Participation Exemption Guide for Corporate Income Tax

Background

On 16 October 2023, the UAE’s Federal Tax Authority (FTA) published a new Guide (the “Guide”) on the Participation Exemption regime under the new Corporate Income Tax (CIT) regime. Whilst the Guide emphasizes various important aspects of the regime, it also provides useful clarifications for taxpayers.     

Exempt Income

The Participation Exemption regime exempts foreign dividends, capital gains and other types of income derived in respect of qualifying shareholdings (i.e., a shareholding that meets all conditions for the Participation Exemption).

The aim of the Participation Exemption is to avoid double taxation of corporate profits, whereby such profits would otherwise have been taxed at the level of the subsidiary and then a second time when the profits are distributed, or when the parent sells its shares in the subsidiary.

Conditions

The main conditions to benefit from the Participation Exemption regime are as follows:

• The parent company must own a shareholding of 5% or more in the subsidiary. This condition will also be considered met where the aggregated acquisition cost of the ownership interests in the subsidiary is at least AED 4 million (i.e., even where this does not represent a shareholding of 5% or more in the subsidiary).
• The parent company must hold the shares for at least 12 months.
• The subsidiary must be subject to tax at a minimum rate of 9%. For this condition to be met, the tax must be applied on a similar basis to UAE CIT and the tax must be levied at a rate of 9% or more.
• Less than 50% of the direct and indirect assets of the participation consist of ownership interests or entitlements that would not have qualified for the participation exemption if held directly by the parent company.

The recently published Guide confirms the above-mentioned conditions and includes further details around some of the specific requirements.

Constructive dividends

The Guide introduces the concept of constructive dividends which could arise, for example, as a result of a transaction under which a parent company receives compensation that exceeds the fair value of the goods or services provided by it, to its subsidiary. This concept is known in some other jurisdictions as a ‘deemed dividend distribution’ and the same would arise when a subsidiary grants a benefit to its parent company by means of transacting with it using below arm’s length prices (e.g., granting an interest free loan to the parent company). Whilst the Guide does not touch on this, it would be interesting to see whether the mirror image situation, where a similar benefit granted by the parent company to its subsidiary, would result in a so-called ‘informal capital contribution’ onto the subsidiary for tax purposes.

Profit participating loans

Whilst ownership interests for purposes of the Participation Exemption would typically be ordinary shares, preferred shares or similar, the regime may also apply to debt instruments with equity characteristics. The Guide indicates that a debt instrument is treated as an ownership interest if it is classified as an equity interest under the accounting standards applied by the taxpayer. This may be particularly relevant for so-called Profit Participating Loans, which are a type of quasi-equity investment.     

Subject to tax test

The subject to tax test, as mentioned under iii. above, is met if the subsidiary is resident in a jurisdiction that levies a CIT of a similar character to the UAE, at a statutory tax rate of at least 9%. The Guide confirms that a recalculation of the foreign subsidiary’s tax base to apply UAE CIT principles is not required.

Deductible dividends

The Guide indicates that the Participation Exemption in respect of dividends does not apply if the foreign subsidiary is able to claim a tax deduction for such payments in its jurisdiction of residence. This condition is intended to prevent situations of potential double non-taxation that would arise if the subsidiary can claim a tax deduction for the dividend payment, whilst this would be exempt income for the UAE parent company under the Participation Exemption regime.

Conclusion

The Participation Exemption Guide casts light on various important aspects of the Participation Exemption under the UAE CIT regime. Most notably, the Guide provides clarification regarding the criteria for the Participation Exemption, including the ownership interest test, holding period test, subject to tax test and asset test. The Guide also elaborates on specific topics such as constructive dividends, tax grouping and tax deductible dividends.