Understanding Non-Deductible Expenses Under Corporate Tax

The introduction of corporate tax in the UAE, effective from June 2023, has introduced several new regulations that businesses must adhere to. Among these regulations, understanding non-deductible expenses plays a crucial role in effective tax planning and ensuring compliance with Federal Decree-Law No. 47 of 2022. This blog aims to delve into the complexities of non-deductible expenses under the UAE Corporate Tax regime, highlighting why it’s essential for businesses to grasp this concept and avoid costly penalties.

Purpose of Non-Deductible Expenses in UAE Corporate Tax Law

Non-deductible expenses serve a key role in preventing abuse of tax deductions by ensuring only business-related expenses are deducted. The primary aim is to prevent personal or extravagant expenses from reducing taxable income and ensure fairness in the tax system. By restricting certain deductions, the UAE Corporate Tax law protects the tax base and avoids potential manipulation of business finances​.

Key Categories of Non-Deductible Expenses

To comply with UAE Corporate Tax Law, businesses must recognize which expenses are non-deductible. The following categories are some of the most important:

1. Expenditure Not Incurred for Business Purposes

Expenses not directly related to business activities are non-deductible. This includes personal or leisure expenses, which are outside the scope of business operations and are thus not permitted to be deducted from taxable income​.

2. Expenditure Incurred for Deriving Exempt Income

Businesses that generate exempt income, such as those operating in free zones, cannot deduct expenses related to generating this income. For example, a company that benefits from tax exemptions in a free zone cannot claim deductions for expenses associated with this exempt income​.

3. Losses Not Connected to Business

Losses that are not connected to the taxable person’s business activities, such as losses from personal investments or activities outside the business’s core operations, are not deductible under UAE tax law​.

4. Donations, Grants, and Gifts

While charitable donations can enhance a company’s public image, not all are deductible under the UAE Corporate Tax law. Only donations to qualifying public benefit entities are deductible. Donations made to non-qualifying entities are not.

5. Fines and Penalties

Penalties and fines imposed for regulatory non-compliance or legal violations cannot be deducted from taxable income. This includes fines for late filing, regulatory breaches, and other forms of non-compliance, except for amounts awarded as compensation for damages or contract breaches.

6. Bribes and Illicit Payments

Payments made for illegal activities, such as bribes, are strictly non-deductible. Engaging in unethical practices not only leads to severe legal consequences but also disqualifies such expenses from being deducted under corporate tax law.

7. Dividends, Profit Distributions, and Owner Withdrawals

Dividends and profit distributions made to shareholders or owners are considered returns on investment rather than operational expenses, and thus, they are non-deductible. Similarly, personal withdrawals made by business owners or partners in unincorporated partnerships are treated as personal income, not deductible business expenses​.

8. Corporate Tax and Other Taxes

Corporate tax payments made by a business are non-deductible under the UAE’s corporate tax law. Additionally, taxes on income imposed outside the UAE are also non-deductible, although businesses may be able to claim foreign tax relief in the form of tax credits​.

9. Recoverable Input VAT

VAT paid by a business that is recoverable is non-deductible under the UAE Corporate Tax regime. Businesses must ensure that VAT incurred on non-deductible expenses is properly accounted for​.

10. Excess Pension Contributions

Employers’ contributions to private pension funds in excess of 15% of an employee’s total remuneration, or those not paid within the relevant tax period, are not deductible​.

Special Rules and Exceptions

In addition to the general categories of non-deductible expenses, UAE tax law provides certain special rules and exceptions:

1. Interest Capping Rules

Businesses may only deduct net interest expenditure up to 30% of their earnings before interest, tax, depreciation, and amortization (EBITDA). This rule, based on the OECD’s Base Erosion and Profit Shifting Project (BEPS), is designed to prevent excessive deductions of interest payments. However, certain sectors, such as banking and insurance, are exempt from this capping rule​.

2. Entertainment Expenses

Expenses incurred to entertain clients, shareholders, and business partners can only be deducted up to 50% under UAE corporate tax law, as these expenses often include non-business elements. Businesses must carefully document and allocate these costs to ensure compliance.

Impact of Non-Deductible Expenses on Tax Planning

Understanding non-deductible expenses is crucial for effective tax planning. By identifying and categorizing these expenses correctly, businesses can ensure accurate tax filings and avoid adjustments or penalties during tax assessments. Proper record-keeping is essential to demonstrate that expenses are business-related, and businesses are advised to consult tax professionals to navigate the complexities of corporate tax regulations.

Conclusion

In conclusion, non-deductible expenses play a significant role in determining taxable income under the UAE Corporate Tax law. Businesses must carefully assess their expenses to distinguish between deductible and non-deductible costs, ensuring compliance with the law and optimizing their tax liabilities. Engaging with experienced tax advisors can provide invaluable guidance to ensure businesses adhere to these regulations and avoid costly penalties​(