Embracing the New Tax Era in the UAE: How CIT is Reshaping M&A Strategies

Dania Yassin Associate dania.yassin@bsabh.com

The introduction of the Corporate Income Tax (CIT) in the UAE is not just a new tax policy; it's a tectonic shift in the nation’s financial architecture. Coupled with the pre-existing VAT and Economic Substance Regulations, the terrain for mergers and acquisitions (M&A) now requires a fresh playbook. In this guide, we will navigate through the essential changes and how to master M&A in this evolving landscape.

1. Tax Due Diligence in the Age of CIT
• Scope of Scrutiny: For businesses whose financial calendar aligns with the year, CIT examinations will commence from 1 January 2024. However, for those starting their fiscal year between 1 June and 31 December 2023, CIT kicks in from those specific start dates.
• The GAAR Watch: Effective since 25 October 2022, the General Anti-Abuse Rule (GAAR) empowers the Federal Tax Authority (FTA) to challenge perceived tax avoidance schemes, putting post-October transactions under keen observation.
• VAT Statute Extensions: The standard VAT review period is five years but can extend up to fifteen in evasion scenarios. Some recent adjustments also allow an extension up to nine years in certain contexts, influencing terms in share purchase agreements pertaining to tax liabilities.

2. M&A's Tax Framework - Key Highlights:
• Deciphering Foundational Laws: It's crucial to comprehend the CIT, i.e., the UAE Federal Decree-Law No. (47) of 2022 alongside relevant Cabinet and Ministerial Decisions. They clarify tax determinations, qualifying incomes, and deduction rules. The CIT is one of the most expansive tax legislations in the UAE, impacting sectors from real estate to manufacturing.
• Identifying Taxable Entities: M&A’s main players include 'Taxable Persons' – both natural and juridical. Grasping an entity's tax status, whether it’s an LLC, foundation, or a joint-stock company, is instrumental in deal valuations.
• Decoding Free Zone Dynamics: These entities are often M&A favorites. Navigators must recognize Qualified Free Zone Persons (QFZP), fathom tax rates (0% for Qualifying Income, 9% otherwise), and uphold transfer pricing regulations for seamless cross-border M&A.
• Mainland Entity Nuances: Distinct tax rates - 0% up to AED 375,000 and 9% beyond - can critically sway M&A transaction evaluations.
• Benefitting from Double Tax Treaties (DTT): M&A strategists should capitalize on treaties like the UAE-KSA DTT and UAE-Russia DTT for potential tax incentives.
• Addressing Withholding Tax: For M&A actions encompassing foreign bodies, the 0% withholding tax rate on some UAE sourced revenues is pivotal.
• Adhering to New Administrative Penalties: Post-merger/acquisition, compliance with tax norms is crucial, especially given penalties instituted from 1st August 2023.

3. Share Deal vs. Asset Deal
M&A transactions usually revolve around either acquiring shares (share deal) or assets (asset deal) of the target entity. Traditionally, share deals are preferred in the UAE due to their simplicity and streamlined process.

• Share Deal:
Liabilities, including tax exposures, remain with the target company after acquisition, emphasizing the importance of thorough due diligence.

From the CIT perspective, taxpayers can use tax losses to offset future taxable incomes, with a cap at 75% of the relevant tax period's income. However, these losses can be indefinitely carried forward. For proper usage, either a consistent 50% shareholding from when the loss occurred is required or the company must maintain its business nature after a significant ownership shift. This makes the assessment of tax losses vital for buyers of loss-incurring UAE firms. In terms of both CIT and VAT, companies can join a tax group, consolidating their tax returns and excluding inter-group transactions. But, any member of this group shares liability for the group's taxes. Therefore, when acquiring a company from such a group, buyers should be cautious about inherited tax liabilities and address potential issues in their purchase agreements.

• Asset Deal:
Here, a company's tax liabilities aren’t transferred to the buyer. This type of deal is typically subject to fewer tax implications, but the introduction of CIT introduces nuances, particularly around the business restructuring relief scheme.

Within the CIT framework, the business restructuring relief scheme provides tax advantages for companies that transfer a business segment or its entirety in return for a stake in the receiving firm. Such transfers are considered tax-neutral, ensuring assets and liabilities are shifted at their net book value, thereby avoiding recognizing any gains or losses. This scheme comes with conditions, including a two-year window where certain subsequent actions might reverse the benefits. While the seller avoids capital gains tax, the buyer might lean towards transfers at market value to benefit from tax deductions on asset depreciation. Additionally, although the typical VAT rate for asset transfers in the UAE is 5%, the Transfer of Going Concern (TOGC) can render these transfers outside the VAT scope if they involve a comprehensive asset bundle representing an autonomous business. For this exemption, the recipient should either be a VAT-registered entity or required to register. Absent TOGC, the buyer can usually offset the VAT over a period, but with TOGC, upfront VAT financing isn't necessary.

4. Financing the Acquisition
Whether financed through equity or debt, the introduction of CIT introduces new considerations. While interest expenses are generally tax-deductible, there are caps and conditions, especially if loans are acquired from related parties. 

For M&A financing in the UAE, choosing between equity or debt has tax implications. Debt might be favored since interest expenses can be tax-deductible. However, the UAE CIT has restrictions:
• Net interest expenses can only be deducted up to 30% of the company's earnings before interest, taxes, depreciation, and amortization.
• Deductions aren't allowed for loans from related parties used to buy an interest in another related company. Exceptions exist if the primary goal isn't a CIT advantage, especially if the creditor's tax rate is 9% or higher.

Buyers using debt for acquisitions should carefully evaluate these rules to maximize tax deductions.

5. Participation Exemption
CIT has a participation exemption regime to prevent double taxation. For dividends and capital gains to be exempt, specific conditions regarding the nature of the holding, duration of ownership, and the subsidiary’s tax rate must be met. UAE companies buying local firms should evaluate potential tax exemptions on post-acquisition dividends and capital gains. The CIT aims to prevent double taxation of profits. To benefit:

• The parent should hold at least 5% in the subsidiary or invest a minimum of AED 4,000,000.
• This ownership should persist for a minimum of 12 months.
• The subsidiary needs a tax rate of 9% or more.
• Over 50% of the subsidiary's assets shouldn't be non-exempt under CIT.

Importantly, dividends from UAE entities are always tax-exempt.

6. Grouping Benefits
Forming a tax group can simplify compliance, with the parent company submitting consolidated returns.
When a UAE-based buyer takes over a local target company, there can be advantages in integrating the acquired subsidiary into a tax group for CIT considerations. As per the CIT framework, a UAE parent firm has the option to submit a request to the FTA, seeking to establish a tax group with one or multiple resident firms. Should specific criteria be satisfied, including the parent firm holding a minimum 95% stake in the subsidiary, this tax group would be viewed as a singular taxable entity.

A significant upside to creating a tax group is the streamlined compliance process. Primarily, the parent company takes on the responsibility of submitting a unified tax return for the entire group, negating the need for individual submissions by each member. Additionally, internal transactions within the tax group aren't taken into account for tax calculations. However, a notable drawback is the application of the standard 0% tax rate, which is only valid for taxable profits below AED 375,000, applied to the collective tax group and not to each individual entity.

In conclusion, while the inception of CIT ensures a reinforced regulatory framework in the UAE, it necessitates businesses to be astute in understanding its ramifications. As the scenario evolves, maintaining awareness and adaptability will be paramount for effective M&A maneuvers in the region.