Ever since its formation, the UAE has developed into the cosmopolitan city it has been today by virtue of its business-friendly policies and wealth multiplying initiatives for expats. What differentiated the UAE from the rest of the world was its tax-free strategy to attract economic migrants and investors from all over the world, however, on the 31st of January 2022, the Ministry of Finance announced that for the first time in its history a corporate tax of 9% will be introduced in the UAE.
This is in line with the neighboring GCC policies as Saudi Arabia, Qatar and Oman have all imposed taxes of 20%, 10%, and 15 % respectively on profits generated by multinationals operating in the region.
Diversification and Caveats:
Over the past 5 years the UAE government has adopted a strategy of revenue diversification to move towards a more sustainable economy rather than staying an oil-dependent nation, and this new initiative aims exactly to do that. It is this very purpose that has seen a rise in the investments made by sovereign wealth funds into multiple industries internationally.
In combination with the external investments, the introduction of VAT in 2018 has helped reduce the dependency on oil as a source of government revenue as in 2021, the VAT collected amounted since its inception reached $26 Billion. It can only be assumed that the total amount of tax collected (corporate and VAT) is going to rise substantially as the region becomes more accustomed to the idea of taxation as a living reality. However, it is important to note that there are certain caveats when it comes to the imposition of corporate tax.
In an effort to reduce the economic burden on SMEs and startups, the UAE government has stated that the tax will only be applicable for companies that record a profit of more than AED 375,000, any firm that does not cross this benchmark will be tax-exempt. This will greatly help SMEs and startups avoid any additional costs that would be fatal for their bottom line since they are setting their foot into the ground.
Secondly, any companies operating in free zones will also be exempt from the tax and this will reduce the negative effects of taxation on the UAE as an investment hub, what this likely would mean is that there would be a surge in demand from companies to operate in the free zones. Currently, there are more than 40 multidisciplinary free zones across the country for multinationals to choose from.
Implications for the General Economy:
The fact that most companies have the option of relocating to free zones causes the effect of taxation to reduce, past introductions in the other GCC states have seen a negligible reduction in the rate of investments. Additionally, studies have shown that the S&P 500 index had higher average returns on every occasion of an increase in corporate taxes in the U.S, however, critics of the policy may deem this a false comparison because US companies have been accustomed to taxation, while firms in the UAE may not have that experience and it is likely the results will vary.
However, the 9% will be an additional cost for companies and will heavily affect their margins, this effect will be multiplied for industries that have had historically low margins. An example would be the service industry where high levels of competition mean that margins tend to be lower and if a firm must pay 9% of its profits to taxation, it could mean that the firms would lose their competitive advantage in terms of pricing.
Possibility of Income Tax:
The quick progression from the VAT introduction to a corporate tax model has had the public questioning the possibility of income tax arising in the country however the UAE’s Minister of State for Foreign Trade Thani bin Ahmed Al Zeyoudi has stated that: “It is not at the table at all now, and the corporate tax is set to replace the majority of the legal fees companies pay now”.
Overall, based on the trend of other countries, it is likely the introduction will see significant changes however, it is evident that this is a step towards a more economically sustainable model for the future. Only time will tell what the actual effect of the taxation will be.