The UAE's Corporate Tax Regime is straightforward on how to use debts and what deductions are available. Debt may be raised by parties, stockholders, etc. Funds are often raised by businesses in the form of equity or debt.
Debts come from various sources such as financial institutions, third parties, family and friends, and shareholders. Besides simple loans, debts are derived from instruments such as debentures, bonds, and alternatives to easily convert them into equity.
Debt capital requires interest payments, apart from legal fees, Bank charges, commissions, and certain processing fees. In the case of accounting, these costs are considered as charges on the profits and are charged. Capitalizing on such expenses would be necessary based on the timing, purpose, and utilizing the funds. Moreover, borrowing funds, especially the interest, may need to be fresh, including accounting treatment as deductibility could be affected.
The process of implementation of the corporate tax in the UAE 2023 has been designed to incorporate best practices globally and minimize the compliance burden on businesses.
How Debt Funds are used under Corporate Tax in UAE?
Deducting interest charges would mainly depend on how the borrowed funds are used. As per the Public Consultation Document, released by the Ministry of Finance, Coporate Tax in the UAE has proposed to exempt the dividends and capital profits on authorized investments. However, it is not clear whether the UAE Corporate Tax would enable deductions for interest on borrowings used to earn exempted incomes. Hence clarity regarding this aspect is awaited.
What are Thin Capitalization Rules?
There should be restrictions on the amount of interest costs that could be deducted. Such limits are referred to as Thin Capitalization Rules. According to the Consultation Document, interest costs would be deducted only up to 30% of the Earnings Before Interest Depreciation and Amortization (EBITDA). This limitation would be applied to the interest payable on all the debts, whether it is received from formal or related parties.
Suppose the disallowed interest could not be carried forward in the future for a set-off; then the entities with debts would look at a permanent disallowance or the non-deductible expense. The entities with debts and involved in capital-driven industries such as real estate, infrastructure, and startups requiring longer growth periods should be aware of this provision, as it would require capital restructuring.
Banks, insurance businesses, specific regulated financial activities and businesses by normal citizens would be exempted from the thin capitalization rules.
Accounting Aspects
The accounting standards require the interest cost on the borrowings used for the acquisition or construction of capital assets to be capitalized until the assets become usable. The Consultation Document has not made any changes to the accounting treatment which is well accepted. With a restriction on the interest amount as per the UAE Corporate Tax, businesses would have to reconsider their leasing arrangements.
While the debt funding leads to the interest as a deductible expense such as a dividend, one needs to plan for a permanent disallowance on the expenses.
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