Foreign Tax Credit vs Foreign Permanent Establishment Exemption September 2025

Background

Under the Corporate Income Tax (CIT) law¹, a Resident Person, whether a juridical or natural person, is subject to tax on its worldwide income, including income derived from foreign sources. Foreign source income refers to income derived from outside the UAE, such as dividends, interest income, royalties, capital gains, profits attributable to a foreign permanent establishment (PE), payments for services performed abroad, and other cross border transactions.

However, the CIT law provides specific exemptions to avoid double taxation and promote the competitiveness within the international tax environment. Notably, the Participation Exemption allows dividends and capital gains from qualifying foreign shareholdings to be exempt, while income of a foreign PE may also be exempt by electing the Foreign Permanent Establishment Exemption (FPEE). Additionally, the UAE permits a Foreign Tax Credit (FTC) for taxes paid in other jurisdictions, which can be offset against UAE CIT liabilities.

This article outlines the specific conditions and tax implications of the FPEE and FTC. It also provides a comparative overview of which mechanism is more advantageous for a UAE Resident Person, where both are available.

 

Foreign Permanent Establishment Exemption

If the UAE Resident Person is subject to tax in a foreign jurisdiction by virtue of having a PE, it may mitigate double taxation by applying the FPEE. If the UAE Resident Person elects for the FPEE, all income (and associated expenditure) derived from a foreign PE is exempt from the CIT in the UAE. In addition, also losses of the foreign PE and FTC in relation to the foreign PE are not taken into account in determining taxable income.

One of the key conditions for applying this exemption is that the foreign PE must be subject to CIT or a tax of a similar nature at a rate of at least 9% in the foreign jurisdiction. The Resident Person must maintain separate financial records for the PE, ensuring clear segregation of income and expenses.

An election for the FPEE applies to all foreign PEs of the UAE Resident Person that meet the required conditions. If the exemption is elected for one qualifying foreign PE, it must be applied to all other qualifying foreign PEs.

Furthermore, all transactions between the Resident Person and its foreign PE must comply with the arm’s length principle, ensuring fair market value and compliance with the transfer pricing (TP) rules. Lastly, the exemption must be elected annually in the CIT return, and once chosen, the income and losses of the foreign PE are excluded from the UAE taxable income.

However, if a foreign PE has previously incurred tax losses that were used to offset other profits, such as those from the head office, the exemption cannot be claimed until those losses are fully offset by future taxable income of the foreign PE in a subsequent tax period(s)².

 

Foreign Tax Credit

As an alternative to the FPEE, a double taxation may be mitigated by claiming an available FTC for the same tax period. The FTC represents the amount of foreign tax paid on foreign-sourced income that has not been exempted under the FPEE or Participation Exemption. It allows a Resident Person to deduct taxes paid in a foreign jurisdiction from the UAE CIT due on the same income. This relief is unilateral and does not depend on the existence of a Double Tax Treaty (DTT) or reciprocal arrangements with the foreign jurisdiction.

Unlike the FPEE, which is only available if the UAE Resident Person has a PE in a foreign jurisdiction, the FTC may be applied in a wider range of circumstances. This includes situations where a foreign PE exists, as well as cases where no PE is created but the UAE Resident Person is subject to CIT or a similar tax in the foreign jurisdiction.

The FTC is applied against the UAE CIT liability on the same income, but is limited to the lower of:

• The actual amount of tax paid on the foreign-sourced income in the foreign jurisdiction; or
• The amount of UAE CIT due on that foreign-sourced income.

Given that the UAE CIT regime applies a 0% rate on taxable income up to AED375,000 and 9% on income exceeding that threshold, the UAE tax due on foreign-source income must be determined on a weighted average basis. This is calculated using the following formula:

UAE Tax Credit on Foreign Income =x*y/z

X= CIT due on total Taxable Income of the Taxable Person before any FTC
Y= Relevant foreign source net income (foreign income reduced by economically related expenses)
Z= Total Taxable Income of the Taxable Person

 

An FTC is available for any foreign tax that is considered similar in nature to UAE CIT. For a foreign tax to qualify, it must be imposed by and payable to the government of a foreign jurisdiction (whether federal or state). Its payment must be compulsory and enforceable under that jurisdiction’s tax laws, and it must be levied on profits or net income. Notably, foreign WHT and ZAKAT are deemed to meet this requirement.

To claim an FTC, the foreign tax must either be remitted or legally accrued to the relevant foreign tax authority. The associated foreign income must be included in the UAE taxable income for the corresponding tax period, and the credit should generally be claimed within that same period. Any unutilised FTC cannot be carried forward and will be forfeited.

Taxpayers must maintain comprehensive documentation to support their FTC claims. This may include a WHT certificate, a copy of the tax return filed in the foreign jurisdiction, an official payment receipt or letter from the relevant foreign tax authority confirming that the taxes have been paid. The records maintained by the UAE Resident person must include the amount of foreign-sourced income subject to tax in its local currency, the exchange rate used to convert it to AED and the financial year in which the income was earned. They should also document the nature and amount of foreign tax levied, the date of payment, and whether the tax represents an advance instalment, WHT, or a final tax payment.

 

Interaction between Foreign Permanent Establishment Exemption and Foreign Tax Credit

The Resident Person cannot benefit from both FPEE and FTC relief on the same income. If the FPEE is claimed, no FTC can be applied to CIT paid in the foreign jurisdiction. This is because the income and related expenses of the qualifying foreign PE are already excluded from the UAE tax base and are not subject to UAE CIT.

Conversely, if the FPEE is not elected, the income from the foreign PE is included in the UAE taxable income. In this case, the taxpayer may claim an FTC for foreign taxes paid, but only up to the amount of UAE CIT that would have been payable on that income.

Therefore, the Resident Person should carefully evaluate which mechanism offers greater benefits from a tax perspective. This depends largely on the foreign tax rate, the PE’s profitability, and the availability of supporting documentation.

While the FPEE applies to all qualifying foreign PEs, the FTC may be claimed for taxes paid on non-qualifying PEs. Additionally, the Resident Person can claim an FTC for other eligible foreign taxes unrelated to exempt PEs, such as WHT on services, interest income, and similar cross-border payments.

 

Practical examples

Foreign income and taxes are typically denominated in a foreign currency and must be converted to AED using the exchange rate published by the UAE Central Bank. For simplicity, the examples below are presented in AED only.

Example A

A company incorporated and resident in the UAE (UAE Company) has a foreign PE located in country A (PE A), which is subject to CIT at a rate of 20% in country A.

In the financial year (FY) 2024, the UAE Company reported a total worldwide taxable income of AED10 million. Of this amount, AED1 million is attributable to the activities of PE A.

The following calculation compares the impact of electing the FPEE versus claiming the FTC.

• If the UAE Company elects to apply the FPEE, its tax treatment would be as follows:

Worldwide taxable income: AED 10 million
Less: AED1 million based on the FPEE
UAE taxable income: AED9 million
UAE tax payable: (AED9 million – AED375,000) * 9% = AED776,250

• If the UAE Company opts to claim the FTC instead, its tax treatment would be as follows:

Available FTC is limited to the lower of:

• The actual amount of tax paid on foreign-sourced income in Country A: AED1 million * 20% = AED200,000
• The amount of UAE CIT due on that foreign-sourced income = AED866,250 * AED1 million / AED10 million = AED86,625

UAE taxable income = worldwide taxable income: AED10 million
UAE tax liability: (AED10 million – AED375,000) * 9% = AED866,250
Less: AED86,625 based on the available FTC
UAE tax payable after claiming the FTC: AED866,250 – AED86,625 = AED779,625

The FPEE is generally more advantageous when the foreign PE is subject to a foreign tax rate of 9% or higher and generates a positive taxable result.

Example B

Let’s consider a similar scenario in which the UAE Company operates in Country B through a foreign PE (PE B), which is subject to CIT at a rate below 9%.

Since the CIT rate applicable to PE B is less than 9%, the PE B does not qualify for the FPEE under UAE CIT Law. Instead, it may only claim an FTC, provided that tax has been paid in the foreign jurisdiction.

Example C

In this example, the UAE Company has a foreign PE located in country C (PE C), which is subject to CIT at a rate of 10% in country C.

In the financial year (FY) 2024, the UAE Company reported a total worldwide taxable income of AED10 million. This amount includes a loss of AED1 million made by PE C.

The following calculation compares the impact of electing versus not electing the FPEE.

• If the UAE Company elects to apply the FPEE, its tax treatment would be as follows:

Worldwide taxable income: AED10 million
Less: - AED1 million based on the FPEE
UAE taxable income: AED11 million
UAE tax payable: (AED11 million – AED 375,000) * 9% = AED776,250

• If the UAE Company does not elect to apply the FPEE, its tax treatment would be as follows:

UAE taxable income = worldwide taxable income: AED10 million
UAE tax payable: (AED10 million – AED375,000) * 9% = AED866,250

Based on the above example, it may be preferable for the UAE Company not to elect the FPEE when the foreign PE is in a loss-making position, as this allows the losses to reduce the UAE taxable base.

However, the UAE Company may think long-term and choose to elect the FPEE in order to preserve the foreign tax losses. The tax losses could be more valuable when offset against future taxable profits of the PE, which is particularly the case if the PE is subject to a higher tax rate (e.g., 20%). This, of course, depends on the tax laws of the foreign jurisdiction, including whether tax loss carryforward is permitted. Another important consideration is that if the foreign PE has carried forward tax losses, the FPEE may be deferred until those losses are fully offset.

Therefore, it is crucial to assess the benefits of the exemption on a case-by-case basis, taking into account both tax efficiency in the current year and long-term tax planning opportunities.

Example D

The UAE Company has a foreign PE in Country D (PE D), where it earns AED1 million and is subject to a 20% CIT. It also operates in Country E, earning AED0.5 million from services provided. Although it does not have a PE in Country E, a 10% WHT is applied to the income earned there. In the UAE, the UAE Company earns AED8.5 million, resulting in a total worldwide income of AED10 million.

By electing the FPEE for PE D, the AED1 million is excluded from the UAE tax base. The AED0.5 million of income from Country E remains fully taxable in the UAE.

However, the foreign WHT paid may be claimed as an FTC.

Worldwide taxable income: AED10 million

Less: AED1 million based on the FPEE
UAE taxable income: AED9 million
UAE tax liability: (AED9 million – AED375,000) * 9% = AED776,250

Available FTC is limited to the lower of:

• The actual amount of tax paid on foreign-sourced income in Country E = AED0.5 million * 10% = AED50,000
• The amount of UAE CIT due on that foreign-sourced income = AED776,250 * AED 0.5 million / AED9 million = AED43,125

UAE tax liability: AED776,250
Less: AED43,125 based on the available FTC
UAE tax payable: AED776,250 - AED43,125 = AED733,125

This example presents a scenario where both the FPEE and the FTC are applied in the same FY; not on the same income, of course.

 

Conclusion

When a UAE company has a foreign PE, it may choose whether or not to elect the FPEE, or alternatively, to claim an FTC. This decision depends on several factors, including the foreign jurisdiction’s tax rate, the profitability of the PE, and the availability of supporting documentation.

As illustrated above, both mechanisms can be applied within the same tax period, but not to the same income. Depending on the specific facts and circumstances, the Resident Person may choose one approach over the other to optimize their overall tax position. The following scenarios outline how different circumstances may influence the choice of mechanism:

While the FPEE may appear simpler and potentially more effective in reducing the CIT liability, its suitability must be assessed on a case-by-case basis. The optimal choice depends on which mechanism offers greater relief and aligns best with the client's overall tax and compliance strategy.

It is important to note that the FTA may deny either form of relief if the Resident Person fails to maintain the necessary supporting documentation.

 

Key takeaway

A UAE Resident Person is subject to tax on its worldwide income, including income derived from foreign sources. To mitigate double taxation, the Foreign PE Exemption and Foreign Tax Credit provide relief.

When a UAE company has a foreign PE, it may choose whether or not to elect the Foreign PE Exemption, or to claim a Foreign Tax Credit.

The preferred approach depends on several factors, including the foreign jurisdiction’s tax rate, the profitability of the PE, and the availability of supporting documentation

 

Reference

• Corporate Tax Guide: Taxation of Foreign Source Income