Application of Tax Credits
The United Arab Emirates is a corporate powerhouse that has been rapidly evolving its tax landscape to support its economic growth. By introducing the new corporate tax regime, the UAE aims to fulfil its developmental goals while maintaining its reputation as a tax-friendly destination. From June 2023, all businesses operating in the UAE are liable to pay the corporate tax on their income, including their overseas income that may have already been subject to a tax equivalent to CT by another country.
This is where tax credits play a very crucial role in incentivizing investment and growth, ensuring that the taxes on income are distributed fairly between the nations while eliminating/ minimizing double taxation for businesses earning the income. In this blog, we’ll explore how tax credits are applied in the UAE and how they can benefit businesses by reducing their double taxation liability.
Double taxation entails taxing the same income twice. A particular income earned by a business may be taxed in the UAE based on its residency, and the same may be taxed in the taxpayer’s home country as per the domestic laws of that country.
You can also read: Adjustments Applicable on UAE Corporate Tax
Types of Double Taxation
Juridical Double Taxation
This occurs when someone is taxed on the same income by two or more countries based on their laws, resulting in double taxation.
Economic Double Taxation
Juridical Double Taxation: Economic Double Taxation: This happens when the same transactions or income items are taxed in two or more states but by different individuals or entities.
Many UAE business entities have operations across different jurisdictions through branches or subsidiaries. When these businesses have foreign branches, they are usually considered to have a permanent presence in that foreign country, leading to them being taxed in both the UAE and the foreign country on their profits. To prevent this double taxation, the new UAE corporate tax system allows businesses to claim a "Foreign Tax Credit" for the taxes they have already paid in another country. However, the maximum amount of Foreign Tax Credit a business can claim is determined by either the tax paid in the foreign country or the UAE corporate tax owed on the foreign income, whichever is lower.
For Instance, XYZ, a global company, has headquarters in the UAE and generates revenue from its operations in multiple countries, including the US and China. The UAE imposes corporate tax on all of the company's revenue, including the income it earns in the US and China. However, the US and China also impose corporate taxes or an equivalent tax on the company's revenue that is earned within their territories. This situation that causes XYZ to pay taxes twice on the same income is known as double taxation.
You can also read: Transfer Pricing Documentation Under Corporate Tax
To prevent this, the UAE tax system offers a Foreign Tax Credit that allows XYZ to claim a credit for the tax paid in a foreign jurisdiction (like the US or China). In simpler terms, XYZ can claim a refund for the tax it paid abroad. However, there is a limit to the amount of Foreign Tax Credit that can be claimed. The tax credit will be the amount that is lower than the tax paid in the foreign country or the UAE corporate tax due to the foreign-sourced income.
For example, if XYZ pays $12 million in tax in the US and $9 million in tax in China, but the corporate tax due in the UAE is only $11 million, then the maximum Foreign Tax Credit it can claim is $11 million.
Furthermore, to claim a Foreign Tax Credit, the taxpayer must maintain all the relevant records. It is also important to note that any unused foreign tax credit cannot be carried forward or backwards to be used in another tax period by the FTA. Tax Credits, thus, promote international business activities while ensuring that the tax system is fair for everyone.
The UAE's tax framework aims to promote economic growth and attract investment. Tax Credits, therefore, play a crucial role in helping businesses optimize their tax positions. Understanding the application of these tax credits is vital for businesses operating in the UAE, particularly those that have a Permanent Establishment in a foreign jurisdiction.
CDA as your Tax Consultant
To navigate the prevailing tax environment effectively, businesses must seek professional guidance from tax experts like CDA. Our tax experts will assist you in meeting your tax obligations and eliminating potential risks while maximizing your financial benefits. Our experts can equip you with premium accounting, auditing, and tax consultancy services in a personalized manner. Hence, you can take your business to the top level and flourish in all the activities.
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