UAE: Opt out to pay corporate tax on the pre-tax era gains

The ending balances of the closing balance sheet for the financial year immediately preceding the start of the first tax period required to be carried forward, at arm’s length, as the opening balances for the first tax period.

The main purpose of adjusting the balances to their fair value is to ensure that gains are taxed in the correct period and losses are allowed for in the relevant period. The taxable person should not pay tax on gains earned before the start of the tax period, and they should not be allowed to claim losses incurred before entering the corporate tax system. For example, if an asset was purchased in June 2023 and sold in June 2024, the gain on the asset that was earned before the start of the first tax period should not be taxed.

For specific assets, ministerial decision no. 120 of 2023 (the decision) was introduced that allows taxable persons to elect to adjust the gains related to qualifying intangible assets (QIA), qualifying immovable property (QIP), qualifying financial assets (QFA), and qualifying financial liabilities (QFL) owned before the start of the first tax period. These elections must be made when the taxable person submits its first tax return and are considered irrevocable except in exceptional circumstances approved by the Federal Tax Authority (FTA).

QIP means an immovable property owned prior to the start of the first tax period, measured at historical cost in the financial statements and disposed of/deemed to be disposed of during the first period for a value exceeding the net book value. The intangible asset should meet the same conditions as well to be qualified as QIA, with the addition the intangible asset was owned for a period less than ten years before the start of the first tax period. Under exceptional circumstances, this ten-year clause can be waived pursuant to the approval by the FTA.

QFAs and QFLs are financial assets or financial liabilities owned before the first tax period and measured in the financial statements on a historical cost basis.

Immovable property means “(i) any area of land over which rights or interests or services can be created, (ii) any building, structure or engineering work attached to the land permanently or attached to the seabed; or (iii) any fixture or equipment which makes up a permanent part of the land or is permanently attached to the building, structure or engineering work or attached to the seabed”.

The taxable person may elect to make an adjustment for gain for any QIP; however, election to make an adjustment of gain for QIAs, QFAs, and QFLs is required for all assets in the respective class. Means; a taxable person can opt to adjust the gain for single QIP where many others QIPs are there; but they cannot opt for single QIA, QFA, and QFL unless there is only one QIA, QFA, and QFL.

If the taxable person has elected to make the adjustment of gain in the first return, then upon disposal of the qualifying asset, the taxable person shall calculate the gain earned before the start of the first tax period and make an adjustment of the gain in the return of the tax period in which the qualifying asset was disposed of.

There are two methods to calculate the prior first tax period gain: the time apportionment method and the valuation method. For QIAs, the taxable person can use the time apportionment method. For QFAs and QFLs, the decision requires the taxable person to use the valuation method. However, the taxable person may elect to use either the time apportionment method or the valuation method for QIPs.

The valuation method allows the taxable person to exclude the amount of the gain that would have arisen at the start of their first tax period had the QIP, QFA and QFL been disposed of at market value and the cost of the QIP, QFA and QFL was higher of the original cost and the net book value. This requires the taxable person to determine the market value of the QIP, QFA and QFL at the beginning of their first tax period. Like an asset was bought at Dh8.5 million at the start of July 2023 and fair value of asset was Dh10 million at the beginning of the tax period 2024. Upon disposal of the asset at the end of July 2024, it has a value of Dh12 million. The taxable person is not liable to pay tax at Dh1.5 million (10m-8.5m) being prior first tax period’s gain; and the person can opt it to be adjusted.

Alternatively, the taxable person may elect to use the time apportionment method to exclude the amount of the gain that would have arisen at the start of their first tax period. This allows the taxable person to exclude a proportion of the total gain based on the proportion of time the QIP and QIA was owned before the start of the taxable person’s first tax period and the time of disposal of the QIP and QIA. Like in the above example, the taxable person can elect to make an adjustment of gain of Dh1.6 million [(12m-8.5m) *6/13].

Where the value of the QIP is required at the beginning of the period like Dh10 million in the above example, it shall be determined by the relevant government competent authority in the UAE. These are the special provision of the law for the specific assets; and for the rest; we need to follow the valuation methods as discussed in our previous articles.

In the light of the above, its proposed to the eligible taxable persons to opt to adjust the gain in the first tax return; and upon disposal of the qualifying asset, they need to calculate the gain; and make adjustment to arrive at their taxable profits.

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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