Corporate Tax: Understanding Transitional Provisions
The purpose of transitional provisions is to ensure a smooth transition from the old era to the new one. Transitional measures are essential since they ensure the UAE’s corporate tax won’t hurt people’s lives or businesses. By enabling a seamless transition, these strategies help lower the costs and uncertainty associated with implementing a new law.
Implementation of Opening Balances for Tax Purposes
The new UAE Corporate Tax includes transitional provisions. According to Article 61(1) of this law, a company’s starting balance for tax purposes is based on its closing financial balance at the end of the fiscal year just before the first tax period, as per UAE accounting standards.
It has a fiscal year that runs from January to December, similar to X Ltd., and the effective. X Ltd’s first tax period begins on January 1, 2023; and the immediately preceding fiscal year is January 1, 2022, to December 31, 2022.
Adherence to Arm’s Length Principle
The second clause of the article is very important. It states that the opening balance should be calculated following arm’s length principles for the first tax period. This criterion was implemented to stop related parties and connected persons from engaging in non-arms-length transactions and agreements that could affect their taxable revenue for a future tax period.
The UAE has used the widely recognised “arm’s length” principle in the agreements and transactions between connected and related parties to determine the arm’s length pricing. According to Article 34 of the corporate tax law, related party transactions and agreements must adhere to the arm’s length principle for calculating taxable income.
The transaction or arrangement meets the arm’s length standard if the outcomes of a trade or arrangement between related parties are consistent with the outcomes that would have been achieved if parties who were not related had engaged in a similar transaction or arrangement under similar circumstances.
Impact on Financial Statements and Adjustments
When preparing financial statements, if a company didn’t follow transfer pricing rules in previous years (e.g., up to 2022), they may need to re-calculate numbers based on the arm’s length principle. This could involve adjusting the accounts to establish opening balances that adhere to transfer pricing principles for the current tax period.
In 2022, if X Ltd pays its owners, officers, or related parties higher than market salaries or sells products or services to associated parties below or above market prices, will these be rectified during the 2022 year-end financial reconciliation? Furthermore, if non-arms length transactions occurred before 2022, impacting the opening balances for the 2023 tax year, should adjustments be made to align these balances with the arm’s length principle? If so, it would be difficult for the firms to track these transactions, calculate the fair market value, and make the necessary adjustments in the books of accounts.
Guidance from the Ministry of Finance
The Ministerial Decision No. (120) of 2023, released by the UAE Ministry of Finance, offers guidance on adjusting a company’s initial financial statements in line with the new UAE corporate tax laws and regulations. This decision clarifies how to handle profits and losses related to real estate, intangible assets, financial holdings, and obligations held by companies before the law’s implementation.
General Anti-Abuse Provision: Article 50
When preparing the starting balance sheet for agreements or transactions executed after the law’s official publication, Article 50’s general anti-abuse provision comes into play. This means that if an individual or business structures deals or conducts transactions intending to evade corporate taxes, which leads to an undue tax advantage or benefit, the FTA has the authority to rectify the situation. In essence, this provision aims to prevent the misuse of tax regulations for unfair financial gains.
Importance of IFRS Compliance
Taxpayers must prepare their financial statements under the IFRS
It is strongly advised that the taxable persons should compile their financial statements per IFRS for the fiscal year that concluded just before the start of their first tax period and use the arm’s length principles following those statements.
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