Introduction to General Interest Deduction Limitation Rule
In recent years, the taxation landscape has witnessed significant developments aimed at ensuring fairness, transparency, and compliance in corporate taxation. One such development is the General Interest Deduction Limitation Rule, which imposes restrictions on the deductibility of interest expenses for tax purposes. This article provides an in-depth analysis of the key provisions and sub-clauses of the General Interest Deduction Limitation Rule.
Interest Component on Financial Assets and Liabilities
The rule specifies that if the financial returns on a financial asset or liability consist of interest or economically equivalent payments, the interest component will be considered as interest expenditure or income, irrespective of its classification and treatment under applicable accounting standards.
Interest in General Interest Deduction Limitation Rule
Interest will include:
- Interest in performing and non-performing debt instruments.
- Interest on interests held in collective investment schemes primarily investing in cash and cash equivalents.
- Interest on collateralized asset-backed debt securities and similar instruments.
- Interest on agreements for the sale and subsequent repurchase of the same security at a future date at an agreed-upon price.
- Interest on stock lending and similar agreements where security is disposed of with an obligation or right to reacquire the same or similar designated security.
- Interest on securitizations and similar transactions involving the transfer of assets in exchange for the issuance of securities that entitle the holder to proceeds generated from these assets.
- Interest on lease or hire purchase arrangements where the lessee has assumed substantially all the risks and rewards associated with owning the underlying asset.
- Interest in factoring and similar accounts receivable purchase transactions.
Amounts Incurred in Connection with Raising Finance for
General Interest Deduction Limitation Rule
Amounts incurred in connection with raising finance are considered interest. This means that expenses related to obtaining financing will be treated as interest expenditures.
Fees to be included as interest: In addition to interest payments, the provision considers certain fees as interest. These are:
- Guarantee fees.
- Arrangement fees.
- Commitment fees.
- Any other fees similar in nature to guarantee fees, arrangement fees, and commitment fees.
Interest will also include:
- Interest component on forward contracts,
- Futures contracts,
- Options,
- Interest rate and foreign exchange swap agreements or
- Any other financial derivative instruments used to hedge risks directly connected with the raising of finance
Islamic Financial Instruments for General Interest Deduction Limitation Rule
The interest equivalent component on Islamic Financial Instruments will be treated as interest for the General Interest Deduction Limitation Rule.
Finance and Non-Finance Lease
Finance Lease Payment: In the case of finance lease payments, the finance element as documented in the accounts of a Taxable Person, prepared according to Accounting Standards, will be considered as interest for the purposes of the General Interest Deduction Limitation Rule. This includes both the expenditure incurred for the finance cost element and the income received from it.
Non-Finance Lease Payment: Similarly, for non-finance lease payments, the finance element will be considered as interest for the purposes of the rule. This also includes both the expenditure related to the finance cost element and the income received from it.
The finance elementrefers to the portion of the lease payment that is proportionate to the share of the total cost of the lease attributable to the finance element.
Total Finance Element: To determine the total finance elementthe total cost of the lease agreement is reduced by the value of the leased asset recognized at the beginning of the lease and the expected depreciated value of the leased asset at the end of the lease. This calculation should be done in accordance with the Accounting Standards and the accounting policy of the Taxable Person in the year when the lease was entered into.
Calculating Finance Element: The values used for calculating the finance element should be based on the date when the lease was entered into. However, if the terms of the lease are amended, the values should be recalculated as if a new lease had been entered into at the date of the amendment.
Foreign Exchange Movements
All foreign exchange gains and losses associated with interest will be considered as interest for the General Interest Deduction Limitation Rule. This provision captures the impact of foreign exchange fluctuations on interest expenses or income, promoting consistency and fairness in cross-border transactions.
Capitalized Interest
When an amount deemed as interest is capitalized in the accounts of a taxable person, the income and expenditure related to the capitalized interest will be subject to the General Interest Deduction Limitation Rule.
De Minimis Net Interest Expenditure
The limitation on deductible Net Interest Expenditure will not apply if the Net Interest Expenditure for the relevant Tax Period does not exceed AED 12 million.
If the Net Interest Expenditure exceeds the threshold mentioned, the Taxable Person has the option to deduct either AED 12 million or the percentage provided, whichever is higher. This implies that the Taxable Person can choose the more beneficial option for deduction.
The adjustment of the threshold mentioned is based on the length of the Tax Period. If the Tax Period is longer or shorter than 12 months, the threshold will be adjusted proportionately to the length of the Tax Period. This ensures that the threshold aligns with the actual duration of the Tax Period.
Accounting Earnings Before Interest, Taxes, Depreciation, and Amortisation (EBITDA)
EBITDA, for a specific tax period, is determined as the higher value between AED 0 and the amount calculated as the Taxable Income. It includes the following components:
- Net Interest Expenditure for the applicable tax period.
- Depreciation and amortization expenses considered when determining the Taxable Income for the relevant tax period.
- Any interest income or expenses related to historical financial assets or liabilities held prior to 9 December 2022.
Qualifying Infrastructure Project: When calculating the EBITDA for the General Interest Deduction Limitation Rule, interest income and interest expenditure related to Qualifying Infrastructure Projects should be excluded.
EBDITA calculation: Regarding the EBITDA calculation for the General Interest Deduction Limitation Rule, any income and expenditures associated with the interest capitalized by the Taxable Person in accordance with the Accounting Standards should be included. This inclusion happens when the capitalized interest is amortized over the useful life of the corresponding asset and not when the interest is incurred.
Adjusting Accounting Income
If a deduction from Taxable Income is claimed under Article 29 of the UAE Corporate Tax Law, that deduction should be applied after adjusting the Accounting Income for the relevant period. This implies that the deduction should be considered after making necessary adjustments to the Accounting Income.
Historical Financial Liabilities
Individuals or entities that entered into debt instruments or other liabilities before 9 December 2022, as well as any contracts entered into before or after that date solely for reducing interest rate risk on those debt instruments or liabilities, will not be subject to the General Interest Deduction Limitation Rule.
The exemption from the General Interest Deduction Limitation Rule applies only to the Net Interest Expenditure attributable to the relevant debt instruments or liabilities.
Principal not yet drawn down at that date by the borrower: If the terms of a debt instrument or liability entered into before 9 December 2022 include provisions for an amount of principal that was not yet drawn down by the borrower at that date, that amount will be considered part of the debt instrument or liability only if the lender was legally obligated to make it available upon the completion of predetermined deliverables or project phases outlined in the terms agreed prior to 9 December 2022. This does not include situations where the borrower calls for a drawdown of the principal.
NIE attributed to debt instruments: The Net Interest Expenditure attributable to debt instruments or other liabilities agreed prior to 9 December 2022 for a specific Tax Period is the lower of two values:
- The Net Interest Expenditure arising on the debt instrument or liability in that Tax Period.
- The Net Interest Expenditure that would have arisen on the debt instrument or liability in that Tax Period based on the terms of the debt instrument or liability as they stood on 9 December 2022.
Tax Groups
Joining a Tax Group: When a subsidiary joins an existing Tax Group, any carried forward Net Interest Expenditure of the subsidiary at the time it becomes a member of the Tax Group can only be utilized against the Taxable Income attributable to that subsidiary within the Tax Group.
Leaving a Tax Group: If a subsidiary leaves a Tax Group, the carried forward Net Interest Expenditure of the tax group remains with the Tax Group, except for any unutilized carried forward Net Interest Expenditure of the departing subsidiary.
Cessation of a Tax Group: In the event of the cessation of a Tax Group:
- If the parent company of the tax group continues to be a Taxable Person, any carried forward Net Interest Expenditure of the Tax Group remains with the parent company.
- If the parent company ceases to be a Taxable Person, the carried forward Net Interest Expenditure of the tax group is not available for offset against the future Taxable Income of individual subsidiaries, except for any unutilized pre-grouping carried forward Net Interest Expenditure of such subsidiaries.
Member of Tax Group is bank or insurance provider: If a member of a Tax Group is a bank or insurance provider and is not subject to the General Interest Deduction Limitation Rule, the income or expenditures of that member are disregarded when calculating the total Net Interest Expenditure and EBITDA of the tax group for the purposes of the General Interest Deduction Limitation Rule.
Independent Business of an Exempted Person
An exempt person who is a Taxable Person with respect to a specific business or business activity under Articles 5 (Government Entity), 6 (Government-controlled entity), 7 (Extractive Business) and 8 (Non-Extractive Business) of the Corporate Tax Law will be subject to the General Interest Deduction Limitation Rule and the provisions outlined in this Decision concerning that particular business or business activity.
What is a Qualifying Infrastructure Project?
A Qualifying Infrastructure Project is a project that fulfills all of the following conditions:
- It is exclusively for the public benefit of the State.
- It is solely aimed at providing transport, utilities, education, healthcare, or any other service within the State, as specified by the Minister.
- The disposal of its assets is not at the discretion of the relevant Qualifying Infrastructure Project Person.
- The assets provided, operated, or maintained by the project should have a lifespan of not less than ten years or a period determined by the Minister.
- All assets must be located within the State’s Territory.
- All Interest income and Interest expenditure of the project must arise within the State.
- It meets any additional conditions prescribed by the Minister.
Who is a Qualifying Infrastructure Project Person?
A Qualifying Infrastructure Project Person is a Resident Person who meets one of the following conditions in the relevant Tax Period:
- They are responsible for the provision, maintenance, or operation of a Qualifying Infrastructure Project.
- They engage in any other activity that is ancillary to or facilitates the provision, maintenance, or operation of a Qualifying Infrastructure Project.
Treatment of Qualifying Infrastructure Project for General Interest Deduction Limitation Rule
Net Interest Expenditure incurred by a Qualifying Infrastructure Project Person in relation to a Qualifying Infrastructure Project is exempt from the General Interest Deduction Limitation Rule.
Conclusion for General Interest Deduction Limitation Rule
The General Interest Deduction Limitation Rule introduces various provisions to regulate the deductibility of interest expenses for tax purposes. By defining key terms, addressing specific types of financial instruments and transactions, and incorporating de minimis thresholds, the rule aims to ensure consistent treatment, prevent abuse, and promote fairness in corporate taxation. Understanding these provisions is essential for taxpayers and tax professionals to comply with the applicable regulations and optimize their tax positions within the defined boundaries.
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FAQs
What is the General Interest Deduction Limitation Rule?
The General Interest Deduction Limitation Rule is a rule specified in the Corporate Tax Law that imposes a limitation on the deductibility of interest expenses or income for tax purposes.
Are Islamic Financial Instruments subject to the General Interest Deduction Limitation Rule?
Yes, the interest equivalent component on Islamic Financial Instruments is treated as Interest and is subject to the General Interest Deduction Limitation Rule.
