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The provision of participation exemption under the UAE Corporate Tax Law are important provisions that alleviate the tax burden on dividends, profit distributions, and other income derived from certain qualifying Participating Interests. This exemption encourages cross-border investments and ensures fair treatment of foreign income.
Let us understand these provisions in detail.
Dividends and Profit Distributions
Dividends and profit distributions received from foreign juridical persons are exempt from Corporate Tax if the recipient has a Participating Interest in the foreign juridical person. This means holding at least 5% ownership in the shares or capital of the juridical person (the Participation), or an acquisition cost of AED 4 million or more, subject to the following conditions:
- The Participation must be held, or intended to be held, for at least 12 months;
- The Taxable Person must be entitled to at least 5% of the profits available for distribution and liquidation proceeds;
- No more than 50% of the Participation’s direct and indirect assets should consist of non-qualifying ownership interests; and
- The Participation must be resident in a country that levies tax at a statutory rate of at least 9% or, alternatively, subject to an effective tax rate of at least 9% on profits.
The characterization of a Participation as such is often prone to litigation. For instance, many corporates issue quasi-equity or hybrid instruments, especially in case of investments in a start-up. In such a case, it may be a grey area as to whether the said instruments qualify for the minimum 5% of profits on distribution.
Participation Exemption for Other Income and Gains
The participation exemption extends to other income and gains derived from a Participating Interest. The conditions mirror those for dividends and profit distributions, with additional inclusions for domestic Participating Interests in Qualifying Free Zone Persons or Exempt Persons.
Taxable Persons meeting these conditions can claim exemptions on gains on transfer of the Participating Interest, foreign exchange gains or impairment gains in connection with the Participating Interest.
Treatment of Expenditure
Expenditures related to the acquisition, transfer, or disposition of Participating Interests are not deductible for tax purposes. This includes professional fees, due diligence costs, litigation expenses, commissions, brokerage fees, etc. Instead, such expenses must be capitalized as part of the acquisition cost of the Participating Interest.
Nexus
Only income received in the capacity of a shareholder is eligible for participation exemption. This includes dividends and gains having nexus to the ownership interest. However, income derived from other relationships, such as interest from a debtor-creditor arrangement or fees for services rendered, remains taxable.
In real life scenarios, a corporate entity may execute various transactions with its shareholders or say with the parent company, i.e., payment of royalty for use of brand, payment for use of common infrastructure etc. Such transactions are excluded from the purview of participation exemption.
Conclusion
From the above discussion, one can say that participation exemption is in the nature of a tax benefit. It is also an important factor while negotiating investment deals as both sides can gain by taking advantage of a tax benefit that is perfectly legit. Companies must take advantage of this exemption, of course, in consultation with their advisors, to ensure that the transactions are not considered as transactions for tax evasion.
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
