Tax guide on interest deduction limitation rules

The UAE Federal Tax Authority (FTA) has released a comprehensive guide on interest Deduction Limitation Rules (hereinafter referred to as ‘the Guide’). The Guide provides essential insights into the deductibility of interest expenditure, meaning of interest, applicability of the General Interest Deduction Limitation Rule (GIDLR) and the Specific Interest Deduction Limitation Rule (SIDLR), and the carry forward of unutilized Net interest Expenditure (NIE).

The Guide, based on illustrative examples, explains significant insights related to:

A. The order in which Corporate Tax provisions should be applied for computing the deductible amount of interest

B. A wide spectrum of financial instruments or payments that may have an interest element or be treated as interest for UAE Corporate Tax purposes

In this alert, we have provided a summary of key highlights of the Guide and important points for Taxpayers to note:

• The Guide recognizes that the term “interest” is to be interpreted broadly to reflect the fact that there is considerable flexibility in how financing arrangements may be structured, which may be different from the interest recorded for accounting purposes following the applicable Accounting Standards (i.e. IFRS or IFRS for SMEs).
• The definition of interest under the Corporate Tax Law covers the following key elements:

1. Any amount accrued or paid for the use of money or credit – This is the additional amount that a borrower pays to a lender on top of the repayment of principal (the underlying amount borrowed/owed).
2. Discounts and premiums – When related to the borrowing of money or the issuance of debt instruments, these are considered as interest as they represent the cost of borrowing. However, discounts provided as sales incentives or for early payment (for e.g. Trade or volume discounts, rebates, loyalty points or rewards) are not considered as interest, as they are not related to the financing or borrowing of money.
3. Profit paid in respect of an Islamic financial instrument – Islamic financing structures used to offer sharia-compliant products such as Mudarabah, Murabaha, Ijara, Sukuk, etc., typically contain an element (such as “profit” or “markup”) that is considered economically equivalent to interest, regardless of the classification and treatment of the element under IFRS (or IFRS for SMEs).
4. Other payments economically equivalent to interest – To determine if a payment is equivalent to interest, it is essential to consider whether its economic substance yields a return similar to debt or equity. This substance may not necessarily follow the treatment under applicable Accounting Standards.
5. Any other amounts incurred in connection with the raising of finance, such as:

The Guide prescribes that the deductibility of interest expense should be assessed in the following order:

1. General principles of deductibility of expenditure
2. Arm’s length principle
3. SIDLR
4. GIDLR

• Business expenditure is deductible for Corporate Tax purposes if it is wholly and exclusively incurred for business purposes and is not capital or personal in nature. Deductions are based on accounting standards (IFRS or IFRS for SMEs), but specific tax rules may override accounting treatment.
• Interest expenses linked to exempt income from Dividends and other profit distributions received from a juridical person that is a Resident Person or from a Participating interest in a foreign juridical person, other income from a Participating interest, income of a Foreign Permanent Establishment, and income derived by a Non-Resident Person from operating aircraft or ships in international transportation may be deductible if they meet GIDLR and SIDLR.

• Interest expenses in relation to Related or Connected Parties must follow market value and arm’s length principles.
• If interest paid to a Related Party or Connected Person is adjusted to reflect arm's length or market value, the adjusted amount is used for applying the interest deduction limitation rules unless it is already disallowed under another Corporate Tax provision.

• The Guide prescribes that the SIDLR applies after general deductibility principles and arm’s length adjustments, but before the GIDLR.
• The SIDLR is not applicable if the main purpose (“Main Purpose Test”) of obtaining the loan and carrying out any of the specified transactions [listed in Article 31(2) of the UAE CT Law] is not to obtain a Corporate Tax advantage. The onus is on the Taxable Person to demonstrate that the main purpose is not to gain a Corporate Tax advantage.

• The Net interest Expenditure (NIE) is the difference between the amount of interest expenditure incurred (including any carried-forward NIE) and the interest income derived during a Tax Period.
• The following will not be included when calculating the NIE:

1. Interest expenditure that is disallowed under any other provisions of the Corporate Tax Law, for example, interest paid to Related Parties that exceeds a non-arm’s length amount or under the SIDLR 
2. Interest income or expenditure related to grandfathered debts, i.e. prior to 9 December 2022
3. Interest income or expenditure in relation to Qualifying Infrastructure Projects
4. Any income or expenditure of a member of the Tax Group who is a Bank or Insurance Provider

• The starting point for “adjusted EBITDA” for a Tax Period is the Taxable Income calculated in accordance with the general rules for determining Taxable Income. All tax adjustments are required to be made to Accounting Income except for adjustments in relation to the GIDLR itself and Tax Loss relief provisions. An adjustment is then required for the following items in the relevant Tax Period:

1. NIE
2. Depreciation and amortization (after adjusting the capitalized interest)
3. NIE on financial assets or liabilities held before 9 December 2022
4. NIE related to Qualifying Infrastructure Projects

• If the adjusted EBITDA result is a negative amount, then the adjusted EBITDA will be AED 0.
• If the relevant Tax Period is more than or less than 12 months, the de minimis threshold of AED 12 million is adjusted in proportion to the length of the Tax Period.
• Where a Taxable Person has capitalized interest, any interest element included in the depreciation charge must be removed before the depreciation charge is added back to Accounting Income for the purposes of calculating adjusted EBITDA.
• Where adjustments are made to accounting or tax figures, for example, due to the application of the General Anti-abuse Rules or following a Tax Audit, the calculations in respect of the GIDLR may need to be revised.
• GIDLR applies when determining the Taxable Income attributable to a Permanent Establishment or to a nexus in the UAE. However, it would not apply while computing state-sourced income.
• Disallowed NIE under the GIDLR can be carried forward for up to 10 Tax Periods on a ‘first-in, first-out’ basis, provided the conditions of the rule are met in those future periods.
• The carried-forward NIE cannot be transferred to or utilized by any other Taxable Person.
• Where a Subsidiary with carried-forward NIE joins a Tax Group, the carried-forward NIE can only be utilized against the Taxable Income of the Tax Group that is attributable to the Subsidiary (and not the entire Taxable Income of the Tax Group).
• Where a Taxable Person deregisters because it has ceased Business Activity, any unutilized NIE that has been carried forward will be forfeited upon deregistration. This applies even when a Non-Resident Person later reestablishes another Permanent Establishment or nexus.

1. Banks and Insurance providers

• Where a member of a Tax Group is a Bank or Insurance Provider that is not subject to the GIDLR, any interest income or expenditure of that member is ignored in calculating the total NIE and adjusted EBITDA of the Tax Group.
• This exception does not apply to treasury companies, captive insurance companies or other non-regulated financial entities that carry out quasi-banking or insurance activities, or to investment vehicles, whether regulated or not.

2. Natural person undertaking Business or Business Activity in the UAE

• Where a natural person conducts Business or Business Activity as a Sole Establishment, then the natural person is not subject to the GIDLR. However, where a natural person conducts Business or Business Activity through a juridical person such as a one-person company, the juridical person would be subject to the GIDLR (unless some other exemption applies).

3. Small Business Relief

• If a Person had NIE disallowed under the GIDLR in a previous Tax Period in which an election for Small Business Relief was not made, the Person may carry forward the disallowed amount to subsequent Tax Periods in which an election for Small Business Relief is not made.

The Guide provides important clarifications on:

• The various expenses that need to be considered as part of interest expenditure while calculating the Taxable Income.
• The order in which the various Corporate Tax provisions should be applied for computing the deductible amount of interest.

Therefore, it is important for taxpayers to consider this Guide while determining their taxable income.