Fairly assessing taxable income of group members

Published: Mon 12 Feb 2024, 10:26 PM

It is mandatory to calculate the taxable income of each individual tax member, involving the attribution of income between the members of the tax group based on an arm’s length basis.

By Mahar Afzal

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It is mandatory to calculate the taxable income of each individual tax member, involving the attribution of income between the members of the tax group based on an arm’s length basis.

Even though the parent company is tasked with calculating the tax group taxable income, but the tax group is still obligated to calculate the individual entity's taxable income at an arm's length basis in these specific situations:

Firstly, within a tax group, a member with unutilised pre-grouping tax losses can offset these losses up to 75 per cent of the group taxable income, if member has adequate taxable income. Secondly, if a member generates income for which the tax group can claim a foreign tax credit, the credit cannot exceed the corporate tax due on the member's relevant income, and it cannot be carried forward. Thirdly, if a member benefits from corporate tax incentives related to qualifying business activities based on the member's taxable income. Lastly, a member with unutilised carried forward pre-grouping net interest expenditure can adjust it up to 30 per cent of the tax group's Ebitda or Dh12 million whichever is higher, provided the member has sufficient taxable income. In all these scenarios, it is mandatory to calculate the taxable income of each individual tax member, involving the attribution of income between the members of the tax group based on an arm’s length basis. The calculation of taxable income of individual member within the tax group is guided by several fundamental principles. For transactions between members of a tax group, adherence to the arm’s length principle is essential when these transactions are eliminated during consolidation. If such transactions are not eliminated, they should hold the same value as reported in the consolidated financial statements of the tax group.

The arm’s length principle requires that the transactions occurred below, above, or at zero value must be corrected at arm’s length basis, and corresponding adjustments should be reflected in the books of the relevant company. Moreover, if a member incurs costs on behalf of another member, these costs must be transferred at market value. It's crucial to emphasise that the taxable income of individual members within the tax group should not exceed the taxable income of the tax group. Additionally, if a particular income or expenditure is recognized in one group member, it will not be considered for the purpose of attributing taxable income. Finally, transfers of assets and liabilities between tax group members can be treated as taking place on a no gain or loss basis.

There can be intra group loans. These lending transactions should be considered to calculate the taxable income of the individual group member on following principles.

Interest deduction limitations will be enforced in the borrower’s records. If the borrower has restricted interest in their books due to a loan from a member of the tax group, the lender will also reverse the corresponding interest income in their records. Furthermore, interest deduction on loans from third parties will only be limited for attribution purposes if, and only if, the interest deduction is also restricted for the tax group. If a lender impairs the receivable of a loan from a group company, this impairment usually does not result in corresponding income for the borrower. In this situation, the deduction should not be considered to calculate the taxable income of individual group member.

When a lender records an impairment of interest receivable on a loan within the same tax group, it's considered to happen after the initial recognition of interest income. As a result, the lender acknowledges both the interest income and the impairment of the interest receivable. Consequently, if the borrower separately recognises interest expenditure, it will reduce the attribution of taxable income to the borrower, while simultaneously increasing the attribution of taxable income to the lender.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants.
Mahar Afzal is a managing partner at Kress Cooper Management Consultants.

Where a lender recognises income by reversing a prior loan impairment within a tax group, it will not affect the borrower's records, unless a member of the tax group acknowledged a deductible loss associated with that loan before becoming part of the tax group. If this exception is not applicable, the reversal of such impairment will not be taken into consideration.

If a lender waives a loan among members of the same tax group, this act usually results in income for the borrower due to the cancellation of its obligation. This income will be evaluated in the lender's records on an arm's length basis and up to the extent of any loss reported by the lender in the corresponding tax period. If the lender has not reported any loss, the income will not be considered.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not the official opinion of Khaleej Times but of the writer. For any clarification, please feel free to contact him at mahar@kresscooper.com.


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