Understanding which expenses are tax-deductible is crucial for businesses operating under the new UAE corporate tax regime. Tax-deductible expenses are those costs that can be subtracted from a company’s gross income to calculate taxable income, thereby potentially decreasing the overall tax liability. In the UAE, corporate tax law delineates specific criteria for expenses to qualify as deductible, emphasising that such expenses must be incurred to generate taxable income.
As businesses navigate this new tax landscape, they must grasp what constitutes a deductible expense to ensure compliance and optimise tax positions. We look at the intricate rules of the UAE corporate tax system, guiding companies in correctly identifying and classifying deductible expenses.
What Is a Tax-Deductible Expense?
How Tax Deductions Work
In the UAE corporate tax context, a tax-deductible expense is usually an outlay, not of a capital nature. It is incurred solely for your business’s purposes. These expenses are subtracted from your company’s gross income to determine the taxable income, which helps lower your overall tax bill.
The UAE corporate tax law specifies that only those expenses incurred to generate taxable income are eligible for deduction. This prevents misuse or excessive claims that don’t align with income production.
The Difference Between Deductions, Credits, and Exemptions
It’s essential for you to distinguish between tax deductions, credits, and exemptions to manage your tax obligations effectively. Tax deductions, like those for business expenses in the UAE, lower the total income subject to tax. Tax credits, by contrast, directly reduce the tax you owe, which isn’t a feature of the UAE corporate tax system.
Exemptions are specific amounts that can be left out of taxable income. However, the UAE corporate tax law primarily uses deductions to reduce taxable income.
Regarding specific expenses, the UAE corporate tax law allows for deducting the identifiable portion of an expense incurred exclusively for earning taxable income. If an expense serves multiple purposes, only the part directly related to the income-generating activity can be considered for deduction. A fair and reasonable proportion determined consistently may be claimed as a deduction for expenses that can’t be easily segregated.
It’s worth noting that the EBITDA used in this calculation is adjusted for certain items—any negative EBITDA results in a zero value for the purpose of the 30% limit. Debt instruments agreed upon before a specified date and certain regulated financial entities are exempt from these interest-capping rules.
Additionally, the law permits the carryforward of disallowed NIE amounts for deduction over the next ten tax periods. However, no deduction is allowed for interest on loans from related parties in specific circumstances, such as those related to dividends or profit distribution.
The UAE corporate tax law explicitly disallowed certain types of expenses for the deduction. These include bribes, fines, and penalties not related to contract damages, corporate tax, recoverable VAT, taxes imposed outside the UAE, and dividends or profit distributions. Also, only 50% of expenses related to entertaining business contacts are deductible. Donations are only deductible if made to qualifying public benefit entities.
The UAE corporate tax law also provides for offsetting tax losses against future taxable income. The set-off can be at most 75% of the taxable income for any given tax period. Tax losses can be carried forward indefinitely, but there are restrictions. For instance, you can’t carry forward losses incurred before the UAE corporate tax regime starts or from exempt activities.
Moreover, the law allows for the transfer of tax losses between group entities under certain conditions. These include a common ownership threshold and business continuity requirements. Additional rules are in place to prevent the manipulation of tax losses through changes in ownership for entities not listed on a recognised stock exchange.
Tax Deductions for Businesses In The UAE Under The New Corporate Tax Law
Interest Expenses
The broad definition of interest encompasses costs related to raising finance, interest on Islamic financial instruments, and the finance element of lease payments. For the calculation of EBITDA — adjustments are made for NIE, depreciation, and amortisation — excluding interest related to financial assets or liabilities held before 9 December 2022.
Financial institutions such as bank, insurance companies, and certain other financial entities are not subject to the interest capping rules. If your interest expenses exceed the allowable limit, the excess can be carried forward for future deduction. Interest on loans from related parties is not deductible when it pertains to certain transactions.
Charitable Contributions
The CT Law specifies that only contributions to qualifying public benefit entities are deductible, ensuring that only donations serving the public good and related to the business’s purpose are considered for tax relief.
Entertainment Expenses
The CT Law permits companies to deduct up to 50% of entertainment expenses, recognising the role of hospitality in business while setting a boundary to prevent excessive claims.
Fine and Penalties
Fines and penalties that do not compensate for contract damages and bribes or illicit payments are not deductible. The law also specifies that corporate tax, recoverable VAT, and taxes imposed outside the UAE are non-deductible, along with dividends, profit distributions, and other expenses outlined in a Cabinet decision.
Net Operating Losses
Group entities with at least 75% common ownership can transfer tax losses between them, provided they meet certain conditions, such as having the same financial year and accounting standards and not being exempt persons or QFZPs.
However, to prevent the manipulation of tax losses through ownership transfers, the CT Law stipulates that tax losses can only be carried forward and utilised if there’s at least a 50% continuous ownership from the time the loss was incurred to the time it is offset. The business must also continue to conduct the same or a similar business after any change in ownership.
For non-listed entities, the carryforward and use of tax losses are contingent on maintaining at least a 50% interest from the tax period in which the loss was incurred to the end of the tax period in which the loss is offset.
Other Non-deductible expenses include the following:
- Donations to non-qualifying public benefit entities,
- Entertainment expenses beyond 50% of the amount incurred
- Corporate tax
- Recoverable VAT
- Taxes imposed outside the UAE
Additionally, dividends, profit distributions, and other expenses specified by a Cabinet decision are not deductible.
Disallowed Corporate Tax Deductions In The UAE
For expenses that serve multiple purposes, only the portion that can be clearly identified as being for the generation of taxable income is deductible. If a part of the expense can’t be distinctly attributed to the production of taxable income, a fair and reasonable proportion of that expense, determined on a justifiable basis, may be claimed as a deduction.
Foreign exchange gains are also treated as interest for the purposes of this limitation.
Certain exemptions apply to the general interest limitation rule. For example, NIE attributed to debt instruments agreed upon before 9 December 2022 and NIE incurred by qualifying infrastructure project persons are exempt. The interest capping rules don’t apply to banks, insurance businesses, other regulated financial entities, or businesses conducted by natural persons or entities specified by a Cabinet decision.
Suppose the NIE is disallowed under the interest capping rules. In that case, it can be carried forward and deducted in the subsequent ten tax periods. However, no deduction is allowed for interest on loans from related parties if the loan is for certain transactions with the related party, such as dividends or profit distribution, share capital transactions, or acquisition of ownership interest.
Maximising Your Tax Deductions
Keeping Accurate Records
Maintaining precise and comprehensive records is crucial for ensuring that you’re capitalising on all eligible tax deductions. A detailed recording system is necessary to substantiate all eligible expenses.
For mixed-purpose expenses, you must employ a justifiable method to determine the deductible portion for CT purposes.
Itemised vs. Standard Deductions
The concept of choosing between itemised and standard deductions is not applicable in the UAE. Each expense must be evaluated for eligibility based on its direct connection to business operations and its non-capital nature.
Timing Deductible Expenses Strategically
Strategically, timing deductible expenses can influence your tax liability. If your net interest expense falls below the $3,267,172.80 (AED 12 million) threshold, you’re entitled to deduct the entire amount. Exceeding the threshold allows for a deduction of either the threshold amount or 30% of your EBITDA, whichever is higher. A negative EBITDA sets the deductible limit at AED 0.
Carrying forward disallowed net interest expense for up to ten tax periods offers the opportunity to align finance-related expenses with future tax liabilities.
Contributions to Retirement Accounts and Tax Implications
While the CT regime does not detail the treatment of retirement account contributions, understanding their impact on taxable income is essential. Losses can be offset against future taxable income, subject to the 75% cap per tax period. Loss carryforwards are subject to continuity of ownership and business operation conditions after any ownership changes.
Navigating Deductions Effectively
As the UAE corporate tax landscape evolves, understanding which expenses are deductible—and the specific conditions that apply—is fundamental to efficient tax planning. The distinction between deductible and non-deductible expenses can significantly impact your corporate tax liability. It’s essential to keep accurate records and grasp the rules to maximise the tax benefits available to your business.
Remember that diligent record-keeping and adhering to the UAE corporate tax law guidelines are your keys to optimising your financial strategy. Equipped with this knowledge, you’re better positioned to navigate the intricacies of tax deductions confidently, ensuring compliance while safeguarding your company’s bottom line.
