UAE corporate tax: Why it is key to identify the right fiscal year for your business

Before June 2023, there were five options available for selecting a fiscal year. However, a Cabinet decision made a significant change to this system. Pawan Singh / The National

Two new corporate tax releases were announced last week, which you can take with you on holidays. One is titled Determination of Taxable Income which I recently discussed. Clause 2.6 in this document emphasises that it is guidance, and not definitive law.

It comprises 107 pages of non-binding advice that is subject to change without notice.

The second release is called Corporate Tax – Public Clarification First Tax Period of a Juridical Person. I have previously addressed various related issues from this document and I will add one more in this article.

If you plan to read both, start with the latter.

Both documents include a detailed section called Legislative References which serve as the foundation for the content. In addition to these references, external rules and regulations must be considered unless explicitly overridden by tax legislation.

One important set of rules to consider is the International Financial Reporting Standards, commonly known as IFRS. The UAE regulatory authorities have stated that IFRS rules will be followed unless specified otherwise in tax laws.

In addition to IFRS, other factors such as VAT, treasury management and financial accounting play a crucial role in managing your business effectively. Balancing these elements is essential for making informed decisions within your organisation.

Now, let us consider a scenario where you make a significant sale of a valuable item, such as a piece of art, for Dh10 million ($2.72 million) with a monthly payment plan spread over three years. A deposit of Dh2.5 million is paid upfront during the first corporate tax fiscal year.

When selling an item, two elements are typically transferred separately: risk and title to the goods. The seller transfers the artwork to the buyer, who assumes all risks associated with the goods. If the buyer damages the artwork, they are responsible for it and still required to make payment. Title, or true ownership, is only transferred to the buyer upon full payment.

In accordance with IFRS rules, in our scenario, the sale of the artwork would be recognised for revenue recognition purposes. The seller is obliged to record the full value of the sale in their accounts.

Let us consider a scenario where a transaction is taking place between two parties in the UAE. In this case, the standard VAT rate of 5 per cent would be applicable. The seller would be required to pay Dh500,000 in VAT to the Federal Tax Authority when filing their return. However, the seller will not receive this amount in full from the buyer until three years later, resulting in a cash flow burden.

Furthermore, from a corporate tax standpoint, the seller must pay 9 per cent on the gross profit of the art, even though payment has not been received.

Some individuals may argue that revenue should only be recognised as payments are received. In order to achieve this, they may suggest issuing one invoice for the deposit and then monthly invoices for subsequent periods. This method would help spread out payments for corporate tax and VAT.

However, this approach is not recommended. As a business, you have agreed to these payment terms, and it is your responsibility to manage them, not the taxman's.

The second document, which pertains to selecting your entity's fiscal year, poses a more intriguing question. Is it possible for your entity to have two fiscal years?

When registering for corporate tax, you have the flexibility to choose a tax period ranging from six to 18 months in theory. This allows entities to align their reporting period with their operational needs.

However, the online portal only permits a 12-month period selection. It is advisable to select an end month that aligns with your desired reporting cycle.

If your initial reporting period is not 12 months, the system does not allow for pro-rating of thresholds. An exception to this rule is for interest charges under the de minimis rule.

Before June 2023, there were five options available for selecting a fiscal year. However, a Cabinet decision made a significant change to this system.

Currently, there are laws in place at both the Emirate and federal levels. Trade licences are typically issued by emirate-level authorities, with the fiscal year often determined by the entity's formation documents. On the other hand, corporate tax falls under the jurisdiction of the federal government.

Given this existing framework, why not allow for separate fiscal years for each entity to ensure there’s no confusion and potential loss of tax allowances?

David Daly is a partner at the Gulf Tax Accounting Group in the UAE