As discussed in my prior blog post, full details here, on January 31, the United Arab Emirates (UAE) Ministry of Finance announced the introduction of a federal corporate tax (CT) on business, to be implemented in June 2023. The UAE is joining the other Gulf Cooperation Council countries (with exception for Bahrain) that collect tax on commercial enterprises. Many American citizens and green card holders have businesses in the UAE. Some US persons run the business as sole proprietorships; others set up UAE corporations but make a so-called “check the box” election. How will this new UAE tax impact these US persons with regard to their US tax situation?
Here are some thoughts:
Foreign Tax Credit or Deduction
Sole Proprietor / “Foreign Disregarded Entity” Election
An individual taxpayer can be subject to the UAE CT on an individual basis. This can happen, for example, if the taxpayer is running his or her UAE business as a sole proprietorship or through a UAE corporation solely owned by the taxpayer for which he has made a check-the-box (CTB) election to treat the corporation as a “foreign disregarded entity”. In such cases, the CT paid or accrued should be eligible for the US foreign tax credit (FTC) or, can be taken by the individual as a deduction on his US tax return.
Not all foreign taxes qualify for such beneficial US tax treatment. In the case of the CT, since the CT is a tax on income from a trade or business carried out in the UAE, the character of the tax is of the type eligible for FTC or deduction and will be considered a “qualified foreign tax”.
Generally, a taxpayer can choose each tax year to take the amount of any qualified foreign taxes paid or accrued during the year as a foreign tax credit or as an itemized deduction. The choice can be changed for each year’s taxes, and the taxpayer can choose the method that is most advantageous for that particular year.
It will generally be better for the taxpayer to take a FTC for the UAE CT rather than to deduct the CT as an itemized deduction. A tax “credit” reduces the taxpayer’s actual US income tax on a dollar-for-dollar basis, while a “deduction” reduces only the total income that is subject to tax. The FTC can be taken if a taxpayer does not itemize deductions. In such case, the taxpayer is allowed the standard deduction in addition to the FTC. If the FTC is chosen, and the UAE CT that was paid or accrued by the taxpayer exceeds the FTC limit for the tax year, it may still be possible to carry forward or carry back the excess to another tax year. None of these benefits are available if the CT is taken as an itemized “deduction” on the individual’s tax return.
Shareholder in a UAE Corporation
The FTC or deduction issue becomes far more complicated when the US person’s participation in business is through ownership in a UAE corporation for which a CTB election has not been made. Depending on the precise facts, from a US tax perspective, the UAE corporation can possibly be treated as a “controlled foreign corporation” (CFC) or a “passive foreign investment company” (PFIC). If you are unfamiliar with these concepts, click the links to understand more. The classification will impact how the taxpayer may be able to utilize the CT on his individual US tax return and will dictate what planning might be available to minimize the tax bite.
The effects of the UAE CT on a CFC and a PFIC will be detailed in next week’s blog post. Stay tuned.
If you need assistance navigating the US tax impact of the UAE CT on your business, we are here to help.
Posted: February 17, 2022
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