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Navigating the intricacies of partnership taxation in the UAE is essential for businesses seeking to operate within its dynamic economic landscape. Whether incorporated or unincorporated, partnerships play a vital role in driving collaboration and fostering growth. The recent release of comprehensive guidelines by the Federal Tax Authority (FTA) sheds light on the diverse legal and tax frameworks governing these partnerships, providing clarity for taxpayers and practitioners alike.
This article delves into the key aspects outlined in the FTA's guidelines, offering insights into the taxation of partnerships and the implications for businesses operating in the UAE.
Incorporated and Unincorporated Partnership
A partnership in the UAE is a collaborative venture between individuals or entities to conduct business, sharing profits and losses.
Incorporated partnerships, like Joint Liability or Limited Partnership Companies, possess separate legal identities and adhere to corporate tax laws.
Unincorporated partnerships in the UAE are defined as contractual relationships between two or more persons, including partnerships, trusts, or similar associations. By default, these partnerships are fiscally transparent, with each partner individually taxed on their share of profits or gains. An unincorporated partnership may, however, elect to be treated as a separate Taxable Person (discusses later in this article).
Who can be a partner?
Partners can be natural persons or legal entities, and partnerships may consist of a combination of natural persons, juridical persons, or both. Unincorporated partnerships themselves do not have separate legal personality and cannot become partners in other partnerships.
Key features of an Unincorporated Partnership
- Partners are jointly and severally liable for corporate tax payable during their partnership.
- While not mandatory, partnership arrangements are often governed by a partnership deed outlining terms such as profit-sharing ratios, contributions, and exit processes.
- Partners' distributive shares are determined based on agreements and can be adjusted.
- Partners contribute capital in various forms, and not all partners are required to contribute equally.
- Partners may receive payments such as interest on capital or salaries.
- Dissolution may occur voluntarily or involuntarily and involves winding up the partnership's business and settling accounts.
Corporate Tax Implications
The guideline analyses tax implications of a partnership under different situations as discussed below:
A. Unincorporated Partnership treated as fiscally transparent
The default stance according to the Corporate Tax Law is that an Unincorporated Partnership is regarded as fiscally transparent. This means it's not treated as a Taxable Person and isn't subjected to Corporate Tax. Instead, each partner is individually taxed depending on their taxable status:
- Where a partner is a natural person
Natural person partners are taxed based on their share of the partnership's profits if it falls under the Corporate Tax scope. Income from Personal or Real Estate Investments is exempt from Corporate Tax. Partners must register for Corporate Tax if their total turnover, including their share from the partnership, exceeds AED 1 million annually. Small Business Relief may apply if turnover is below this threshold.
- Where a partner is a juridical person
A resident person is subject to Corporate Tax based on their distributive share in the partnership and other business activities. Eligibility for Small Business Relief is considered.
For a non-resident person, Corporate Tax applies if they have a Permanent Establishment in the UAE, derive State Sourced Income, or have a nexus in the UAE. Otherwise, the partner's distributive share is treated as State Sourced Income.
- Mixed partnership
A mixed partnership includes both natural persons and juridical persons as partners. Partners’ income will be taxed as per the principles discussed above.
B. Unincorporated Partnership treated as fiscally opaque
Partners in an Unincorporated Partnership have the option to request the partnership be treated as a Taxable Person, known as fiscally opaque. If approved by the FTA, the partnership will be subject to Corporate Tax as a Resident Person, paying tax on its own profits instead of the partners. However, partners remain jointly liable for Corporate Tax during their partnership.
C. Income received by the Unincorporated Partnership and/or its partners
Partners in fiscally transparent partnerships must determine joint income and expenditure, then add their share of partnership net income to other business income. Income from partnership operations is typically distributed according to each partner's share. Specific types of income and expenditure in an Unincorporated Partnership require careful consideration.
- Investment income received by an Unincorporated Partnership and its partners
In case of fiscally transparent Unincorporated Partnership, income from investments made by the Unincorporated Partnership is taxed as follows :
- For juridical person partners: Dividends or profit distributions pass through to partners based on their distributive share and are subject to Corporate Tax individually. Exemption applies if received from a Resident Person or a Participating Interest in a foreign juridical person.
- For natural person partners: Dividends or profit distributions and gains or losses on shares are treated as Personal Investment income if on personal account and not requiring a license, exempt from Corporate Tax without the need for a Participation Exemption assessment. If received in the course of a Business Activity, it's considered in their Taxable Income.
In case of fiscally opaque Unincorporated Partnership, income is treated at the partnership level. Exemption from Corporate Tax applies to Dividends or profit distributions received from a Resident Person or a Participating Interest in a foreign juridical person.
- Transfer of partner’s distributive share in an Unincorporated Partnership
In case of fiscally transparent Unincorporated Partnership, gain or loss on the transfer, sale, or disposal of a partner’s distributive share is treated as Business income for partners and is subject to Corporate Tax individually.
In case of fiscally opaque Unincorporated Partnership, gain or loss on the transfer, sale, or disposal of a partner’s distributive share is not subject to Corporate Tax for partners if the distributive share meets the conditions of the Participation Exemption.
D. Deductible Expenditure:
Expenses solely for business purposes are deductible, excluding capital expenses. Dividends, profit distributions, and partner withdrawals are not deductible.
Interest for business purposes is deductible, with limitations on related party interest. Interest on capital contributions is not deductible in transparent partnerships but treated as profit distribution in opaque ones. Interest on Partner Loans is deductible if it is for business purposes and at arm's length.
Partner Salaries are typically treated as withdrawals and not deductible. Payment for Services are deductible if they are at arm's length and serve business purposes. Likewise, reimbursed expenses may be deductible if incurred solely for business purposes.
E. Tax Loss Relief and Limitation:
The Corporate Tax Law permits Taxable Persons to reduce Taxable Income by offsetting previous Tax Losses, subject to specific conditions. However, Tax Loss relief cannot be claimed for losses incurred before certain periods or from exempt income. Only 75% of Taxable Income can be offset by Tax Losses, with unused losses carried forward indefinitely under conditions of ownership continuity or continuity of business. Even with ownership changes, losses can be carried forward if the business remains the same. In the context of unincorporated partnerships, the limitation on carry-forward of Tax Losses depends on transparency and ownership continuity.
F. Foreign Tax Credit:
Unincorporated partnerships may receive a credit against Corporate Tax for foreign taxes paid, allocated based on partners' shares.
Other Significant Aspects
A. Foreign Partnerships
Foreign partnerships must meet specific criteria to be treated as unincorporated partnerships for tax purposes in the UAE, including not being taxed in their foreign jurisdiction, individual taxation of partners' income shares, submission of an annual declaration, and cooperation in sharing tax information with the UAE. Failure to meet these conditions results in the partnership being treated as fiscally opaque and subject to UAE Corporate Tax.
B. Free Zone Person
Free Zone Person status applies to juridical persons under Free Zone laws, but unincorporated partnerships cannot qualify as Free Zone Persons. However, Free Zone Persons can participate as partners in unincorporated partnerships. Tax implications for Free Zone partners depend on the transparency of the partnership, and eligibility for Small Business Relief is determined based on the type of partnership and the individual partner's status.
C. Transactions with Related Parties and Connected Persons
The Corporate Tax Law mandates adherence to the arm’s length standard for transactions between Related Parties to prevent value distortion. Related Parties, including partners in the same Unincorporated Partnership, are treated as Connected Persons for tax purposes.
Payments between partners and Related Parties within an Unincorporated Partnership must align with the arm’s length standard. Deductions for payments to Connected Persons are allowed only if they are at market value and incurred solely for the Taxable Person’s Business purpose.
D. General Anti-abuse Rule
The General Anti-abuse Rule empowers the FTA to counteract transactions lacking commercial substance or not reflecting economic reality, undertaken primarily to gain a Corporate Tax advantage inconsistent with the Corporate Tax Law's intention.
If a partnership or its partners engage in such transactions, the FTA can adjust tax advantages by disallowing exemptions, deductions, or reallocating income, among other measures. Establishing or modifying a partnership for tax advantages may trigger adjustments under this rule, subjecting the parties to penalties.
Tax Administration and Compliance
A. Application to be treated as Taxable Person
Partners of an Unincorporated Partnership can apply for it to be treated as a Taxable Person, with approval determining the effective date. This status change impacts gains or losses on transfers under Business Restructuring Relief, subject to specific conditions, and is generally irrevocable once approved, though exceptions may apply. Procedurally, the partnership must notify the FTA of any partner changes within 20 business days of approval, while partners following different accounting methods should maintain consistency to avoid taxation issues.
B. Compliance
Partners are considered Taxable Persons unless the partnership is approved as a Taxable Person. Regardless, each entity must determine its Taxable Income separately using standalone Financial Statements based on International Financial Reporting Standards.
Juridical persons are automatically registered for Corporate Tax, while natural persons must register if their turnover exceeds AED 1 million annually.
Tax Returns filing depends on the partnership's transparency status, with transparent partnerships requiring individual filings and opaque partnerships filing collectively.
Tax Periods for filing vary based on partnership transparency and partners' individual tax periods.
The FTA may request Financial Statements to determine taxable income. Partners in a fiscally transparent partnership may need audited Financial Statements if individual revenue exceeds AED 50 million. For fiscally opaque partnerships, the partnership itself requires audited Financial Statements if revenue exceeds AED 50 million.
Conclusion
The FTA's guidelines represent a significant milestone in the realm of partnership taxation in the UAE, offering much-needed clarity and guidance to taxpayers and practitioners. By delineating between incorporated and unincorporated partnerships and outlining compliance requirements, the guidelines pave the way for smoother operations and enhanced tax certainty. As businesses continue to navigate the evolving landscape of taxation, understanding the nuances of partnership taxation is paramount. Through comprehensive guidance and a commitment to transparency, the UAE reinforces its position as a hub for business innovation and growth.
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.
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