Article 23 of the UAE Corporate Tax Law stipulates the Exemption for Participating Interest which is a substantial ownership stake in a juridical person, denoting a degree of control or influence over said entity. To qualify, certain conditions stipulated by this article must be satisfied. This article outlines the exemption provision for income originating from a Participating Interest. Such income encompasses dividends and capital gains and is exempt from Corporate Tax.
Conditions for Qualifying as a Participating Interest
The law sets conditions that determine ownership interest as a Participating Interest, thus, eligible for the exemption:
- Minimum Ownership Threshold: A Participating Interest necessitates ownership of 5% or more in the shares, capital, membership interests, or equivalent rights of the juridical person. This stipulates that the entity's capital structure must involve divisible shares or similar instruments that confer entitlement to profits and liquidation proceeds. Aggregation of various share types is permissible if the condition in Clause 2(c) remains satisfied. Ownership below 5% is deemed a passive or portfolio investment, ineligible for the Participation Exemption unless Clause 11's acquisition cost threshold is met.
- Mandatory Holding Period: The Participating Interest must be held or intended to be held for an uninterrupted span of at least 12 months. The condition does not mandate the complete Tax Period or the minimum holding period's fulfillment at the time of income derivation. Income from a Participating Interest, even before the minimum period elapses, qualifies for the exemption if the Taxable Person's intent is to retain the interest for 12 months. The determination of intent often hinges on factual circumstances, such as the Taxable Person's business activities.
- Asset Composition Criterion: The Participation's non-qualifying ownership interests should not comprise more than 50% of its assets. An ownership interest in a Participation will not be eligible for the Participation Exemption if, on a consolidated basis, over 50% of the assets consist of ownership interests that do not individually satisfy Article 23's conditions, as they would if directly held by the Taxable Person. Examples of non-qualifying assets encompass ownership interests in foreign juridical persons exempt from foreign corporate income tax unless they meet the conditions specified in Clause 3 or those prescribed by the Minister under Clause 2(e).
- Additional Conditions: There may be some other conditions prescribed by the Minister having authority to introduce additional conditions and requisites deemed suitable for the effective application of this Article.
Tax Test for Specific Exemption Participation:
There may be a possibility for a Participation that does not face Corporate Tax or an equivalent of at least 9% to satisfy the subject-to-tax test under Clause 2(b). This occurs when the Participation's primary objective and activity are the acquisition and retention of shares or equitable interests, provided these ownership interests conform to the prerequisites. Additionally, the Participation's predominant income should encompass dividends, capital gains, and other qualifying income originating from Participating Interests.
Exemptions for Qualifying Free Zone Person or Exempt Person:
Clause 4 establishes that Participation in a Qualifying Free Zone Person or an Exempt Person is deemed to meet the subject-to-tax test under Clause 2(b), subject to any conditions determined by the Minister.
Territorial Tax Elements For Participation Exemption:
While Resident Persons are typically subject to Corporate Tax on both local and foreign income (as explained in Article 12), the Corporate Tax Law integrates facets of a territorial tax framework. This framework allows the exclusion of specific income, unrelated to UAE activity or sources, from Corporate Tax liability.
- Mitigating Double Taxation: The exemption established in this article serves as a strategic tool to alleviate or eradicate instances of economic double taxation within a residence-based tax system. This mechanism ensures that income obtained from a Participating Interest remains free from taxation, safeguarding entities from multiple taxation occurrences.
- Preventing Double Taxation: This exemption plays a pivotal role in scenarios where a juridical person distributing profits or selling shares has previously borne taxation on its earnings. By exempting income received from an ownership interest in a Participation, the provision effectively prevents redundant taxation, both domestically and internationally.
- Impact on Expenditure: The exemption's ambit encompasses expenditures linked to income derived from a Participating Interest. As per Articles 22 and 28(2)(b), such expenditures lose their deductibility, with the exception of Interest expenditure in alignment with Article 29. This ensures coherence within the taxation structure.
Participation Exemption: A Symmetrical Income Exemption
- Nature of the Exemption: The Participation Exemption extends beyond a mere net income exemption. It operates as a symmetrical exemption, encompassing various forms of income associated with a Participation Interest. This includes qualifying capital gains, revaluation gains, and foreign exchange gains, all of which are exempt from Corporate Tax.
- Symmetrical Treatment of Gains and Losses: The symmetry of this exemption is noteworthy. It not only exempts gain but also disallows deductions for losses. Capital losses, foreign exchange losses, and impairment losses are not eligible for the deduction, ensuring uniformity in the application of the exemption (excluding losses realized from Participation liquidation as per Clause 8).
- No Election or Application Required: Clause 1 clarifies that the Participation Exemption is applicable without necessitating a specific election or application by the Taxable Person. Once the qualifying conditions are fulfilled, the exemption automatically applies to all pertinent income derived from the Participating Interest. No formal application is required to avail the exemption to come into effect.
- Application by UAE Permanent Establishment: A UAE Permanent Establishment, being a Taxable Person, can invoke the Participation Exemption for income originating from ownership interests that meet Article 23's conditions. This attribution is governed by Article 12(3)(a).
Seek the expert services of trusted Tax Consultants UAE
Article 23 of the UAE Corporate Tax Law establishes the "Exemption for Participating Interest," subject to specific criteria. To qualify as a Participating Interest, an ownership stake must meet conditions including a 5% ownership threshold, a 12-month holding period, and limitations on non-qualifying assets. This exemption, applied automatically, covers various income types while disallowing certain deductions, promoting tax fairness. It also plays a crucial role in preventing double taxation and upholding uniformity in tax treatment, contributing to a balanced and effective tax system in the UAE. Thus, contact us today and we shall be glad to assist you.
Read More: UAE Corporate Tax : An Explanatory Guide