Transitional provisions ensure smooth entry into the corporate tax era

The transitional provisions are provisions that are included in a law to provide for the smooth transition from the old era to the new era. Transitional provisions are important because these help to ensure that the new law does not have a disruptive impact on businesses and individuals. By providing for a smooth transition, transitional provisions can help to minimise the costs and uncertainties associated with the implementation of a new law.

The recently introduced UAE corporate tax law (the law) is carrying the transitional provisions and article 61(1) of the law requires that the opening balance sheet for corporate tax purposes of a taxable person shall be the closing balance sheet prepared for financial reporting purposes under accounting standards applied in the UAE on the last day of the financial year that ends immediately before the commencement of the first tax period. Like X Ltd has financial year from January to December; and effective date of the law for X Ltd is January 01, 2023. X Ltd first tax period will start from January 01, 2023; and their immediately preceding financial year is January 01, 2022, till December 31, 2022. For the financial year of 2022, X Ltd will be liable to prepare the financial statements; and numbers reflecting in the closing balance sheet of the year 2022 will become the opening balances for the tax period starting from January 01, 2023. I would like to highlight that profit and loss are carrying “for the year” numbers while the balance sheet having “as on” numbers since the inception of the business. The profit and loss of the year 2022 will not be carried forward but numbers reflecting in the balance sheet of year 2022; will be carried forward.

The clause 2 of article 61 is very important. This requires that the opening balance for the first tax period should be based on arm’s length principles. This requirement is introduced to prevent non-arm’s length transactions and arrangements entered between the related parties and connected persons that may impact the taxable income for the future tax period.

To set the arm’s length price, the UAE has applied the internationally recognised “arm’s length” principle to the transactions and arrangements between related parties and with connected persons. In the article 34 of the law, it has been given that while determining taxable income, transactions and arrangements between related parties must meet the arm’s length standard. A transaction or arrangement between related parties meets the arm’s length standard if the results of the transaction or arrangement are consistent with the results that would have been realised if persons who were not related parties, had engaged in a similar transaction or arrangement under similar circumstances. There are various methods to establish the arm’s length price that we have already discussed in our previous article.

To comply with the provision 61(2) of the law, taxable persons will be liable to prepare the financial statements as per applicable International Financial Reporting Standards (IFRS). While preparing the financial statement, they will be required to comply with transfer pricing rules. Where they have not complied with transfer pricing principles in the previous financial years ended before the commencement of first tax period; like in 2022 and earlier years considering the above example, then at the time of preparation of financial statement, will they be liable to recalculate the numbers based on the arm’s length principle and pass an adjustment in the books of accounts to arrive at the opening balances based on the arm’s length principles?

Like in the above example, if X Ltd is paying any salaries to the connected person (owners, officers etc.) above the market prices in 2022; will it be adjusted? Moreover, if the X ltd has sold any goods or services to the related parties above or below the market price in 2022; will it be adjusted as well while closing the books of 2022? Moreover, where businesses made non-arm’s length transactions with the related parties and connected persons before 2022 and the impact of these transactions is showing in the opening balances for the tax year 2023; will they be liable to pass the adjustment for the previous periods to arrive at the balances as per arm’s length principle? If, yes, it would be quite challenging for the businesses to identify such transactions, doing calculation as per fair market price and passing the adjustment in the books of accounts.

This area was requiring more clarification, and the UAE Ministry of Finance has issued Ministerial Decision No (120) of 2023 on transitional rules for corporate tax, providing guidelines for adjusting a taxable person’s opening balance sheet under the corporate tax law, which clarifies a lot. This Ministerial Decision has provided guidance about the adjustment of the gains and loss related to the immoveable property, intangible assets, financial assets, and financial liabilities held by businesses before the law comes into effect. We will discuss in detail this Ministerial Decision in our coming article.

The general anti-abuse rule as given in the article 50 of the law, are applicable to the preparation of the opening balance sheet with respect to transactions or arrangements entered on or after the date the law is published in the Official Gazette. This clause permits the FTA to counteract arrangements put in place or transactions entered by a person before they become subject to corporate tax where such arrangements or transactions would result in undue corporate tax advantages, benefits, or corporate tax relief in the future.

It is highly recommended that the taxable persons should prepare their financial statements as per IFRS for the financial year immediately ending before the commencement of their first tax period; and they need to apply the arm’s length principles accordingly.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official opinion of the Khaleej Times but an opinion of the writer and it should not be considered a formal advice. For any queries/clarifications, please write to the writer at mahar@kresscooper.com

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