Taxation of Foreign Source Income

The Federal Tax Authority has issued a new guidance on Taxation of Foreign Source Income on November 16, 2023.

A Resident person in the UAE or Non-resident person with a Permanent Establishment (thereafter referred to as PE) may earn income from foreign jurisdiction. The treatment of such income generated from a foreign jurisdiction is subject to multiple conditions, e.g. type of Person receiving the income, the nature of the income and the availability of exemptions available.

How do I determine the residency of such a person under Corporate Tax?

A person is a resident person if they conduct business in the UAE or is incorporated or otherwise established or recognized in the UAE or is effectively managed in the UAE.

As per the Cabinet Decision No. 85 of 2022 an individual is considered a resident person when –

If he has been physically present in UAE for a period of 183 days within 12 consecutive months.
If he is UAE national and holds valid Residence Permit in UAE and meets the followings conditions –
1. Permanent Place of Residence in the UAE.
2. An employment or Business in the UAE

What types of foreign source income are subject to Corporate Tax?

The following could be scenarios where foreign source income can be subject to Corporate Tax –

Entity resident person is subject to tax on its worldwide income.
Natural resident person is subject to tax on any income derived from its business activity if it crosses more than AED 1 million within 12 months. The income also includes foreign source income linked to the business activity.
Non-resident having PE in UAE generating foreign source income.

Are there any exemptions that a Taxable Person can avail in respect to foreign source income?

We can consider the following exemptions with respect to foreign source income so as to avoid/eliminate potential double taxation –

Participation exemption with respect to Dividends/ profit distributions or capital gains as per Article 23 of Federal Decree Law no. 47
Foreign PE whereby income associated to expenditures incurred for foreign business operations is disregarded.

There is also a possibility of acquiring foreign tax credit in case there is tax paid in a foreign jurisdiction which can vary from a case-to-case basis in accordance with the Double Taxation Avoidance Agreements (DTAA) that UAE has in place with other foreign jurisdictions.

As per VAT law, the designated free zones are treated as outside UAE. So, if we derive income from a Qualifying Free Zone Person considered foreign source income?

Income derived from a Free Zone will be considered as income derived with the State (UAE) as a Free Zone is an area within the UAE territory.

What is the impact of Double Taxation Agreements on foreign source income?

The Double Taxation agreements takes precedence over provisions of the Corporate Tax law to extent there is any inconsistency between the agreement and provisions of the law.

In case the Double Taxation Agreement assigns residence to another jurisdiction, that foreign jurisdiction will have the taxing right as a residence country over the income of that Person In this situation, the UAE would not have a taxing right over any income of that Person unless that income is sourced from the UAE under the Corporate Tax Law and to the extent the taxing right is allocated to the UAE under the applicable Double Taxation Agreement.

How do we determine the foreign source income that will be taxed?

After the residency is assigned as per the Double Taxation Agreements (if any) then the accounting net profit as per the financial statements will be the starting point.

The applicable accounting standards will be as per IFRS and if under AED 50 million revenue then the Taxable Person can apply for IFRS for SME’s
Taxable Person can also maintain for cash basis of accounting if total revenue is AED 3 million.

Can we offset the expenditure and losses relating to foreign sourced income?

The General rules of taxation will apply for foreign sourced income.

Any expenditure incurred for business purposes will be allowed as a deduction. Additionally, any losses can also be offset in accordance with the normal rules. Thus, any tax losses from a foreign source can be offset against income from UAE sources when determining Taxable Income.

What if a Taxable Person with a PE in the UAE is subject to tax on its foreign source income?

While there are exemptions in types of foreign source income, to the extent foreign source income is nevertheless included in the Taxable Income of a Taxable Person, potential double taxation can be reduced or eliminated by way of a Foreign Tax Credit.

Therefore, Foreign Tax Credit allows a taxable person to deduct taxes paid under such tax laws of foreign jurisdiction from UAE Corporate Tax due on same income.

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