The UAE has established robust corporate tax laws addressing the taxation of foreign source income for both residents and non-residents, including those with permanent establishments.
To prevent double taxation, mechanisms like the participation exemption and foreign permanent establishment exemptions are implemented. However, in cases where foreign source income remains taxable, the corporate tax law allows for the use of foreign tax credit. These credits enable taxable persons to offset foreign jurisdiction taxes against UAE corporate tax on the same income, offering relief and ensuring fair taxation practices.
Foreign tax credit is available for tax that is of a similar character to UAE corporate tax paid in any foreign jurisdiction. For similar character, it must be imposed and payable to a foreign government, enforceable by foreign tax laws, and applied to profit or net income. The consideration of applicable double taxation agreements is essential in identifying qualifying foreign taxes for a foreign tax credit. This credit is applicable to tax “paid” under the foreign jurisdiction’s laws, covering both remitted and accrued amounts.
The calculation of the foreign tax credit involves determining the lesser amount between the tax paid in a foreign jurisdiction and the UAE corporate tax due on the relevant foreign source income. Given that UAE corporate tax operates on a net basis, the credit is computed on the net foreign source income after deducting economically linked expenditures. Notably, the foreign tax credit is not available in respect of exempt income, such as foreign dividends under the participation exemption, and when UAE taxable person 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 payable on foreign source income, no foreign tax credit is allowed. This restriction also applies to cases of small business relief, natural persons with turnover below Dh1 million, and qualifying free zone persons subject to zero corporate tax.
A foreign tax credit can mitigate corporate tax liabilities for a given tax period. However, timing mismatches between the UAE and foreign jurisdictions may occur. To resolve this, a symmetrical approach is employed, granting the credit in the tax period when foreign source income is included in the taxable income under UAE corporate tax Law. Notably, credit is allowed even in the absence of a double taxation agreement, but if one exists, its terms supersede any inconsistencies with the corporate tax law.
The foreign tax credit cannot be carried forward to future tax periods or carried back to earlier ones, leading to forfeiture if unutilised. Moreover, the credit is calculated on an income-by-income basis, preventing the offsetting of excess credits against other foreign source incomes.
In conclusion, the UAE’s corporate tax law provides a comprehensive framework for handling foreign source income through mechanisms like the participation exemption, foreign permanent establishment exemption, and the essential foreign tax credit. Navigating these provisions effectively is crucial for businesses and individuals engaged in cross-border activities, ensuring compliance, and mitigating the risk of double taxation.
The writer is Partner – MICS