GCC Tax Theatre | International Tax | Juridical vs economic double taxation, and tax imputation systems in the context of UAE Corporate Tax

Juridical double taxation

Juridical double taxation refers to the inclusion of the same income in the hands of the same taxpayer in the tax base of one or more countries. An example of juridical double taxation is taxable income of a subsidiary of a parent company headquartered in mainland UAE. Such a subsidiary is categorized as a foreign permanent establishment under the UAE Corporate Tax. In ordinary circumstances, such a subsidiary would be subject to tax in UAE because of being an economic extension of the juridical resident parent, and also be subject to tax in the foreign country in which it is incorporated. Unless measures are in place to avoid such juridical double taxation, it would damage the trade and investment flow between the two countries.

Economic double taxation

Economic double taxation refers to the same income being subjected to tax in the hands of different taxpayers. A good example of such economic double taxation is seen in Pakistan, where corporate tax is levied on taxable profits of a company @ 29% (2023). However, when this company distributes dividends, a tax at source is deductible at the rate of 12.5 percent.

Tax imputation systems

In some parts of the world, resident shareholders are assessed for tax on dividends received plus any “franking credits” attached to those dividends. A franking credit represents corporate tax paid by the company on the profits giving rise to the dividend, which the shareholder can use to offset their own tax liability. The shareholder is assessed on the “grossed-up” income and then allowed a “franking tax credit” in respect of the corporate tax paid by the company on the profits from which those dividends are paid. This system is referred to as the dividend imputation system.

UAE perspective

UAE has complied with the recommendations of OECD's Model Tax Convention by allowing international double taxation reliefs/exemptions as follows:

Foreign Permanent Establishment

Under Article 24 of the UAE Corporate Tax Decree, a Resident Person can make an election to exclude the income, and associated expenditure, of its Foreign Permanent Establishments in determining its Taxable Income. Alternatively, Corporate Tax due in UAE can be reduced by the amount of Foreign Tax Credit for the relevant Tax Period claimed under Article 47. This comes with a condition that the Foreign Tax Credit cannot exceed the amount of Corporate Tax due on the relevant income. Furthermore, any unutilized Foreign Tax Credit as a result of Clause 2 of this Article cannot be carried forward or carried back.

Dividends and other Participation Interest

As per Article 23 of the Federal Decree Law No. 47 of 2022 and Ministerial Decision No. 116 of 2023, income viz. gains or losses on transfer of Participating Interest, dividends or profit distributions, etc. from Participating Interest is exempt from Corporate tax subject to certain conditions.

·??????Ownership Interest of at least 5%

·??????Entitlement to receive at least 5% of profits or liquidation proceeds

·??????Continuous ownership for at least 12 months

·??????Should not hold assets > 50% not eligible for Participation Exemption

·??????Participation is subject to tax in foreign jurisdiction which is applied on a basis similar to UAE CT**

·??????Any other conditions prescribed

Withholding Taxes on Non-Resident Person

Article 45 of the UAE Corporate Tax Decree has fixed the rate of Withholding Tax at zero percent (0%) on UAE Sourced Income derived by a Non-Resident Person to the extent such income is not attributable to a Permanent Establishment of the Non-Resident Person in the UAE. This rate may change in future and, consequently, Non-Resident Persons may be allowed to be registered for Corporate Tax on their UAE Sourced Income to allow them relief from being over-taxed due to hefty Withholding Tax deductions in the UAE, which would consider only the gross invoice values and ignore allowable deductions like the rest of the world.