Emirates: The UAE’s corporate tax law (UAE CT law) requires taxable persons to calculate their taxable profits by applying an indirect approach. The indirect process entails preparing financial statements per applicable accounting standards and adjusting the accounting profits to arrive at the taxable profits.

The adjustments to the accounting profits typically involve adding back expenses not deductible for tax purposes and subtracting expenses not recognised in accounting profits. Conversely, income not subject to UAE CT law should be excluded from accounting profits. The income subject to tax but not part of the accounting profits should be included to arrive at the taxable profits.

Among the various adjustments to the accounting profits, the adjustment of unrealised gains and losses is critical. Under Article 20(3) of the UAE CT law, an option has been given to the taxable person to take into account the gains and losses on a realisation basis related to all assets and liabilities that are subject to fair value or impairment accounting under the applicable accounting standards; or all assets and liabilities held on capital account at the end of a tax period. However, the gain or loss on all assets and liabilities held in the revenue account will be considered on an unrealized basis as given in clause 20(3)(b) of the UAE CT law. This means the taxable person can elect for the gain to be taxed or the loss to be allowed on a realisation basis only for the assets and liabilities subject to fair value or impairment accounting or held on capital account. Whatever the treatment, it will apply to all assets and liabilities of the respective category.

The assets and liabilities subject to fair value generally include financial assets, financial liabilities, investment property, biological assets measured at fair value less cost to sell, and Intangible assets acquired in a business combination. The assets subject to impairment accounting include property, plant, and equipment (PPE), goodwill, intangible assets not acquired in a business combination, investments in equity instruments that are not held for trading etc.

The “assets held on capital account” include assets that the person does not trade, assets that are eligible for depreciation, or assets treated under applicable accounting standards as property, plant and equipment, investment property, intangible assets, or other non-current assets. The “liabilities held on capital account” refers to the incurring of which does not give rise to allowable tax expenditure or non-current liabilities.

The “assets and liabilities held on revenue account” refers to assets and liabilities other than those held on a capital account. These assets and liabilities are items held for generating revenue rather than for use in the ordinary course of business operations. These assets and liabilities are typically short-term and expected to be converted into cash or consumed within one year like inventory items.

The taxable person can realise gain and loss on the assets and liabilities subject to fair value or impairment testing or held on account on a realisation basis. When the taxable person sells such assets or settles liabilities, the gain will be taxable, and the loss will be allowable. Still, for the assets and liabilities held on the revenue account, the taxable person will have to assess the unrealised gain or loss by the end of the tax period and adjust the accounting profits accordingly.

For example, if a P Ltd (taxable person) buys a stock (inventory item) for $500, which is part of the inventory items by the end of the year, and its market value increases to $550, P Ltd will be liable to pay tax on this unrealised gain of $50. On the contrary, if the value of the closing inventory has been reduced to $ 400, then $100 will be allowed as a tax-deductible expense. In both scenarios, accounting profits will be adjusted accordingly.

In the second situation, suppose P Ltd has bought machinery (asset held on the capital account) of $1 million, which will be used for business purposes and booked as a non-current asset. The tax written down value (WDV) of the machinery is $0.8 million after two years, but the market value of the same machinery is $0.9 million simultaneously. In this scenario, P Ltd is not required to pay any tax on the unrealised gain if P Ltd has already elected to tax the gain on a realisation basis. If P Ltd has yet to elect to tax the gain on realisation basis, then P Ltd will be liable to pay tax on $ 0.1 million. In the same way, tax loss if any, will be allowed on a realisation basis if elected. If not elected, then unrealized tax loss will be allowed by the end of the tax period. In both cases, P Ltd will adjust the accounting profits accordingly.

The law is silent about the pattern of allocation of assets, and we can assume the tax depreciation would be the same as accounting depreciation, so tax WDV will be equal to the accounting WDV. The regulations, which will be promulgated soon, will give us more clarity about this.

Taxable persons must do the internal assessment. After the what-if analysis, they need to decide internally to be elected for the taxation of gain or loss on a realisation basis or not.