New Corporate Tax Guide: Interest Deduction Limitation Rules

The Federal Tax Authority released the Corporate Tax Guide on Interest Deduction Limitation (CTGIDL1) earlier this week to provide guidance on the application of the rules for the deductibility of interest expenses under the UAE Corporate Tax Law (Federal Decree-Law No. 47 of 2022).

Below is the summary of the key outcomes from the guide.

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The guide clarifies the general principles, limitations, exemptions, and compliance requirements regarding the deduction of interest expenses when calculating taxable income.

1. General Deductibility of Interest Expenses

• Interest expenses are generally deductible if they are:

• Incurred wholly and exclusively for the purposes of the taxable business.

• Meet the conditions of Article 28 of the Corporate Tax Law.

• Not specifically disallowed under other provisions (e.g., related party anti-abuse rules).

• Capitalized interest (i.e., interest added to the cost of an asset) may be deducted through depreciation or amortization over time.

• Interest on loans that fund non-taxable or exempt income activities (e.g., investment in exempt assets) may not be deductible.

2. Net Interest Expense and the 30% EBITDA Limitation

• Net Interest Expense = Interest expense incurred minus interest income earned.

• The 30% EBITDA Rule:

• Businesses can deduct Net Interest Expenses only up to 30% of their adjusted EBITDA.

• Adjusted EBITDA = Taxable income before deducting interest, tax, depreciation, and amortization — further adjusted for exempt income and non-deductible items.

• If the Net Interest Expense exceeds the 30% limit, the excess is disallowed in the current tax period but may be carried forward.

3. Threshold Exemption: Small Business Relief

• If the Net Interest Expense is AED 12 million or less in a tax period:

• The 30% EBITDA limitation does not apply.

• Full deduction of interest expenses is allowed (subject to general deductibility rules).

• The AED 12 million threshold applies per tax group if the business is part of a tax group.

4. Carry Forward of Disallowed Interest

• Disallowed Net Interest Expense can be carried forward for up to 10 subsequent tax periods.

• Carried forward interest can be deducted in later periods, subject to the 30% EBITDA limitation applicable in those periods.

• Businesses must track carried forward interest expenses separately and maintain appropriate records.

5. Related Party Interest Payments and Anti-Abuse Rules

• Interest payments to Related Parties are not deductible if the main purpose of the arrangement is to obtain a Corporate Tax advantage.

• Related Party Interest can still be deductible if:

• The recipient is subject to at least 9% tax on the interest income.

• The arrangement is commercially justifiable without regard to tax benefits.

• This rule targets Base Erosion and Profit Shifting (BEPS) practices where businesses artificially shift profits by creating excessive or artificial debt with related parties.

6. Exclusions and Special Cases

• Banks, insurance companies, and certain regulated financial entities may be subject to different or additional rules. Special sector-specific rules may apply in future guidance.

• Interest-free loans: These do not create deductible interest expenses as no actual expense is incurred.

• Foreign Currency Loans:

• Interest incurred on loans denominated in foreign currency may be deductible.

• Forex gains and losses may also impact the net expense calculation.

7. Documentation and Compliance Requirements

Businesses must maintain adequate documentation to demonstrate:

• The purpose of the loan and its relevance to the taxable business.

• The calculation of Net Interest Expense.

• Compliance with the 30% EBITDA limitation.

• Proper tracking of any disallowed and carried forward interest amounts.

• Justification that Related Party transactions are commercially driven and not primarily tax-motivated.

Failing to maintain sufficient records may lead to disallowance of deductions and administrative penalties.

8. Key Takeaways

• The UAE applies a balanced approach to interest expense deductions by allowing reasonable deductions while curbing excessive debt financing aimed at base erosion.

• Businesses with significant financing activities should carefully assess their EBITDA position and Related Party structures to ensure compliance.

• Proper forecasting, documentation, and monitoring of interest expenses and taxable income are essential to optimize tax positions and avoid surprises.