Every business incurs expenses; however, certain expenditures are not allowable or non-deductible under the tax laws. This may sound unusual, but it is true, and every business must follow it, depending on the jurisdiction where it operates. Entities must comply with the tax laws, primarily the corporate tax law, and understand the allowable expenses under the UAE corporate tax rules. In this blog, we provide a simple understanding of deductible expenses compared to non-deductible or non-allowable expenses.
IFRS vs. UAE Corporate Tax Law
UAE businesses primarily prepare their financial statements in accordance with the International Financial Reporting Standards (IFRS). The final result of such reporting is “net income.” However, for tax purposes, entities need the “taxable income,” which is actually net income adjusted for tax adjustments. In simple terms, business income must be adjusted for any adjustments required by tax law. Therefore, if any expense is not allowable under the tax laws, it should be added back, and hence, the income for tax purposes, taxable income, will rise.
What are Allowable Expenses under UAE Corporate Tax?
For UAE businesses, it is very important to understand allowable expenses under the corporate tax law. In simple terms, non-deductible expenses will increase taxable income, thereby increasing tax liability. Therefore, entities must understand the importance of allowable expenses and strive to minimize the non-deductible expenditure.
Article 28 of the tax law provides general guidance on deductible expenses:
“Expenditure incurred wholly and exclusively for the taxable person’s business that is not capital in nature shall be deductible in the tax period in which it is incurred, subject to the provisions of the Decree-Law.”
Thus, as per the tax law, there are mainly two conditions for an expense to be deductible:
- The expense should be wholly and exclusively for business.
- It should not be a capital expense; only a revenue expense
Then the expense is deductible in the tax period in which it was incurred.
The Case of Entertainment Expense
As per Article 32 of the tax law, a taxable person can deduct only 50% of entertainment expenses in a relevant tax year. This includes any expense incurred on entertaining a taxable entity’s customers, shareholders, vendors, or business partners. It includes:
- Meals
- Accommodation
- Transportation
- Admission Fees
- Facilities and equipment used in connection with such entertainment, amusement, or recreation.
- Any other expense specified by the Minister.
This means, if, for instance, AED 20,000 is spent on entertainment expenses in a tax year, only AED 10,000 will be allowable for tax purposes.
Which Business Expenses are Non-Allowable for Tax Deductions?
As a general rule, expenses incurred for the following purposes are non-allowable under the corporate tax law.
a) Expenditure not incurred wholly and exclusively for the taxable entity’s business.
b) Expenditure incurred in deriving exempt income.
c) Losses not related to or arising out of the taxable entity’s business.
d) Any other expense specified in a decision issued by the Cabinet at the suggestion of the Minister.
Furthermore, Article 33 provides a list of certain expenses that are not allowable under the tax law.
- Donations or gifts made to an entity that is not a qualifying public benefit entity.
- Fines and penalties, excluding the amounts awarded as compensation for damages or breach of contract.
- Bribes and other illicit payments
- Dividends, profits, or any other benefits of a similar nature paid to the owner.
- Drawings from the business by a natural person that is a taxable person under the tax law or a partner in an unincorporated partnership.
- Corporate tax imposed on a taxable person under the tax law.
- Input VAT that is recoverable under the VAT law.
- Tax on income imposed on the taxable person outside the state.
- Any other expense specified by the Minister.
How do Businesses Determine if an Expense is Deductible?
As discussed in our above discussion, the UAE tax law provides clear guidance on deductible expenses. However, there are areas that need expert advice or guidance to correctly analyze and highlight allowable expenses under the UAE corporate tax rules. The basic guideline follows two basic conditions for an expense to be deductible:
- The expense should be wholly and exclusively for business.
- It should not be a capital expense; only a revenue expense
However, this is not as simple as we say; there are various other factors and guidelines to follow.
Understanding Complex Matters
For instance, there are cases when an expense is incurred for more than one purpose. So, what to do in this case? Clause no. 3 of Article 28 guides this issue. The deduction is only allowable for the following two cases:
a) Any identifiable part or proportion of the expenditure incurred wholly and exclusively for the purposes of deriving taxable income.
b) An appropriate proportion of any unidentifiable part or proportion of the expenditure incurred for the purposes of deriving taxable income that has been determined on a fair and reasonable basis, having regard to the relevant facts and circumstances of the taxable person’s business.
Thus, in many situations, it is important to consult a local expert from the UAE, such as Creative Zone Tax & Accounting (CZTA).
What Records Should Businesses Keep for Deductible Expenses?
A UAE taxable entity must maintain corporate tax-related documents for a period of at least 7 years from the end of the relevant tax period. The records include documentation that:
- Support the information provided on the tax return
- Enable the taxable income to be readily ascertained by the tax authority.
Thus, entities must maintain complete records and also keep them for a minimum of seven years from the end of the relevant tax period. Key records for claiming deductible expenses may include the following:
- Purchase invoices and receipts
- Bank statements and payment proofs
- Supplier contracts and agreements
- Payroll records and employee salary documents
- Utility bills and office rent agreements
- Travel and business entertainment records
- Asset purchase invoices and depreciation records
- VAT invoices, credit notes, and VAT returns
- Accounting records, including the financial statements
The key is to attach and maintain any document that proves the legitimacy of allowable expenses under UAE corporate tax rules.
Summary
In simple terms, any business expense is usually a deductible expense if it meets the basic criteria. However, there are rules for specific categories of expenses, such as entertainment expenses. Furthermore, there are some complex scenarios where a business needs to apportion the deductible and non-deductible portion of an expenditure. Therefore, entities must make arrangements to consult a tax expert in these cases. Taxable entities must understand allowable expenses under the corporate tax law, as well as non-allowable expenses, to comply with the tax laws.
Creative Zone Tax & Accounting (CZTA)
As an experienced UAE tax consultant, we simplify the complex tax rules and apply them to our clients’ circumstances. This is achievable through our setup of trained tax professionals. Thus, you just need to focus on your business; the rest is our job. Contact us today.
Frequently Asked Questions (FAQs)
W
Article 28 of the tax law provides general guidance on allowable expenses:
“Expenditure incurred wholly and exclusively for the taxable person’s business that is not capital in nature shall be deductible in the tax period in which it is incurred, subject to the provisions of the decree-law.”
As a general rule, expenses incurred for the following purposes are non-allowable under the corporate tax law.
a) Expenditure not incurred wholly and exclusively for the taxable entity’s business.
b) Expenditure incurred in deriving exempt income.
c) Losses not related to or arising out of the taxable entity’s business.
d) Any other expense specified in a decision issued by the Cabinet at the suggestion of the Minister.
The basic guideline follows two basic conditions for an expense to be deductible:
The expense should be wholly and exclusively for business.
It should not be a capital expense; only a revenue expense
There are other scenarios and situations too; seek professional advice where needed and contact CZTA.
A taxable person can deduct only 50% of entertainment expenses in a relevant tax year. However, personal expenses are not deductible.
The records include documentation that:
Support the information provided on the tax return
Enable the taxable income to be readily ascertained by the tax authority.
Example: Purchase invoices and receipts, bank statements and payment proofs, supplier contracts and agreements, payroll records and employee salary documents, utility bills and office rent agreements, and travel and business entertainment records.
