The Ministry of Finance has announced amendments to existing ministerial decision no.116 of 2023 on the participation exemption and foreign permanent establishment exemption for the purpose of Federal Decree-Law No. 47 of 2022 (UAE CT law) by issuance of an updated ministerial decision no. 302 of 2024 (new decision).

The key changes brought about by this new decision are explained as follows:.

Definitions added

The new decision has added definitions for a qualifying foreign permanent establishment and a non-qualifying foreign permanent establishment.
Qualifying foreign permanent establishment (QFPE) is a permanent establishment that is subject to Corporate Tax or a tax of a similar character under the applicable legislation of the relevant foreign jurisdiction at a rate not less than 9%''
Non-qualifying foreign permanent establishment (NQFPE) would mean a permanent establishment that does not meet the above-mentioned criteria.

Clarifications provided on various implications on transfer of ownership interest in a participation

Clause 9 of Article 23 of the UAE CT law provides that participation exemption shall not apply for 2 years in cases where participation was acquired:

a) in exchange for transfer of an ownership interest which did not meet the conditions of participation exemption provided under clause 2 of Article 23, or
b) by way of an exempt transfer (as per Article 26 - Transfers within qualifying tax group and Article 27 - Business restructuring relief).

Article 4(2) of the new decision has clarified that in case of transfer as per Article 27 the period of 2 years shall commence from the date of first exempt transfer and shall continue for such subsequent transfers.
New decision provides that where participation exemption was not claimed in case of participation acquired under an exempt transfer and subsequently the transfer becomes taxable due to violation of any conditions, the taxable person may reverse any income which was previously taken into account due to restriction applicable under Article 9 of the UAE CT law. This adjustment to taxable income shall be done during the tax period in which there is a violation of conditions of exempt transfer.

Minimum Acquisition Cost

The earlier decision required the condition of Article 23(2), para (c), i.e. entitlement to 5% of profits available for distribution and 5% of liquidation proceeds to be met even if minimum acquisition cost criteria is satisfied.
This difficulty is resolved in the new decision which states that the condition of 5% ownership interest as well as 5% entitlement to profits available for distribution and liquidation proceeds shall all be treated as met if minimum acquisition cost criteria is satisfied.

Asset test

Para (d) of clause 2 of Article 23 of the UAE CT law prescribes an asset test as per which participation exemption shall not be available if more than 50% 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 this Article if held directly by the Taxable Person.
The new decision has clarified that this test shall apply only where participation is a related party of the taxable person.

Liquidation proceeds and Losses.

Clause 8 of Article 23 of the UAE CT law provides that no exemption shall apply to loss realized on liquidation of a Participation.
Liquidation loss is to be computed as a difference between the acquisition cost of the participating interest and fair value of the liquidation proceeds.
Certain adjustments were prescribed to be made to the liquidation loss in the earlier decision. These adjustments have been updated in the new decision.
The liquidation loss determined as above shall be reduced by the following in the relevant tax period and preceding seven tax periods as applicable -

a) Tax losses transferred by participation or its participations to taxable person or any of their related parties.
b) Exempt dividends or profit distributions received from participation.
c) The difference between the Market Value and the amount of consideration paid for an asset or liability which was transferred between the Taxable Person or the Taxable Person's Related Parties and the Participation or its Participations where the Market Value exceeds the amount of consideration paid insofar such difference has not already been taken into account by the Taxable Person under paragraph (a) or (b) of this Clause or under Articles 20 and 34 of the UAE CT law.
d) Any other adjustment in respect of above if not already taken into account while determining liquidation loss.

The new decision also covers implications for liquidation of a participation which was a member of a tax group. In such a case any liquidation loss recognized in relation to that Participation by the Tax Group or the Parent Company or any of its Related Parties shall be reduced by the following in the relevant Tax Period and preceding seven Tax Periods, as applicable:

a) Tax Losses attributable to the Participation while it was a member of the Tax Group calculated in accordance with Article 7 of Ministerial Decision No. 301 of 2024 (Relief for pre-grouping tax losses) which have been taken into account in determining the Taxable Income of the Tax Group.
b) Dividends or other profit distributions made by the Participation while it was a member of the Tax Group that were eliminated for the purposes of determining the Taxable Income of the Tax Group under Article 42 of the UAE CT Law.

A loss cannot be realized by a Tax Group on the liquidation of a Participation where the Participation leaves the Tax Group due to business restructuring as per Article 10 of Ministerial Decision No. 301 of 2024.

Foreign Permanent Establishment Exemption

The earlier decision provided that before applying for exemption for income of foreign permanent establishment, the tax losses incurred by the foreign permanent establishment and utilized by the taxable person should be fully offset by the taxable income of the foreign permanent establishment in subsequent tax period or periods.
The new decision provides for a similar condition for opting for exemption method. However, instead of loss and profit of a Permanent Establishment it has allowed to consider all the Qualifying Foreign Permanent Establishments of the taxable person.
New decision also provides that in case where a Taxable Person transfers all the assets and liabilities of a QFPE to a Participation, resulting in the termination of the existence of that QFPE, the Taxable Person can only benefit from the provisions of participation exemption on the amount of income from the Participation in excess of the aggregate Tax Losses incurred by the Taxable Person's QFPE which has been utilized by taxable person.
Similar mechanism for claiming participation exemption is prescribed where a Taxable Person transfers all the assets and liabilities of a Non-Qualifying Foreign Permanent Establishment to a Participation.

Applicability

The new decision shall apply for tax periods beginning on or after 1 January 2025. The earlier decision shall continue to apply for tax periods that commenced before 1 January 2025.

Our Comments

Restricting asset test only to related parties is a welcome move and would provide relief to many taxpayers. However, clarifications provided on transfer of ownership interest, treatment of liquidation loss and adjustment of losses for foreign permanent establishment may need detailed review on a case-to-case basis.

It would be imperative for companies in the UAE to re-evaluate their tax position in light of the recent clarification provided through this new decision. Reduction of tax losses and exemptions claimed seven years before the liquidation of participation may be viewed as a rigorous provision by some tax payers in UAE.