UAE anticipates implementation Pillar Two by implementing domestic top-up tax

Background

On 24 November 2023, the UAE took a significant step in aligning with global tax reforms by amending its Corporate Income Tax (CIT) Law. The Federal Decree Law No. (60) of 2023, published in the Official Gazette, modifies some provisions of the original Federal Decree Law No. (47) of 2022 (CIT Law). This amendment introduces the concept of the 15% global minimum tax rate for Multinational Enterprises (MNEs), in line with the OECD’s BEPS Pillar Two rules.

Introduction of Top-up Tax

The new law introduces two key definitions to article 1 of the CIT Law:

• Top-up Tax: Defined as an additional tax levied on MNEs. This tax aligns with the OECD Pillar Two rules and will be detailed further by the Cabinet under Article (3) of the Decree-Law.
• Multinational Enterprise: this term now encompasses any entity, or its members, operating within the UAE or abroad, as specified by the Cabinet following the Minister’s recommendation.

The Decree-Law further states that a separate Cabinet Decision will be issued, which will lay out the relevant mechanisms, terms, conditions, rules, controls and procedures for imposing the Top-Up Tax on MNEs and relevant exemptions, to ensure that they will be subject to an effective tax rate of at least 15%.

A separate Cabinet Decision will determine the date of entry into effect of the new Top-Up tax mechanism.

Timeline for implementing Globe Rules

In September 2023, the UAE announced that it will not implement the Pillar Two rules until 2025. This decision was announced during a Regional Forum on the Global Minimum Tax hosted by the UAE Ministry of Finance in collaboration with the OECD. A public consultation on Pillar Two is planned for the first half of 2024 indicating that the UAE is taking a strategic pause to thoroughly evaluate the implications and frameworks of these rules before implementation.

In its Frequently Asked Questions (FAQs) on CIT, the UAE Ministry of Finance (MOF) has stated that “the introduction of a Corporate Tax regime helps to provide the UAE with a framework to adopt the Pillar Two rules”. Therefore, while the UAE has implemented its new CIT regime starting from financial periods after June 2023, the specific adoption of the OECD’s Pillar Two rules, including the Income Inclusion Rule (IIR) and Undertaxed Profits Rule (UTPR), is expected to be delayed until 2025.

Reason for introduction

The IIR and UTPR are designed to ensure that profits of MNEs are taxed at a minimum rate globally. Without a domestic top-up tax, profits earned in the UAE by MNEs could be subject to additional taxation in other jurisdictions where their parent companies are based, if they fall below the global minimum rate. The UAE’s top-up tax mechanism acts as a safeguard, ensuring that these profits are taxed domestically rather than abroad, thereby retaining tax revenue within the UAE.

Conclusion

In the evolving landscape of global taxation, the UAE has taken a proactive step by introducing a domestic top-up tax mechanism.

In our view, this move is not just about complying with international standards, instead, it represents a strategic initiative to protect the UAE’s tax revenues. It specifically addresses potential implications resulting from the implementation of the Income Inclusion Rule (IIR) and Undertaxed Profits Rule (UTPR) by other jurisdictions in line with the OECD’s BEPS Pillar Two model rules.

Currently, there remains a degree of uncertainty regarding the exact timeline for the implementation of the new top-up tax, particularly whether it will be effective for the financial year 2024. Despite this ambiguity, the UAE has made it clear that the Globe Rules will not be implemented until 2025 at the earliest. Multinational enterprises operating in the UAE should anticipate compliance with these global tax rules once formally adopted.