Foreign Tax Credit (FTC) in the UAE: Overview and Application

A Foreign Tax Credit (FTC) is a tax relief mechanism that allows businesses to offset taxes paid to foreign tax authorities against their domestic tax liabilities. This prevents the risk of double taxation, which occurs when the same income is taxed in both the country of origin (where the income is generated) and the country of residence (where the taxpayer is based). The Foreign Tax Credit system is typically designed to reduce the tax burden on businesses that operate internationally, ensuring that they do not face unfair tax treatment from multiple jurisdictions.

In the context of the United Arab Emirates (UAE), the introduction of Corporate Tax (CT) in 2023, combined with the UAE’s extensive network of Double Taxation Treaties (DTTs), provides certain opportunities for businesses to claim Foreign Tax Credits under specific circumstances.

1. Foreign Tax Credit (FTC) in the UAE: Key Features

The UAE does not have a broad Foreign Tax Credit (FTC) system like many other countries. However, it does have mechanisms that help mitigate the impact of double taxation, specifically through the Double Taxation Treaty networkand by allowing businesses to claim credits or exemptions under certain conditions. Below are the key points relevant to FTC in the UAE’s new Corporate Tax (CT) framework:

No General Foreign Tax Credit System

Unlike many countries that offer a general foreign tax credit to offset taxes paid in other jurisdictions, the UAE does not have a domestic foreign tax credit mechanism for businesses to offset foreign taxes against their UAE tax liabilities. This means that businesses cannot directly claim a credit for foreign taxes paid when calculating their corporate tax liability in the UAE.

However, businesses in the UAE can benefit from other tax relief mechanisms to mitigate the risk of double taxation:

1. Double Taxation Treaties (DTTs): The UAE has signedDouble Taxation Treaties with more than 100 countries. These treaties help businesses avoid double taxation by providing either tax exemptions or reduced tax rates on certain types of income, such as dividends, royalties, interest, and capital gains.
2. Permanent Establishment (PE) in the UAE: If a foreign business operates in the UAE through apermanent establishment (PE), the business is subject to UAE Corporate Tax on the income attributable to the PE. If taxes are paid in the foreign jurisdiction, a DTT might provide relief through tax exemptions or reductions.

2. How Double Taxation Treaties (DTTs) Affect Foreign Tax Credit

While the UAE does not provide a general foreign tax credit for taxes paid abroad, its DTT network plays a crucial role in reducing or eliminating the risk of double taxation. These treaties typically allow for tax exemptions or reductions on income that is taxed both in the UAE and a foreign country. The primary purpose of these treaties is to avoid double taxation and provide tax certainty for businesses operating internationally.

Key Features of DTTs:

• Reduced Withholding Tax Rates: Many of the UAE’sDouble Taxation Treaties reduce or eliminate withholding tax on cross-border payments, such as:

• • Dividends
  • Interest
  • Royalties

For example, if a UAE company receives dividends from a foreign subsidiary in a country with which the UAE has a DTT, the treaty may reduce or eliminate the withholding tax that would otherwise be charged by the foreign jurisdiction on the dividend payments.

• Tax Exemptions: DTTs often provide exemptions or credits for income generated in a foreign country, such as income from a foreign subsidiary, capital gains, or other business profits. This helps avoid double taxation by ensuring that income earned abroad is either exempt from tax in the UAE or taxed at a reduced rate.
• Residency Clauses: DTTs usually contain provisions that allow businesses to determine which country has theprimary right to tax certain types of income based on residency. The business or individual must be a tax resident in one of the two contracting countries (the UAE or the other country) to claim treaty benefits.

Example of DTT Impact on Foreign Tax Credit:

If a UAE company receives income from a subsidiary based in India and there is a DTT between the UAE and India, the treaty may reduce or eliminate Indian withholding tax on dividends. If the withholding tax is eliminated, the UAE company would only be subject to corporate tax in the UAE, and there would be no need for a foreign tax credit.

3. How the UAE Corporate Tax Regime Treats Foreign Taxes

Under the UAE’s Corporate Tax (CT) regime, which applies to businesses starting from June 1, 2023, foreign tax treatment is largely governed by the following principles:

• Foreign Income: The UAE generally taxes income that is earned within its jurisdiction, but under certain conditions,foreign income may not be subject to UAE tax. For instance:
• Income earned from aforeign branch or subsidiary is generally not taxed in the UAE, provided the company has not opted for the CT regime to tax such income.
• Dividend Exemption: Dividends received by a UAE-based company from a foreign subsidiary are typicallyexempt from UAE Corporate Tax under the participation exemption. However, this exemption is subject to specific criteria related to ownership thresholds (usually a minimum 5% stake) and the nature of the foreign company’s income.
• Income from a Permanent Establishment (PE): If a foreign company has aPermanent Establishment in the UAE, the income generated by that PE will be subject to UAE Corporate Tax. However, if the foreign country has already imposed taxes on the same income, the UAE’s tax treaties may offer relief from double taxation.

4. Potential Alternatives to Foreign Tax Credit in the UAE

Since the UAE does not have a general foreign tax credit system, businesses must rely on the following options to mitigate the impact of double taxation:

1. Double Taxation Treaty (DTT) Relief:

DTTs between the UAE and other countries are one of the most effective ways for businesses to avoid double taxation. The specific benefits of a treaty depend on the country involved and the type of income in question. By referencing the DTT, businesses can:

• Reduce or eliminate foreign withholding taxes.
• Gain tax exemptions on foreign income (e.g., dividends, interest, royalties).
• Lower the tax burden on cross-border transactions.

2. Transfer Pricing and Group Relief:

For multinational businesses with operations in the UAE and abroad, the introduction of transfer pricing rules under the UAE’s corporate tax system ensures that intercompany transactions are priced at arm’s length to reflect the true economic value. By following proper transfer pricing documentation and ensuring compliance with OECD guidelines, companies can avoid tax adjustments and minimize risks of double taxation.

Additionally, UAE companies with foreign subsidiaries may be able to offset taxes through group relief mechanisms, where profits or losses from different entities are netted off, depending on the structure of the business.

5. Practical Considerations for Businesses

• Review DTTs Regularly: Businesses should regularly review theDouble Taxation Treaties between the UAE and the countries where they operate. This ensures they are aware of the benefits available under the treaties and can plan accordingly.

Consult Tax Professionals: Given the complexity of international taxation and the U, particularly regarding transactions with Free Zones, tax refund processes, and certain exemptions.

2.4. Federal Tax Authority (FTA) Publications and Guides

The Federal Tax Authority (FTA) is the regulatory body responsible for administering VAT in the UAE. It publishes various guides, FAQs, and tax rulings to clarify specific situations and ensure consistent application of VAT laws across the country.

Some important FTA publications include:

• VAT Manual for Businesses
• VAT Refunds for Tourists
• VAT on Real Estate Transactions
• VAT Treatment of Financial Services

2.5. VAT Rulings and Decisions

The UAE FTA issues binding VAT rulings to interpret specific provisions of the VAT Law. Businesses can request a ruling on specific matters, which helps ensure correct VAT treatment in complex cases.

3. Applicability of VAT in the UAE

3.1. General Applicability

VAT is applicable to most goods and services that are supplied in the UAE. This includes:

• Sales of goods and services in the UAE.
• Importation of goods into the UAE.
• Certain digital services provided to consumers in the UAE.

3.2. VAT Registration Requirements

Businesses that supply goods or services subject to VAT must register for VAT if their taxable supplies exceed the mandatory registration threshold. The thresholds are:

• Mandatory Registration: If the taxable turnover exceeds AED 375,000 per year.
• Voluntary Registration: Businesses with taxable turnover between AED 187,500 and AED 375,000 may voluntarily register for VAT.

3.3. VAT Exemptions and Special Cases

While VAT applies to most goods and services, there are exemptions and special cases, including:

• Exemptions:
  • Healthcare services: Certain medical services and pharmaceuticals are exempt from VAT.
  • Education services: Specific educational services are VAT-exempt.
  • Real estate: Sale of residential properties is generally exempt from VAT.
  • Financial services: Many financial services are exempt from VAT (e.g., loans, insurance).
• Zero-Rated Goods and Services:
  • Exports: Goods and services exported to countries outside the GCC are subject to a 0% VAT rate (zero-rated).
  • International transport: Passenger transport services and goods in transit are subject to 0% VAT.
  • Certain health and education services: Some services in these sectors may be zero-rated instead of exempt.

3. VAT Exemptions and Reliefs

4.1. VAT Exemptions

• The VAT system includes specific exemptions where no VAT is charged on certain goods or services. These exemptions typically apply to sectors of public interest, such as healthcare and AE’s relatively new Corporate Tax regime, businesses with cross-border operations should consult with tax professionals to assess their potential tax liabilities and eligibility for treaty benefits.

Transfer Pricing Compliance: Companies involved in cross-border transactions should ensure that they maintain proper transfer pricing documentation to support the arm’s length nature of their intercompany pricing. This will help avoid disputes with tax authorities and ensure compliance with both local and international tax regulations