The United Arab Emirates has established robust corporate tax laws that address the taxation of foreign-source income for both residents and non-residents, including those with permanent establishments.
To avoid double taxation, mechanisms such as participation exemption and foreign permanent establishment exemptions are implemented. However, in cases where foreign-source income remains subject to tax, corporate tax law allows the use of foreign tax credits. These credits allow taxpayers to offset foreign jurisdiction taxes against UAE corporate tax on the same income, offering relief and ensuring fair tax practices.
The foreign tax credit is available for taxes similar to UAE corporate tax paid in any foreign jurisdiction. To be of similar character, it must be imposed and paid to a foreign government, enforced by foreign tax laws, and applied to net profits or income. Consideration of applicable double tax agreements is essential to identifying foreign taxes that qualify for a foreign tax credit. This credit applies to the tax “paid” under the laws of the foreign jurisdiction, covering both remitted and accrued amounts.
Calculating the foreign tax credit involves determining the lesser of the tax paid in a foreign jurisdiction and the UAE corporate tax due on the relevant foreign source income. Since UAE corporate tax operates on a net basis, the credit is calculated on foreign-source net income after deducting economically linked expenses. In particular, the foreign tax credit is not available in respect of exempt income, such as foreign dividends under the participation exemption, and where a UAE taxpayer has a loss position under UAE corporate tax law. .
A crucial limitation is that the foreign tax credit cannot exceed the corporate tax due on the relevant foreign income. Therefore, when no corporate tax is paid on foreign source income, no foreign tax credit is allowed. This restriction also applies to relief cases for small businesses, individuals with a turnover of less than Dh1 million, and qualified free zone individuals subject to zero corporate tax.
A foreign tax credit can mitigate corporate tax liabilities for a given tax period. However, temporary mismatches may occur between the UAE and foreign jurisdictions. To resolve this, a symmetrical approach is employed, granting the credit in the tax period when foreign source income is included in taxable income under the UAE Corporate Tax Law. Notably, the credit is allowed even in the absence of a double taxation agreement, but if one exists, its terms supersede any inconsistencies with corporate tax law.
The foreign tax credit cannot be carried forward to future tax periods or carried forward to prior tax periods, resulting in its loss if not used. Furthermore, the credit is calculated income by income, which prevents the offsetting of excess credits with other income from a foreign source.
In conclusion, the UAE corporate tax law provides a comprehensive framework for handling foreign source income through mechanisms such as participation exemption, foreign permanent establishment exemption and essential foreign tax credit. Effectively navigating these provisions is crucial for businesses and individuals involved in cross-border activities, ensuring compliance and mitigating the risk of double taxation.
News Source: Khaleej Times