Understanding Corporate Tax-Deductible Expenses

Federal Corporate Tax Law of the United Arab Emirates by its passage heralds a new era for this country on the matter of taxation, focusing on economic growth, transparency, and compliance. It shall apply to financial years beginning on or after June 1, 2023, and enforce a new federal corporate tax regime across different sectors in the country. This is about knowing what types of expenses could be deducted and hence whose tax liability could be reduced. Accurate determination of deductions of expenses will result in tax minimization, maximization of financial performance, and compliance. This page explains deductible expenses under the UAE Federal Corporate Tax Law from the view of the type of expenses eligible, conditions for deductibility, and special considerations to help businesses make the right decisions.

Eligible Deductible Expenses

Direct Costs Related to Business Operations

Direct costs encompass the expenses that are directly assignable to the production of goods or services. These costs are essential for the day-to-day functioning of a business and typically include:

• Raw Materials : The cost of materials used in manufacturing products.
• Inventory Costs : Expenses related to purchasing inventory for resale.
• Labor Costs : Wages paid to employees directly involved in production or service delivery.

Indirect Costs

Indirect costs, also known as overheads, are expenses that are not directly tied to a specific product or service but are necessary for overall business operations. Examples include:

• Administrative Expenses : Salaries of administrative staff, office supplies, and other general office expenses.
• Utilities : Costs for electricity, water, and heating that support the business premises.
• Depreciation : The gradual reduction in the value of fixed assets used in the business.

Specific Expenses Allowed Under the Law

Certain specific expenses are generally recognized as deductible under tax law, including:

• Salaries and Wages : Payments made to employees for their work, including bonuses and overtime.
• Rent and Utilities : Costs associated with leasing business premises and utilities necessary for operation.
• Marketing and Advertising : Expenses incurred for promoting products or services, including digital marketing, print ads, and promotional events. Marketing expenses are deductible only if incurred wholly and exclusively for the business and not related to exempt income or personal use.
• Travel Expenses : Costs related to business travel, such as transportation, lodging, and meals incurred while traveling for business purposes. Travel costs are deductible only for the business-use portion. Mixed personal/business travel must be proportionately adjusted. UAE allows tax grouping for entities with 95% common ownership. The group must apply jointly and meet ongoing compliance criteria.
• Professional Fees : Fees paid to external professionals for services rendered, including accounting, legal advice, consulting, and other specialized services.

Conditions for Deductibility

Expenses Must Be Incurred Wholly and Exclusively for Business Purposes

To qualify as deductible, expenses must be incurred solely to generate income or conduct business activities. Personal expenses or those not directly related to business operations cannot be claimed.

Expenses Must Be Properly Documented and Recorded

Proper documentation is essential for substantiating claims for deductible expenses. Businesses should maintain:

• Invoices and receipts that clearly outline the nature of the expense.
• Records detailing how each expense relates to business activities.
• Accurate accounting entries reflect these transactions in financial statements.

Expenses Must Not Be Capital in Nature

Deductible expenses must not be capital expenditures. Capital expenditures typically involve significant investments in assets that provide long-term benefits (e.g., purchasing machinery or property). Instead, deductible expenses should relate to the operational costs incurred within a financial year.

Expenses Must Not Be Specifically Disallowed Under the Law

Certain expenses may be explicitly disallowed by tax legislation. Common examples include:

• Fines and penalties incurred due to non-compliance with laws.
• Personal expenses are disguised as business expenses.
• Certain entertainment expenses that do not meet regulatory criteria.

Disallowed Expenses

Personal Expenses

Expenses that are personal and not incurred for business purposes are disallowed. This includes costs related to personal travel, family expenses, and any other expenditures that do not directly contribute to the generation of business income.

Entertainment Expenses

While some entertainment expenses may be partially deductible, many jurisdictions impose strict limitations or outright disallow these costs. For example:

• Meals and entertainment expenses incurred while entertaining clients may only be partially deductible (e.g., 50% in some countries).
• Costs associated with events that do not have a clear business purpose or benefit are generally disallowed.

UAE law does not allow a fixed percentage deduction for entertainment. Only business-related entertainment may be allowed, subject to scrutiny. 

UAE disallows entertainment costs unless they are directly tied to business activities and not related to exempt income.

Fines and Penalties

Any fines or penalties incurred due to violations of laws or regulations are typically disallowed as deductible expenses. This includes traffic fines, regulatory penalties, and other legal fines. Tax authorities view these as costs resulting from non-compliance rather than legitimate business expenses.

Interest on Loans for Non-Business Purposes

Interest expenses on loans taken out for personal reasons or unrelated to business activities are not deductible. Only interest on loans used to finance business operations or investments in income-generating assets can be claimed.

Net interest expense is deductible only up to AED 12 million or 30% of tax-adjusted EBITDA. Excess is carried forward for 10 years.

Charitable Donations (Except as Specified)

Only donations made to government-approved public benefit entities are deductible under UAE corporate tax law In general:

Donations made to recognized charities may be deductible, but this varies by country.
Contributions that do not meet the criteria set by tax authorities or that exceed specified limits may be disallowed.

Special Considerations

Depreciation and Amortization

Depreciation : Businesses can deduct the cost of tangible fixed assets over their useful lives. This process spreads the expense over several years, reflecting the asset's consumption.
Amortization : Similar to depreciation but applies to intangible assets (e.g., patents, trademarks). Businesses can deduct amortization expenses over the asset's useful life.

Only tax-compliant depreciation of qualifying capital assets is allowed. Capitalised costs including non-deductible items are not permitted.

Provisions and Allowances

Provisions are only deductible if they are commercially reasonable and relate solely to taxable business income. Bad debts must be written off to claim.

Tax Losses

Depending on local tax laws, businesses experiencing losses can carry these losses forward to offset future taxable profits. This mechanism allows businesses to reduce their tax liability in profitable years.

Group Relief and Consolidation

In some jurisdictions, companies within a corporate group may benefit from group relief provisions that allow them to offset profits and losses among group members. This can result in reduced overall tax liabilities for the group as a whole.

Record-Keeping and Documentation

Importance of Maintaining Accurate Records

Maintaining accurate records is crucial for substantiating claims for deductible expenses and ensuring compliance with tax regulations. Proper record-keeping helps businesses:

• Track financial performance accurately.
• Prepare for audits by tax authorities.
• Provide evidence for any deductions claimed on tax returns.

Required Documentation for Deductible Expenses

To support claims for deductible expenses, businesses should retain the following documentation:

• Invoices and Receipts : Detailed invoices and receipts for all purchases related to business operations.
• Bank Statements : Statements showing payments made for business expenses.
• Contracts and Agreements : Documentation supporting any contractual obligations related to incurred expenses.
• Expense Reports : Internal reports detailing travel, entertainment, and other business-related expenditures.

Consequences of Inadequate Record-Keeping

Inadequate record-keeping can lead to several negative consequences:

• Disallowance of Deductions : Without proper documentation, tax authorities may disallow claimed deductions during audits.
• Increased Risk of Penalties : Businesses may face penalties for non-compliance due to insufficient records.
• Financial Mismanagement : Poor record-keeping can lead to inaccurate financial reporting, affecting decision-making and strategic planning.

Conclusion

• Allowable Deduction under UAE Corporate Tax Law : Companies look at the minimum tax liability under this head. That is to say, it helps companies infer the eligible deductions. So, proper record-keeping and documentation become indispensable. Professional advice is required for proper compliance and not to miss any tax planning opportunity.
• Tax Professional for your Business : At Reyson Badger, business owners have seasoned tax professionals who can offer bespoke solutions to navigate the complexities of UAE tax laws. Protect your business and maximize deductions talk to Reyson Badger today. With the expert guidance of Reyson Badger, remain ahead of UAE tax compliance.