With the announcement that the UAE will implement corporate tax to generate income, John Martin St. Valery, Founding Partner, the Links Group and Chas Roy-Chowdhury, Head of Global Taxation, Association of Chartered Certified Accountants, consider the impact on businesses in general, as well as SMEs

The introduction of a federal corporate tax has been in the offing since as early as 2005. Although the draft legislation has not yet been published and is yet to go through the legislative process, no implementation date has been set. Nevertheless, the Ministry of Finance's intentions have been clearly set out in its 2014 annual report, indication the days of tax-free living in the UAE are coming to an end, according to Chas Roy-Chowdhury, Head of Global Taxation, Association of Chartered Certified Accountants (ACCA).

The International Monetary Fund's (IMF) Managing Director Christine Lagarde repeated the IMF's taxation advice to the Gulf Cooperation Council (GCC) at a conference held in Abu Dhabi at the end of February.

She said oil exporters in the MENA region lost more than $340 billion in oil revenue from their budgets last year, which equates to 20 per cent of their combined GDP, and highlighted the need to increase Government revenues and emphasised the need for corporate income taxes, as well as property and excise taxes in order to generate income.

Corporate tax is generally accepted as a levy placed on the profit of a firm, with different rates used for different levels of profits. Corporate taxes are taxes against profits earned by businesses during a given taxable period; after expenses and depreciation have been deducted from revenues.

For long-term economic sustainability, there is a definite need to need to raise taxes in order to diversify revenues and strengthen fiscal positions; cutting subsidies or spending will be difficult to implement at this stage, according to John Martin St. Valery, Founding Partner of consulting firm, Links Group.

He added that since the proposed tax rate is among the lowest in the world, it would help the Government diversify its income but would avoid placing an excessive burden on the other sectors.

Moreover, the introduction of corporate tax is unlike to deter foreign investors from establishing a commercial presence in the UAE, as long as the rate is not too high. The new law should not have too much of an adverse on businesses in the UAE.

"However, if the corporate tax amount exceeds what companies are willing to pay, then it could decrease the competitiveness of the region and businesses will be more likely to try finding ways around it. Therefore it is critical for the UAE to set it at the right rate from the start," said St. Valery.

More important than the comparative tax rates, according to Roy-Chowdhury, will be the implementation of the tax regime. He said the Ministry of Finance faces crucial decisions-how to determine the scope and level of the tax, how to communicate effectively with taxpayers, how to draft tax legislation that is simple, clear, and fair and how to administer the new tax system with a minimum burden for all involved.

Implications for SMEs

One of the drawcards bringing businesses into the UAE has always been the opportunity of operating tax-free. A major concern for smaller businesses is how the draft legislation of the corporate tax will translate practically in terms cash flow management. Without proper planning this may cause added strain in managing their capital in terms of having the cash available to pay tax liabilities as they are due, on top of unforeseen expenses such as paying out end of service benefits.

"The biggest factor business owners will need to consider is the administrative implications-taxes will have to be built into management and financial reporting systems, which in turn will be a significant technical and HR investment," said Roy-Chowdhury.

He added it means, practically, that companies spend approximately two months per year complying with tax regulations-generally 15 days on corporate taxes and 21 days on consumption taxes, such as VAT-and that smaller companies incur up to five times the administrative burden per employee than larger firms.

"Since the UAE provides a sturdy platform for entrepreneurship and innovation, introduction of the corporate tax will offer SMEs a stable environment for inclusive and sustained economic prosperity; particularly in the wake of the oil prices and the need to create new enterprises that can innovate and forge new opportunities at a foundational  level," said St. Valery.

Roy-Chowdhury said there is also potential for tax reliefs to be brought in to support SMEs. Loss reliefs-the ability to carry forward deductible trading losses to offset future taxable profits-could help to smooth out the cash flow impact of fluctuations in trading conditions. Also, tax incentives to providers of capital to encourage the financing of SMEs, either through debt of equity, will be particularly welcome.

Potential pitfalls

Tax neutrality
Many foreign companies are registered in free zones, which provide guaranteed multi-decade tax holidays on personal and income taxes. These guarantees are very unlikely to be reversed-to retain the UAE's competitiveness for foreign investment-so the bulk of the new corporation tax charge seems set to fall on local businesses and SMEs.

To add to the complexity, each of UAE's emirates currently has its own laws on corporate taxes for companies operating within the emirate. Ensuring a smooth transition from emirate-specific taxes to federal taxes, while avoiding double taxation and other surprises, could pose a challenge.

Taxing SMEs disproportionately in comparison to international operations, or treating companies registered in one emirate differently from companies registered in another, could result in unintended consequences and ultimately undermine economic stability in the longer term.

Tax transparency
Tax payers need to understand what they are paying, why they are paying it, and what the benefits of paying will be. Paying tax may never be fun, but engagement with a demonstrably fair tax policy will be more palatable. This is particularly important as UAE introduces corporation tax for the first time, to businesses that may be resistant to the move.

One major issues of tax policy such as the introduction of corporation tax here, there is an opportunity for the Ministry of Finance to undertake clear consultations where different options are specified at the start, with each option then being able to be properly considered with an audit trail including unambiguous minutes and written responses explaining the rational of decisions. A welcome indication from the Ministry of Finance is that a grace period of at least a year will be given for corporate tax compliance. Communication about the determination of the first period of assessment, the scope of tax, and the compliance and payment mechanisms, will be key.

Tax competitiveness
The UAE could face competition for foreign capital from neighbouring countries. To mitigate this it would be prudent to undertake a careful benchmarking exercise to align UAE's headline rate of corporation tax to those of its neighbours, something the UAE government is no doubt already considering.

However, a 'race to the bottom' on tax rates should be resisted. Very low tax rates used to lure inward investment from one country to another can undermine international financial regulation initiatives, and entrench wealth inequality in the region.

Source: Chas Roy-Chowdhury, Head of Global Taxation, ACCA

© FinanceME 2016