This briefing document summarizes the key aspects of the taxation of foreign source income under the UAE Corporate Tax Law, drawing from the “Taxation of Foreign Source Income 2023” guide.
1. Overview and Purpose
The Federal Decree-Law No. 47 of 2022 (the “Corporate Tax Law”), effective for Tax Periods commencing on or after June 1, 2023, establishes a federal tax on corporations and business profits in the UAE. This guide aims to provide general guidance on the taxation of foreign source income for Taxable Persons, including:
- The relevance and definition of foreign source income.
- Which Taxable Persons are subject to tax on foreign source income.
- When foreign source income becomes taxable.
- Determining Taxable Income and Exempt Income from foreign sources.
- The concept and computation of Foreign Tax Credit.
Key takeaway: The Corporate Tax Law impacts anyone deriving income from outside the UAE, including Qualifying Free Zone Persons, and operates in conjunction with other relevant legislation and guidance from the Federal Tax Authority (FTA).
2. Defining Foreign Source Income
“Foreign source income, for the purposes of the Corporate Tax Law, is any income which has originated in a foreign jurisdiction and is earned or received by a Person in the UAE.” While not explicitly defined in the Corporate Tax Law, it is generally understood as income derived from outside the UAE, contrasting with “State Sourced Income” which originates in or is derived from the UAE.
Examples of Foreign Source Income include (but are not limited to):
- Dividends and other profit distributions from non-resident juridical persons.
- Income from the disposal of shares or capital of non-resident juridical persons.
- Interest income from loans or deposits outside the UAE.
- Income from the sale of goods or provision of services outside the UAE.
- Income from movable or immovable property located outside the UAE.
- Royalties for the use of intellectual or intangible property outside the UAE.
- Profits or losses of a Foreign Permanent Establishment of a Resident Person.
Important Distinctions:
- Income from Free Zone Persons: Income derived from a Free Zone Person is not considered foreign source income, as a Free Zone is within UAE territory.
- Income from Qualifying Free Zone Person’s Permanent Establishment: Income or profits from a Domestic Permanent Establishment (in mainland UAE) are not foreign source income. However, “Income or profits derived by a Qualifying Free Zone Person from its Foreign Permanent Establishment, which is a Permanent Establishment located outside the UAE, is foreign source income.”
3. Who is Subject to Tax on Foreign Source Income?
The taxability of foreign source income depends on a Person’s legal status (juridical or natural) and residence status (Resident Person or Non-Resident Person).
3.1 Resident Persons
- Juridical Person: A juridical Resident Person (e.g., a UAE-incorporated company or one effectively managed and controlled in the UAE) “is subject to tax on its worldwide income.” This includes both domestic and foreign source income.
- Natural Person: A natural Resident Person (one conducting a Business or Business Activity in the UAE with a total turnover exceeding AED 1 million in a Gregorian calendar year) “is subject to tax on any income derived from a Business or Business Activity they conduct in the UAE… Thus, any foreign source income which is linked to the Business or Business Activity they conduct in the UAE may be subject to Corporate Tax in the UAE.” Importantly, “Wages, Personal Investment income and Real Estate Investment income are not subject to Corporate Tax, irrespective of their source.”
3.2 Non-Resident Persons
- Juridical Person: A non-resident juridical person with a Permanent Establishment (PE) in the UAE “will be subject to Corporate Tax on Taxable Income attributable to that Permanent Establishment.” Foreign source income is taxable only if “attributable to its Permanent Establishment in the UAE.”
- Natural Person: A non-resident natural person with a PE in the UAE (and a turnover attributable to that PE exceeding AED 1 million annually) is subject to Corporate Tax on foreign source income only if it “is attributable to its Permanent Establishment in the UAE.”
3.3 Impact of Double Taxation Agreements (DTAs)
“A Double Taxation Agreement takes precedence over the provisions of the Corporate Tax Law to the extent there is any inconsistency.” DTAs can impact the residence status and allocation of taxing rights, potentially shifting the right to tax foreign source income away from the UAE.
4. When Foreign Source Income Becomes Taxable
The timing of taxation of foreign source income aligns with the general income attribution rules of the Corporate Tax Law, depending on the accounting method adopted by the Taxable Person:
- Cash Basis of Accounting: Income and expenditure are recognized “as and when cash payments are received and paid.”
- Accrual Basis of Accounting: Income is recognized “when earned and expenditure when incurred.” Financial Statements must be prepared based on IFRS or IFRS for SMEs.
For a juridical person, the Tax Period is their 12-month financial year. For a natural person, it is always the Gregorian calendar year.
5. How Foreign Source Income is Taxed
Foreign source income is subject to the general rules for determining Taxable Income and Corporate Tax rates in the UAE.
5.1 Determining Taxable Income
- Starting Point: The accounting net profit or loss from Financial Statements, adjusted for exemptions, reliefs, deductions, etc.
- Accounting Standards: IFRS (or IFRS for SMEs for revenue below AED 50 million) must be applied consistently.
- Cash Basis Eligibility: Available if total worldwide revenue (including foreign sources) does not exceed AED 3 million.
- Expenditure and Losses: Generally, expenditure incurred wholly and exclusively for business purposes is deductible, and tax losses can be carried forward. Expenses related to Exempt Income or to a Foreign Permanent Establishment (if an exemption is elected) are not deductible.
- Aggregation: “Taxable Income and deductible expenditure from all sources, whether domestic or foreign, are aggregated for the purposes of calculating Taxable Income.” This means foreign source tax losses can offset UAE-sourced income.
- Currency Conversion: Foreign currency amounts must be converted to AED using applicable Central Bank of the UAE exchange rates (spot, monthly average, or yearly average), consistently applied.
5.2 Exemptions for Foreign Source Income
The Corporate Tax Law provides exemptions to mitigate double taxation:
- Participation Exemption: Exempts “Dividends and other profit distributions, as well as capital gains or losses from the transfer, sale or other disposal of a Participating Interest” from Corporate Tax. This requires meeting conditions like a minimum 5% ownership or AED 4 million acquisition cost and a 12-month holding period. If Tax Losses from a Foreign Permanent Establishment were previously utilized, this exemption may be restricted until those losses are fully offset by subsequent income from that PE.
- Foreign Permanent Establishment Exemption: A Resident Person can elect to “disregard the income and associated expenditure of its Foreign Permanent Establishment while determining the Resident Person’s Taxable Income.” This election applies to all qualifying Foreign PEs and requires the PE to be subject to corporate tax (or a similar tax) at a rate of not less than 9% in its foreign jurisdiction. If elected, the PE’s losses, income, associated expenditure, and Foreign Tax Credits are not considered in the UAE’s Taxable Income. For transfer pricing purposes, a Foreign PE is treated as a Related Party of the UAE head office.
5.3 Corporate Tax Payable
Foreign source income is aggregated with all other income for calculating Corporate Tax. For most Taxable Persons (excluding Qualifying Free Zone Persons), the rates are:
- 0% for Taxable Income up to AED 375,000.
- 9% for Taxable Income exceeding AED 375,000.
6. Foreign Tax Credit (FTC)
Where foreign source income is taxable in the UAE and taxes have been paid in a foreign jurisdiction, a Foreign Tax Credit (FTC) can be claimed to reduce the UAE Corporate Tax due, preventing double taxation.
6.1 Eligibility for FTC
- Foreign Tax Character: The foreign tax must be “of a similar character to Corporate Tax,” meaning it is:
- Imposed by a foreign government.
- Compulsory and enforceable.
- Imposed on profit or net income (foreign withholding tax is deemed to meet this).
- Non-eligible Taxes: Consumption taxes (VAT, GST), customs duties, transaction taxes, property taxes, wealth taxes, estate/inheritance taxes, interest, fines, and penalties are generally not considered similar to Corporate Tax.
- “Paid” Definition: Foreign tax is considered “paid” when it has been remitted to or accrued to the foreign tax authorities. Proof of payment is required.
6.2 Who Can Claim FTC?
FTC can be claimed by Taxable Persons on their taxable foreign source income:
- Resident juridical persons.
- Resident natural persons (if foreign source income relates to their UAE business activity and turnover exceeds AED 1 million).
- Non-Resident Persons with a PE in the UAE (if the foreign source income is attributable to that PE).
6.3 Calculating FTC
The FTC amount is the lower of:
- The actual amount of tax paid on foreign source income in the foreign jurisdiction (converted to AED).
- The amount of UAE Corporate Tax due on that specific foreign source income.
Formula: Corporate Tax due on relevant foreign source income = (Corporate Tax due on total Taxable Income of the Taxable Person before any Foreign Tax Credit * Relevant foreign source income) / Total Taxable Income of the Taxable Person.
Important Notes:
- Unutilized FTC: Any unutilized FTC “cannot be carried forward to future Tax Periods or carried back to earlier Tax Periods” and will be forfeited.
- Income-by-income Approach: For multiple sources of foreign income, FTC is calculated on an income-by-income basis. Excess FTC from one foreign source cannot offset tax due on another.
- Scenarios with No FTC: FTC is not allowed if there is no UAE Corporate Tax payable on the foreign source income, such as:
- Exempt Income (e.g., dividends under Participation Exemption).
- Loss scenarios (where overall Taxable Income is negative).
- Income benefiting from Small Business Relief.
- Qualifying Income of a Qualifying Free Zone Person (subject to 0% Corporate Tax).
6.4 Timing Mismatches
To address discrepancies in tax periods or accounting methods between the UAE and foreign jurisdictions, a symmetrical approach is applied. FTC is allowed “in the Tax Period in which the foreign source income forms part of Taxable Income under the Corporate Tax Law.” This means foreign tax paid in one year for an unrealized gain may be credited in a later year when that gain is realized and taxed in the UAE.
6.5 Impact of Double Taxation Agreements (DTAs) on FTC
- FTC is available even without a DTA.
- If a DTA specifies a different method of double taxation relief (e.g., exemption instead of credit, tax sparing relief), the DTA’s terms prevail.
- If a DTA limits the source country’s taxing rate (e.g., 5% withholding on dividends), the UAE FTC will be limited to that rate (assuming the income is not otherwise exempt).
6.6 Documentation
Taxable Persons claiming FTC must maintain detailed records, including:
- Amount of foreign source income in foreign currency and AED.
- Financial year of derivation.
- Nature and amount of foreign tax, and date paid.
- Whether foreign tax was an advance, withholding, or final payment.
Acceptable evidence includes official receipts, withholding tax certificates, foreign tax returns with calculations, or letters from foreign tax authorities. Certified translations are required for non-Arabic/English documents.
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