Clarifying the Tax Implications of Participating Interest Income.
A taxable individual might hold investments in the share capital of resident and nonresident juridical persons. If this investment equals or exceeds five percent or four million dirhams in the capital of a juridical person, it constitutes participation. Returns from participation encompass dividends, profit distribution, gains/losses from investment disposal, impairment gains or losses, and foreign exchange gains or losses. The income stemming from participation can either be exempt from the UAE Corporate Tax law (“CT law”) or taxable. For instance, dividend and profit distribution from resident juridical persons are tax-exempt under Article 22(1) of the law. However, the exemption for other related income from juridical persons (resident and nonresident) hinges on specific criteria outlined in Article 23(2) of the law.
Exemption from CT for income from participation is contingent on fulfilling certain conditions. If these criteria aren’t met, CT applies to the related income. As per Article 23(2)(a), a taxable person needs at least a five percent ownership interest or a four million dirham investment sustained for a continuous twelve-month period in the capital of the juridical person. This investment may comprise various equity interests, such as ordinary shares, preference shares, redeemable debentures, or any instrument granting profit and liquidation proceeds entitlement, as long as it’s classified as an equity interest in the taxable person’s books. When calculating this threshold, ownership interests by the taxable person in the same juridical person, or ownership interests held by members of a qualifying group in the same juridical person, are consolidated.
Article 23(2)(b) pertains to investment in the shares or capital of foreign juridical persons. It mandates that the foreign juridical entity should be subject to a corporate or similar tax of at least nine percent in the respective jurisdiction, and it must be a tax resident throughout the tax period in another country or foreign territory. If the foreign juridical person demonstrates to the FTA (Federal Tax Authority) that they’ve paid an effective nine percent tax, or if the tax is levied on recalculated profits resulting in an effective rate of at least nine percent, the minimum tax requirement is considered met. If the foreign jurisdiction doesn’t impose tax, the requirement is still met if the tax applies to income, equity, net worth, or a combination, resulting in an effective tax rate of at least nine percent based on accounting profits per applicable accounting standards.
Article 23(2)(c) stipulates that the taxable person should have the right to receive at least five percent of distributable company profits. In case of liquidation, the taxable person should have the right to receive at least five percent of liquidation proceeds. Article 23(2)(d) specifies that a maximum of fifty percent of participation assets should consist of ownership or entitlements that wouldn’t have qualified for an exemption if directly held by the taxable person.
Several scenarios negate exemption: deductions claimed by the company for dividend and distribution; recognizing impairment losses before meeting exemption conditions; recognizing a deductible impairment loss in relation to a loan receivable from the company. Losses from participation liquidation aren’t exempt under this article. Exemption is suspended for two years if conditions aren’t met, or if participation was acquired via transfer within a qualifying group or as part of business restructuring relief.
When a taxable person’s ownership interest drops below the five percent or four million dirhams threshold for a continuous twelve-month period, income that wasn’t initially taxable under this article becomes taxable in the relevant tax period.
Expenses linked to acquiring, selling, transferring, or disposing of participating interest aren’t deductible since the income isn’t taxable. Such expenses include professional fees, due diligence costs, litigation costs, commissions, brokerage fees, stamp duty, registration duties, unrecoverable taxes, appraisal and valuation costs, and refinancing costs. Interest expenditure related to acquiring and holding participating interest is deductible within interest limitation rules.
Taxable individuals should assess their investment status in juridical persons to ensure accurate tax positioning and appropriate taxation of related income.
