According to the United Nations Conference in Trade and Development, global foreign direct investment in 2020 shrank by one-third because of the COVID-19 pandemic. One year later, UNCTAD reports that global FDI flows have increased by 77%, from USD 929 billion in 2020 to USD 1.65 trillion in 2021.
The United Arab Emirates is among global business leaders’ preferred countries for FDI. It ranks 14th in Kearney’s 2022 FDI Confidence Index rankings, only one of the four emerging markets in the top 25 list.
Will this change with the new corporate tax in the UAE?
Corporate tax and foreign direct investments
Corporate tax hurts foreign direct investments. Governments levy corporate tax on business or corporate income. Thus, it is an expense — i.e., something that reduces a business’s net profit.
Naturally, a business entity looking for a new location to invest in will consider candidate markets’ corporate taxing practices. All things being equal (i.e., infrastructure, government policies, labor availability, labor costs, etc.), a country with corporate tax is less attractive than one without.
In “The impact of tax incentives on foreign direct investment: the case of tax holiday and corporate income tax rates in Indonesia,” authors Bella and Yudianto (2021) find this true. The results of their study, published in the Journal of Accounting Auditing and Business, demonstrate that corporate income tax has a significant and negative effect on FDI.
In other words, corporate tax can discourage foreign direct investors, and the higher the corporate tax rate, the less attractive a country is to foreign direct investors.
That being said, should corporate tax be or not be a concern for foreign direct investors considering investing in the UAE?
The old corporate tax regime in the UAE
Currently, the UAE remains one of the 15 territories and one of the two in Asia (Bahrain is the other) without a general corporate income tax.
The UAE federal government has always practiced a hands-off policy over corporate income and has left the individual emirates to decide whether or not they will tax enterprises in their jurisdictions.
The emirates, in turn, have also been very selective about which businesses to charge corporate income taxes. Most importantly, the emirates have chosen to tax only branches of foreign banks and companies in extracting natural resources. Thus, while most enterprises in mainland UAE don’t have to pay corporate taxes, upstream oil and gas companies can be taxed as much as 55%.
How about the UAE-free zones? Free zone authorities have always had complete discretion over taxation. These free zones often offer infinitely renewable corporate income tax holidays within their jurisdiction to remain competitive.
Indeed, for most businesses, the UAE has very favorable tax rates. However, this will change on 1 June 2023.
The new UAE corporate tax
A new corporate income tax regime is set to take effect in the UAE. The UAE Ministry of Finance announced on 31 January 2022 that the UAE will start charging a federal corporate tax.
Rate and scope of application
The corporate tax will apply to all enterprises and business activities in the UAE. It will apply to:
- All entities (businesses and individuals) conducting activities that require a business license in the UAE.
- All free zone businesses, although any existing free zone tax incentives, will be honoured as long as the free zone business remains in good standing, compliant with regulations, and do not operate on the mainland.
- Foreign entities and individuals that regularly or continuously conduct a trade or business in the UAE.
- Companies in banking.
- Brokerage, real estate management, development, construction, and agency businesses.
The following rate will apply to all in-scope businesses in the UAE:
- 0% if the annual taxable profit from business activities is lower than or equal to AED 375,000
- 9% if the annual taxable profit is greater than AED 375,000
- Variable if an enterprise is part of a large multinational group, which will fall under a separate corporate tax rate scheme
Timing
The new federal income tax rate will take effect on 1 June 2023
UAE businesses whose fiscal year will start on 1 June 2023 and end on 1 May 2024 will be subject to corporate tax. UAE businesses whose fiscal year will begin on 1 January 2023 and end on 31 December 2023 will be subject to the new corporate tax regime at the start of their next fiscal year (i.e., 1 January 2024).
Exemptions
The new corporate tax regime is likely not applicable to enterprises extracting natural resources — e.g., upstream oil and gas companies. The emirates will probably continue to set their corporate tax rates for these companies.
Will investors continue to invest in the UAE?
In the face of the new federal corporate tax in the UAE, are global business leaders still likely to continue their plans to invest in the UAE? The short answer is yes.
Jacques Morisset, a lead economist in the Foreign Investment Advisory Service, wrote an excellent treatise on whether or not tax incentives truly attract foreign investments. He posits that while tax incentives can sway investors, they are not the main determining factors in foreign investment decisions.
In his words, “tax incentives affect the decisions of some investors some of the time.”
Thus, while the lack of a general corporate tax (i.e., effectively a tax incentive) is a draw to foreign investors, it is not the most crucial factor. Even if this incentive is removed, it should not significantly affect FDI inflows as long as the country remains attractive in other aspects.
What other aspects are these? They include infrastructure, political and financial stability, labour availability, labour cost, liquidity levels, regulatory framework, and per capita income.
Kearney’s list of top 25 markets for foreign direct investments supports this. Twenty-one of the 25 countries are developed markets, and the top five (see below) have far from the lowest corporate tax rates.
- United States of America: 25.75%
- Germany: 29.9%,
- Canada: 26.47%
- Japan: 29.74%
- United Kingdom: 19%
In other words, the new corporate tax regime is unlikely to make serious investors reconsider investing in the UAE. This is particularly true because the UAE is a thriving logistics hub and a politically and financially stable market with high-quality infrastructure, a flourishing expatriate population, and robust real estate development.
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