Key takeaways from Ministerial Decision on Participation Exemption

Ministerial Decision No.116 of 2023

As per Article 23, specified income from participating interest is exempt from Corporate Tax in UAE (CT). As per Clause 2 of the said Article, a participating interest represents a 5% or greater ownership in the Participation.

The notification from the UAE's Finance Ministry clarifies various aspects and conditions for availing Participation Exemption. Below are some key highlights of the notification:

Components of Ownership Interest

• Ownership interest shall include holding any one or combination of the following if they are classified as equity interest under accounting standards applicable to the taxable person:

1. Ordinary shares.
2. Preferred shares.
3. Redeemable shares.
4. Membership and Partner interest.
5. Other types of securities, capital contributions and rights entitle the owner to receive profits and liquidation proceeds.

• Ownership interest in any entity must represent control, legal and beneficial ownership of the taxable person.

Aggregation Rules

• For computing 5% or more participating interest, different types of ownership interest in the same juridical person shall be aggregated.
• Furthermore, ownership interest held by other members of a qualifying group of which the taxable person is a member shall be aggregated with those of the taxable person.

Conditions for continuing Ownership Interest in the event of a Transfer

• The original ownership interest has been exchanged for another ownership interest on account of the transfer of the entire or independent part of the business as provided in Article 27 of the Corporate Tax (CT) Law; and
• 5% or more of ownership interest continues.

Debt Instruments issued by Participation

• Income from debt instruments issued by Participation can also enjoy an exemption if such debt instruments are classified as equity instruments under Accounting Standards.

Clarifications on Participation subject to tax

One of the key conditions provided under Clause 2(b) of Article 23 provided that the participation exemption would be available only if the participant is subject to CT or a similar tax of not less than 9% in their country of residence.

• Participation exemption would be available in cases where following reliefs/benefits are provided by the tax legislation of the country in which the Participation is resident :

1. Differences in reductions and reliefs.
2. Lower tax rates applicable to certain brackets of income.
3. Targeted incentives or exemptions of a temporary nature.
4. Application of alternative taxes on income or profits.

• Whereas the tax rate condition shall be deemed to be not satisfied if:

1. The tax is applicable only to selected activities.
2. The tax paid is refunded when the relevant profits or income is distributed.
3. The tax is only due in the event of a distribution of profits or income.

• The tax rate condition shall also be deemed to be satisfied if the Participation is subject to an effective tax rate of at least 9% if it recalculates its taxable profits in accordance with the CT law.
• Furthermore, Participation Exemption would be available even in case where Participation is a resident of a country that does not impose taxes similar to CT but imposes taxes in respect of income, equity or net worth or a combination of these, resulting in an effective tax rate of at least 9% on accounting profits of the Participation.

Conditions for Holding Companies

• Where a Participation's principal business activity is holding of shares and its income substantially consists of income from participating interests, the Participation shall be considered to satisfy the tax rate condition if:
  • It is managed and directed ina foreign country.
  • It complies with the documentation and reporting requirements under the foreign country's laws.
  • It has adequate personnel and premises to carry out the holding company business.
  • It shall not conduct any other activity other than those that are incidental or ancillary to activities as a holding company.

• It is further clarified that substantial income shall mean at least 50% average of income from participating interest for the relevant and preceding tax periods.

Minimum Acquisition Cost

• If the aggregate cost of acquisition of ownership interest is more than or equal to AED 4 million, the taxable person shall be treated as having participating interest even if the 5% threshold is not met.
• For computing minimum acquisition cost, the value of equity interest or capital contribution paid in cash or kind, along with any subsequent contributions and expenses incurred in relation to the acquisition that is eligible for capitalization, shall be aggregated.
• Subsequent value adjustments under applicable accounting standards shall be ignored.
• The exchange rate on the date of acquisition shall be used.
• In the event of a partial transfer of ownership interest by any means, acquisition cost shall be proportionately reduced.
• The minimum acquisition cost threshold must be met for at least 12 months failing which exemption availed in any previous tax period shall be reversed and income shall be taxable in the tax period in which the threshold was not met.

Indirect Ownership

One of the conditions for claiming participation exemption is that the Participation shall not hold more than 50% of assets either directly or indirectly, which would not have qualified for exemption if directly held by a taxable person. To determine this 50% threshold, the notification clarifies that the consolidated balance sheet of the participation and book value of assets or market value of direct and indirect ownership interests and other assets of the Participation shall be considered.

List of expenses in relation to the acquisition and disposal of a Participating Interest

• An inclusive list of expenses is provided below:
  • Professional fees.
  • Due diligence costs.
  • Litigation costs.
  • Commissions and brokerage fees.
  • Stamp duty, registration duties and other irrecoverable taxes.
  • Appraisal and valuation costs.
  • Refinancing costs.

These expenses are not deductible and shall be capitalized as part of the acquisition cost of the participating interest. However, interest expenses shall be deductible as per the provisions of the CT law.

Furthermore, income from participating interest that is not derived in the capacity of an owner or is not directly from ownership interest shall not be exempt.

Liquidation Proceeds and Losses

• Liquidation loss shall be computed as a difference between the acquisition cost of the participating interest adjusted for partial disposals and the fair value of the liquidation proceeds. This loss shall be further adjusted for:
  • Tax losses are transferred by Participation to taxable persons.
  • Exempt dividends or profit distributions received from Participation.
  • Income on the transfer of assets or liabilities between the taxable person and Participation that was not considered due to relief for transfers within a qualifying Group (Article 26) and business restructuring relief (Article 27)

Ministerial Decisions provide a much-needed clarity on various provisions of the CT law. The decision on participation exemption provides clarity on its various aspects of claim. It is crucial for taxpayers to evaluate the law along with the guidance providedin the Ministerial Decision to understand the impact.

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