Exploring the mysteries of deferred tax in the UAE

In our previous three articles, we had generic discussion about the deferred tax, where we highlighted the difference between accounting profits and taxable profits due to the different basis applied to calculate the profits. Some items like fines and penalties create differences of a permanent nature, which have an impact on one tax period while others, like the pattern of allocation of assets, generate differences of a temporary nature, which have an impact in multiple tax periods. Only temporary differences lead to deferred tax, which is the tax that will be settled in the future tax period.

The International Accounting Standard 12 Income Taxes (IAS 12) deals with deferred tax. The UAE has already adopted the International Financial Reporting Standards (IFRS); and the para 47 of the IAS 12 states “Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period”.

Cabinet Decision No. 116 of 2022 that was issued on 30 December 2022 (effective Feb 1, 2023) and enforced within 15 days from its publication (January 16, 2023), requires that a standard rate of nine per cent will apply to taxable income exceeding a threshold of Dh375,000, and a rate of zero per cent will apply to taxable income not exceeding that threshold. Following the issuance of the cabinet decision that provides the rate and tax threshold, the tax law is deemed “enacted” as of January 16, 2023. Consequently, companies are required to evaluate the implications of deferred tax and calculate the estimated deferred tax for reporting periods ending on or after January 16, 2023 onwards.

The computation of deferred tax is contingent upon the basis — accrual or realisation — adopted by the company for tax purposes. If the company uses the accrual basis for tax purposes and the financial statements are already prepared on an accrual basis, then there will generally be no variance between the carrying amount and tax base for most items, provided that the balances in the balance sheet reflect the fair market value. If the balances in the balance sheet are not carried at the fair market value as mandated by tax law to be carried forward at an arm’s length price (transitional provisions of the law), deferred tax will arise unless the difference is permanent in nature.

For instance, if the fair market value of a carried forward building is Dh20 million and is reported in the balance sheet at the same value, there will be no temporary difference, thus no deferred tax implications. Permanent differences such as exempt income, and non-allowable expenses (e.g., fines, penalties, 50 per cent entertainment expenses, bribes, illicit payment, nonbusiness expenses, and expenses related to exempt income) will not result in deferred tax as they are permanent in nature.

Keeping in view the adjustments as outlined in Article 20(2) of the law, required to convert the accounting profits into taxable profits, it is evident that some items like depreciation, amortisation, provisions, etc., as presented in the financial statements, are allowable for tax purposes, unless stipulated otherwise by the Minister under Article 20(2)(i) of the law.

When a taxable person adopts the realisation basis for tax purposes after preparing their financial statements on accrual basis, the carrying values of assets and liabilities presented in the financial statements will differ from the tax base. The figures in the financial statements are displayed on an accrual basis, while for taxation purposes on the realization basis/cash basis. These temporary differences lead to deferred tax unless they are of a permanent nature as described earlier.

For instance, if the written down value of a plant and machinery in the financial statements is Dh20 million (cost of Dh25 million less accumulated depreciation of Dh5 million), and the same is carrying amount for tax purposes, whereas the tax base is Dh25 million on realisation principles. This difference in the carrying amount and tax base creates a deductible temporary difference of Dh5 million, that will lead to deferred tax asset.

In a nutshell, when accrual basis is used with balances reflecting at fair market value in financial statements, temporary differences are generally not generated for most items. However, 16, necessitating thorough analysis.

The writer is a managing partner at Kress Cooper Management Consultants. The above article is not an official view of Khaleej Times but an opinion of the writer. For any queries/clarifications, please write to him at mahar@kresscooper.com

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