1. Overview of Equity Method and Dividend Adjustments:
- Equity Method of Accounting: Under IFRS 10 (Consolidated Financial Statements), when using the equity method for investments, a company records its share of the profit or loss of the investee in its financial statements. Dividends received from the investee should not be included as they are distributions of profit rather than part of the investor's share of profit.
- Dividend Treatment: IAS 28 (Investments in Associates and Joint Ventures) requires that dividends received be excluded from the share of profit or loss to prevent double-counting income. Under IAS 12 (Income Taxes), dividends may be exempt or subject to tax, depending on their source and tax jurisdiction.
2. Potential Accounting Issue:
- Incorrect Inclusion of Dividends: If dividends declared are not excluded from the share of profit or loss, they may inflate income, leading to an overstatement of Accounting Income. This creates potential tax issues, as incorrectly categorized dividends may lead to inaccurate CIT filings, especially if the dividend is exempt under UAE’s Participation Exemption.
- Tax Implications: In UAE, dividends received by a juridical resident person from qualifying entities are exempt income and should not contribute to taxable income. Including exempt dividends in Accounting Income could result in overreported taxable income, impacting the CIT return.
3. Tax Authority Perspective:
- Accuracy in Reporting Exempt Income: Tax authorities expect a clear separation of exempt and non-exempt income. Incorrectly reporting dividends as part of the equity method income without proper adjustments may raise questions during an audit, as it could impact the amount reported as exempt income.
- Reconciliation with Exempt Schedules: The tax authority would likely review whether exempt dividends are accurately adjusted in the ‘UAE Dividends’ or ‘Participation Exemption’ schedules. Inconsistent reporting might trigger inquiries or adjustments, especially if the income is overstated.
4. Example Scenario in AED: Scenario: ABC LLC, a UAE resident, holds a 30% stake in an associate company, DEF Co., which declares a profit of AED 1,000,000 for the year. ABC LLC records a share of profit of AED 300,000 (30% of AED 1,000,000). DEF Co. also declares a dividend of AED 50,000 to ABC LLC.
- Financial Statement Treatment: Share of Profit: ABC should record AED 300,000 in its income statement as its share of DEF’s profit. Dividend Exclusion: The AED 50,000 dividend received should be excluded from the share of profit calculation to prevent double-counting, as dividends are distributions of profits and not additional income.
- Tax Treatment: Exempt Dividend: Since ABC LLC is a UAE resident and the dividend qualifies as exempt, it should be reported separately in the ‘UAE Dividends’ schedule as exempt income.
5. Resolving the Accounting Issue:
- Accurate Adjustment of Dividends: Exclude any declared dividends from the share of profit/loss of the investment and instead report them separately in the relevant tax schedules. This ensures compliance with IAS 28 and aligns with IFRS 10 by avoiding the double-counting of income.
- Reconcile with CIT Schedules: Ensure that any exempt dividends are adjusted in the CIT return and included in the appropriate schedule (e.g., ‘UAE Dividends’ or ‘Participation Exemption’).
- Documentation: Keep detailed records of dividend declarations and share of profit entries to provide a clear audit trail that demonstrates compliance with IAS 12 and local tax regulations.
6. Example Resolution: ABC LLC addresses this by:
- Excluding Dividends: Records only the AED 300,000 as its share of profit in its income statement, excluding the AED 50,000 dividend from this figure.
- Reporting the Dividend Separately: Records the AED 50,000 in the ‘UAE Dividends’ schedule in the CIT return as exempt income, ensuring it doesn’t inflate taxable income.
- Regular Reconciliation: Periodically review investment income entries to verify that dividends are properly excluded from the equity method’s share of profit/loss.
- Training for Compliance: Train finance teams on the requirements of IFRS and IAS 28, ensuring they understand the need to exclude dividends from the share of profit/loss.
- Automated ERP System Adjustments: Configure ERP systems to differentiate share of profit and dividend entries, ensuring accurate reporting in financial statements and tax filings.
Summary: Accurately separating share of profit from dividends aligns with IFRS and IAS 12 requirements, preventing double-counting and ensuring correct CIT reporting. Proper reconciliation, documentation, and training mitigate risks, helping businesses maintain tax compliance and transparency in their financial statements.