Participation Exemption – how to apply and what to avoid?

Introduction

From 1^st June 2023, UAE businesses are subject to the new corporate tax law[1]. The UAE Corporate Tax Law applies to all income for UAE businesses including income sourced from outside the state (Article 12).

Tackling a Key Issue – Double Taxation

In certain cases, income sourced from an entity located outside the UAE may be subject to tax in the source country (source principle), and then again in the country of the taxpayer’s residence (residence principle).

The Corporate Tax Law includes many ways to avoid double taxation in such situations, and include an exemption from Dutch tax law to nullify double taxation on the following categories of income received from foreign entities:

• • dividends and other profit distributions;
  • gains and losses (in certain cases), including foreign exchange gains and losses; and
  • impairment gains and losses.

This exemption is called the Participation Exemption and requires that entities meet certain conditions set by the UAE Corporate Tax Law and Ministerial Decision No. 116 of 2023.[2]

The Participation Exemption applies to foreign and domestic income derived from the abovementioned categories.

Participation Exemption Conditions

To benefit from the Participation Exemption, taxpayers must meet four conditions:

1. Minimum Holding Period

The Taxpayer must own 5% (five percent) or more of the shares or capital of a juridical person, referred to as the “Participation,” and hold, or intend to hold, the ownership interest for an uninterrupted period of at least 12 months.

The Ministry of Finance has explained in official guidance that: “there is no requirement for the Participating Interest to be held for the full Tax Period, nor is it required for the minimum holding period to be met at the time the income is derived.”[3]

Further, the MD clarified that the ownership interest can be achieved by holding different classes of shares, such as ordinary shares and preferred shares. The threshold is calculated with reference to the total paid-up capital of the Participation, or the total equity interest contribution made to the Participation.

The threshold does not need to be met if the aggregated acquisition cost of the ownership interests in the Participation is equal to or exceeds AED 4 million.

The ownership interest condition will continue to be met even if the ownership interest is exchanged for ownership in another juridical person, as long as the transferred interest constitutes the entire Business or an independent part of the Business (Business Restructuring Relief) – if other conditions described below are met.

2. Already Subject to Corporate Tax

The Participation must already be subject to a corporate tax (or its equivalent) at a rate of not less than 9%.

There are certain characteristics determine if the levy is a corporate tax. Income from such Participation will not benefit from the Participation Exemption, if the levy demonstrates any of the following:

• • the levy is applicable only to selected activities;
  • the levy paid is refunded at the time of distribution of the relevant profits or income; or
  • the levy is only due in the event of a distribution of profits or income.

This means that corporate taxes that are imposed only on certain sectors will not qualify for the Participation Exemption. As an example, the Bahrain tax of 46% on profits from the extraction or refinement of hydrocarbons does not qualify for the Participation Exemption.

In addition, the following countries and territories have a corporate tax lower than 9% and therefore cannot benefit from the Participation Exemption:

Importantly, Participation in a Qualifying Free Zone Person (that is an entity subject to 0% tax on Qualifying Income) is considered as meeting the condition of minimum tax for the Participation Exemption.

3. Economic Ownership Requirement

The Participation must entitle the holder to at least 5% of the profits available for distribution, and at least 5% of the liquidation proceeds upon cessation of business.

4. Not a Pass Through Entity

Finally, not more than 50% (fifty percent) of the direct and indirect assets of the Participation consist of ownership interests or entitlements that would not have qualified for an exemption from Corporate Tax under the Participation Exemption if held directly by the Taxable Person.

This provision is an anti-abuse clause to avoid situations where the Participation is a pass-through entity holding assets whether directly or indirectly of more than 50% of an entity located in no tax jurisdiction.

For example, this provision will be triggered if a UAE entity has a 6% ownership interest in a Singaporean entity that generates profits from its 100% owned subsidy located in Guernsey. In such a case, the profit received from the SG entity will not be exempt from taxation under the Participation Exemption.

Key Considerations

Since the Participation Exemption provides the Taxpayer with tax exempt income, expenditures related to the acquisition, sale, transfer, or disposal of all or part of a Participating Interest is not deductible for corporate tax purposes (UAE Corporate Tax Law, Article 28(2)(b).

The Participation Exemption cannot be applied for a period of two years:

• • Where the Participation is acquired in exchange for the transfer of an ownership interest that is not a Participating Interest.
  • Where the Participation is acquired in exchange for a transfer of assets and liabilities within a Qualifying Group at no gain or no loss under Article 26 of the UAE Corporate Tax Law.
  • Where the Participation is acquired in a Business restructuring transaction, and the Business restructuring relief is applied under Article 27 of the UAE Corporate Tax Law, i.e. the “cool-off period.”

Moreover, if the ownership interest falls below 5% for an uninterrupted period of 12 months, any income previously not considered for the UAE Corporate Tax computation must then be included in a Tax Period where the threshold was not met.

Despite the detailed legislation regarding the Participation Exemption, grey areas remain that will require further interpretation and clarification.

In house finance and tax professionals would be well served to work with external advisors like AMERELLER to analyze the application and potential benefits of the Participation Exemption.

[1] Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (the “UAE Corporate Tax Law”).
[2] Ministerial Decision No. 116 of 2023 on the Participation Exemption for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“MD No. 116 of 2023” or the “MD”).
[3] Ministry of Finance, Explanatory Guide On Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses, May 2023, p. 58.

If you would like more information about this topic, then please contact us.

• PATRYK KARCZEWSKI PARTNER pk@amereller.com

• DR. JOCHEN MURACH PARTNER murach@amereller.com

• CHRISTOPHER GUNSON PARTNER gunson@amereller.com

• JONATHAN P. NOBLE PARTNER noble@amereller.com

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