaty network is expected to expand even further. Tax treaties play a crucial role in mitigating corporate tax for non-residents forming permanent establishments in other countries, or reducing their withholding tax exposure in the four GCC countries. (The UAE does not levy withholding tax or other forms of non-resident taxation.)

What is withholding tax (WHT)?

Withholding tax (WHT) is income tax paid to the government by the payer of the income rather than by the recipient of the income. The tax is thus withheld or deducted from the income due to the recipient.

In most jurisdictions, tax withholding applies to employment income. Many jurisdictions also require withholding taxes on payments of interest or dividends.

Governments use tax withholding as a means to combat tax evasion, and sometimes impose additional tax withholding requirements if the recipient has been delinquent in filing tax returns, or in industries where tax evasion is perceived to be common.

How do countries monitor corporate tax?

The countries that have introduced the tax are actively using technology for corporate tax compliances whereby business contracts, tax returns and declarations are being filed online into portals.

This allows tax authorities to cross verify information easily and initiate tax audits where there are discrepancies versus acceptable standards.

Bottom line?

As tax reforms in the GCC region rapidly evolve with economic diversification into the non-oil sector, wealth managers opine how taxpayers or business owners should seek to aptly prepare tax-related documentation in advance.

One of the main reasons for taxpayers being asked to be cautious in tax-related compliances is because many jurisdictions do not allow tax returns to be revised.