Expense Deductibility under UAE Corporate Tax Law

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The FTA recently issued a guide on the Determination of Taxable Income, which explains the concept on expenses deductibility in great detail along with case studies and examples. 

Taxpayers often try to claim more expenditure to reduce their taxable income whereas the tax authorities tend to disallow expenditure and increase the taxable income. While disputes on these aspects cannot be totally ruled out, this guide attempts to clarify some of the common situations and provides clarity to taxpayers as well as tax authorities. 

Let’s understand. 

Overview 

Deductible expenses are those that are incurred wholly and exclusively for the purpose of generating taxable income. These expenses directly contribute to a company's ability to earn income and are therefore allowed to be subtracted when calculating taxable income. Common examples of deductible expenses include personnel costs, energy and fuel costs, rent and leasing costs, interest etc. 

There are some general principles governing the deductibility of expenses, i.e., expenditure must be incurred wholly and exclusively for the purposes of the business, personal expenses of directors or other personnel are not allowed. Further, payments to the related parties or connected persons must be at arm’s length, i.e., any payment exceeding the arm’s length price will not be deductible. Further, no deduction is allowed for expenditure incurred in deriving exempt income and losses not connected with business.

Capital Expenditure

Capital expenditures, which typically involve the acquisition of long-term assets such as machinery, vehicles, or buildings, are not directly deductible. Instead, these expenses are subject to depreciation, which allows businesses to deduct a portion of the asset's cost over its useful life. For example, if a company purchases a machine for AED 100,000 with a useful life of 10 years, it can deduct AED 10,000 annually as depreciation. 

Depreciation which relates to such non-deductible expenditure will not be allowed as a deduction, viz. purchase cost of machinery paid to related parties/connected persons which do not meet the arm’s length standard.

Pre-incorporation Expenses

Pre-incorporation expenses, incurred before a business is officially established, such as feasibility studies and legal fees, are deductible if they meet the general deduction criteria. These expenses are deductible in the tax period when they are recorded in the financial statements, based on the accounting method used (accrual or cash basis). Similarly, pre-trading expenses, incurred before generating revenue, are also deductible when recorded.

Entertainment Expenditure

Business-related entertainment expenses, such as client meals or hospitality, are 50% deductible. However, employee-related entertainment expenses, such as staff parties or team-building events, are fully deductible, provided they are wholly and exclusively for business purposes.For example, if a company spends AED 20,000 on a client dinner, only AED 10,000 can be deducted. In contrast, if AED 15,000 is spent on a staff party, the full amount is deductible.

Expenditure incurred on providing commercial hospitality as part of business (examples, in-flight entertainment by an airline) will be considered as normal business expenditure eligible for 100% deductibility. 

Bad Debts and Provisions

Bad debts, or debts that are unlikely to be recovered, can be deducted if they are written off in accordance with relevant accounting standards. However, if a debt that was previously written off is later recovered, it must be treated as taxable income. For example, if a company writes off a debt of AED 50,000 as uncollectible, it can deduct this amount from its taxable income. If the debtor later pays AED 30,000, this amount must be reported as income.

Non-Deductible Expenses

The UAE Corporate Tax Law explicitly outlines certain expenses that are non-deductible. These include:

• Corporate tax paid (other than local taxes such as property or municipality taxes); 
• Dividend, profit distributions or benefits of a similar nature paid to shareholders; 
• Amount withdrawn by a partner in a partnership; 
• Foreign tax paid (thought foreign tax credit is available); 
• Any illegal payments, including bribes and fines;
• Penalties paid for violating laws, such as traffic fines, cannot be deducted; and 
• Donations or contributions to entities not recognized as qualifying public benefit organizations.

Conclusion

Deductibility or non-deductibility of an expenditure is often a litigation prone issue worldwide, especially when the expenditure is huge or involves intangible assets. 

It is the taxpayer’s responsibility to maintain adequate documents and records to prove that the expense incurred is genuine, for the purpose of business and is at arm’s length. 

Disclaimer: Content posted is for informational and knowledge sharing purposes only, and is not intended to be a substitute for professional advice related to tax, finance or accounting. The view/interpretation of the publisher is based on the available Law, guidelines and information. Each reader should take due professional care before you act after reading the contents of that article/post. No warranty whatsoever is made that any of the articles are accurate and is not intended to provide, and should not be relied on for tax or accounting advice.