Participation exemption and exempt income under UAE corporate tax

The participation exemption removes from UAE corporate tax the income a business earns from a qualifying shareholding in another company, mainly dividends and gains on selling the shares. It applies only when ownership, holding period and tax tests are met. Dividends from UAE resident companies are generally exempt income on their own, without those tests.

Key takeaways

• Exempt income is income the Corporate Tax Law leaves out of taxable income; it is not the same as being an exempt person or paying 0% as a qualifying free zone person.
• Dividends from UAE resident companies are generally exempt, while income from a wider shareholding can be exempt under the participation exemption if its tests are met.
• The participation exemption looks at the size of the holding, how long it is held and how the company invested in is taxed.
• A business that elects small business relief does not use the exempt income rules for that period, because it is treated as having no taxable income.
• Exempt income does not remove the duty to register, file a return and keep records for seven years.

On this page 9 sections

What exempt income means

Exempt income is income that the Corporate Tax Law leaves out when taxable income is worked out. The aim is to avoid taxing the same profit twice: once in the company that earns it, and again when it reaches a shareholder as a dividend or shows up as a gain on the shares.

It is easy to confuse with two other ideas. An exempt person, such as a government body, is outside the tax as an entity. A qualifying free zone person pays 0% on a defined category of qualifying income and the standard rate on the rest, as set out in the qualifying free zone person conditions. Exempt income is different again: the business is an ordinary taxable person, and one stream of its income is removed from the calculation under its own rules.

The rest of the income is taxed as usual: 0% on the first AED 375,000 of taxable income and 9% above that, explained in the 0% and 9% corporate tax rates.

The main types of exempt income

Several kinds of income can fall outside taxable income. The table groups the ones most businesses meet, in outline. It describes the general position, not every condition.

Summary prepared by UAE Business Explained from the Corporate Tax Law, not a substitute for the law. See Sources for what was and was not read.

How the participation exemption works

A participation is a shareholding or similar ownership interest in another company. When the holding passes the tests, the income from it is exempt: normally the dividends and other profit distributions, and the gain on selling the holding. In practice the rule matters most to holding companies and to businesses that own foreign subsidiaries, because dividends from UAE resident companies are already exempt under the separate rule in the table.

The tests in outline

The exemption is conditional. In outline, the conditions look at three things:

• The size of the holding. A token shareholding is not enough.
• How long it is held. The exemption is aimed at lasting investments, not short-term trading in shares.
• How the company invested in is taxed. Income from a company that is taxed at a very low level, or not at all, is not meant to be left out of tax twice.

Each test has a specific threshold in the legislation. This page does not state them, because their text was not reproduced from the primary source for this article. Take them from the law and the FTA’s guidance, check their date, and test each holding against them. A holding that fails any test is not exempt, so its dividends and gains become part of taxable income.

Dividends and gains

A dividend is a share of profit paid out to the owner of the shares. A gain arises when shares are sold for more than they cost. Both can fall within the exemption when the holding qualifies, so a business that is planning to sell a subsidiary should test the holding before the sale, not after it.

What it does to the calculation

Exempt income is left out when taxable income is calculated. It is not taxed, but the same principle works in the other direction: as a general rule, the costs of earning exempt income and any loss on the investment cannot be used to reduce other taxable income. The detailed treatment is in the law, so check it before taking a position on a particular cost.

The exemption removes tax on the income, not the income from the accounts. The return starts from the business’s financial results and adjusts them to arrive at taxable income, and exempt income is one of the adjustments. The steps for the return are in filing the corporate tax return.

Worked example

The example shows how an exempt dividend changes the tax bill. It uses the 0% and 9% bands from the rate guide.

Worked example

A UAE company with an AED 200,000 dividend from a UAE subsidiary

The figures are illustrations, not data from any source. A resident company has taxable income of AED 1,000,000 from trading and receives a dividend of AED 200,000 from a UAE resident subsidiary. It has no other adjustments or reliefs.

1. The dividend is exempt income, so it is left out. Taxable income stays at AED 1,000,000.
2. The first AED 375,000 is taxed at 0%: tax AED 0.
3. The rest is AED 1,000,000 minus AED 375,000, which is AED 625,000.
4. Tax on that part is AED 625,000 × 9% = AED 56,250.

Corporate tax due: AED 56,250, with no tax on the dividend.

Now suppose the AED 200,000 came from a foreign holding that failed the tests, so it was not exempt. Taxable income would be AED 1,200,000, the tax would be AED 825,000 × 9% = AED 74,250, and the difference of AED 18,000 is the AED 200,000 taxed at 9%. The corporate tax calculator shows the same bands for other figures.

How it fits with other rules

• Small business relief. A business that elects the relief is treated as having no taxable income under Article 21 of the Corporate Tax Law, so the exempt income rules are not used for that period. Dividends still count as revenue for the AED 3 million test. See small business relief.
• Free zone companies. A free zone company that holds shares faces the free zone conditions as well as the exemption. Start with corporate tax in free zones.
• Related parties. Receiving an exempt dividend does not remove the arm’s length rules for loans, services or sales between related parties. They are covered in transfer pricing rules.
• Foreign income and treaties. A UAE company with foreign income may be asked for evidence of residence, covered in the tax residency certificate guide.

What to report and keep

Exempt income does not end the compliance duties. The business is still a taxable person: it registers with the Federal Tax Authority and files a return no later than nine months after the end of each tax period. Taxable persons must keep the records that support their returns for seven years after the end of the tax period (Article 56 of the Corporate Tax Law).

For a holding company, the records that matter are the ones that show why income was treated as exempt: share certificates or registers, the dates shares were acquired, and the financial statements of the companies invested in. Late filing and payment carry penalties, set out in the corporate tax penalties guide. The wider set of rules is collected in the corporate tax guides.