UAE Corporate Tax Law: Can you use the total amount of interest paid to determine your taxable profit? 

Companies have access to a variety of funding options, and debt finance is one of them. Debt financing can take many different forms, including overdrafts, preference shares, and regular loans from financial institutions. The cost of debt financing, also known as interest, is typically less expensive than the cost of equity. The interest payments are seen as a business expense when borrowed money is used for commercial reasons, which reduces the accounting earnings. If allowed by tax authorities, interest payments can lower taxable profits, resulting in tax savings, as corporate tax is assessed on taxable profits, which are determined after reducing. 

A taxable individual can choose to take on more debt because the cost of debt is cheaper than the cost of equity, therefore they don’t need to think about the best capital structure. To move their profits from a high tax jurisdiction to a low or no tax jurisdiction, taxable individuals can take out large loans from relatives in tax-free countries and zones with lower taxes. 

For instance, a corporation in the UAE’s mainland may borrow a sizable sum from a connected party in the free zone, where revenue is taxed at 0%. Companies operating in free zones will not pay any corporate tax on their interest income. The mainland company’s taxable profits will also be lowered by interest expense on its books. As a result, the interest on debt makes it easier to move profits from a country with high taxes to one with low or no taxes, which lowers the tax burden on the mainland company. 

Interest capping rules have been added to Article 30 of the UAE Corporate Tax Law to discourage excessive debt financing, ensure that debt financing used or arising as a result of certain specific intra-group transactions will only be deductible if there is a valid commercial reason for obtaining the loan, and to combat profit shifting practices (UAE CT Law). 

Interest is the sum cost to raise funds and accrued or paid to use money or credit, according to the UAE CT law. It is crucial to keep in mind that any expense used to raise money has also been categorized as interest under UAE CT law; typically, this is a loan or debt initial processing expense. 

A taxable person may deduct a maximum of 30% of adjusted earnings before interest, tax, depreciation, and amortization (EBITDA) for net interest during a tax period, according to Article 30 of the UAE CT law. Any residual net interest amount may be carried forward for a further ten years. The interest limitation requirements, however, will not apply if the net interest amount is below the minister’s set level, and the taxable person may instead deduct the full amount of net interest. 

Excess net interest over interest income is referred to as net interest. Exempt income won’t be taken into account for calculating EBITDA. The net interest amount will also not take into account any interest income or expenses related to the exempt income. 

Several sections of the UAE CT law align with Action 4 of the OECD’s Base Erosion and Profit Shifting (BEPS) project, and the member countries of the OECD have implemented it. If the interest amount exceeds the limit set by the minister, taxpaying individuals must determine the acceptable interest amount using the processes listed below:

• Taxable persons are required to calculate the accounting profits as per IFRS (International Financial Reporting Standards). 
• These accounting profits will be adjusted to arrive at the EBITDA (exempt income will not be considered).
• Net interest (interest expenses less interest income) will be calculated.
• 30 per cent of the adjusted EBITDA is to be determined [adjusted EBITDA *30%]
• The maximum allowed interest is calculated in the above point. Any net interest above 30 per cent of EBITDA will be carried forward for ten years.

As previously stated, article 30(3) of the UAE CT law permits taxable persons to deduct up to a set amount of net interest expenses in order to reduce their tax liability and administrative expenses (safe harbor or de minimize amount). This indicates that if the net interest is less than the threshold, a fixed amount of interest is permitted. The calculation would be quite straightforward and economical if we used this method, but we’ll have to wait for the Minister to decide whether to use this particular sum. 

If a related party loan is used to finance income that is exempt from CT, the interest on that loan is not deductible unless the taxpayer can show that getting the loan and carrying out the transaction was not done primarily to benefit from a CT advantage. For instance, interest on a loan taken from a connected party to pay the connected party for dividends, profit distribution, the redemption of or contribution to share capital, or the acquisition of ownership interest in a person who is or becomes connected to the connected party after the acquisition. 

If the connected party (lender) is required to pay a tax rate of nine percent or higher on the earned interest income, no CT advantage shall be regarded to exist. Any interest paid to a related party will only be regarded as a deductible expense if there is a business rationale and the interest income in the lender’s possession is subject to at least 9% tax. 

Interest limiting regulations won’t apply to certain industries since they have different risk profiles and capital requirements, such as banks, insurance companies, and some other regulated financial services corporations. Moreover, interest capping laws will not be applicable to firms run by natural people, according to the UAE CT law. 

Taxpayers must do a thorough impact analysis and, if necessary, arrange debt while keeping in mind the particular requirements of the law.