UAE to launch corporate income tax – Key impacts for projects

Looming tax reform means additional costs and complications for energy and infra projects in the Gulf state 

On 31 January 2022, the UAE's finance ministry announced federal corporate income tax (CIT) will be introduced in a major shift for the Middle Eastern state. The decision came after similar moves from neighbouring Gulf states, with the UAE eager to meet international tax standards. While detailed policies remain unknown, CIT will impact businesses across a range of industries. In this article, we consider its potential impact on projects in the UAE.

Existing projects

• While the impact of CIT on existing projects will be significant, it is expected that such project companies would be entitled to claim for increased costs under typical change-in-law provisions in the concession/offtake agreement. This would need to be assessed on a case-by-case basis, with a careful review of relevant provisions to check whether relief is available and to ensure all requirements are adhered to (such as giving notice and thresholds for claiming).
• Parties involved in projects should consider how to manage accounting requirements so arrangements can be put in place to capture all relevant income, expenses and deductions under the CIT regime. 

Forthcoming projects

• For forthcoming projects, CIT will impact on sponsors' internal rate of return (IRR). The treatment of expenses and allowable deductions under the CIT regime will be important considerations, particularly given that project companies are typically thinly capitalised and subject to debt service payments.
• The experience from other jurisdictions suggests there are to be detailed provisions explaining allowable deductions under the CIT regime, including specific provisions detailing the treatment of interest payments and thinly capitalised entities. 
• Given the impact on profits, CIT will need to be factored into financial models. We expect tariffs submitted in bids will rise accordingly, particularly for projects where the request for proposal or invitation to bid requires a minimum projected equity IRR.
• While details are not yet known, it appears dividends and capital gains derived from certain qualifying shareholdings may be exempt from CIT. Entities that are part of large multinational corporate groups will also need to consider the availability of tax group structures, as well as the interaction with the Organisation for Economic Co-operation Development's Pillar Two regime, which outlines implementing a minimum 15% tax rate for multinational enterprises. The adoption of tax groups may allow losses from one project to be set off against profits from another project and possibly simplify administration by allowing group returns to be filed, rather than individual returns for each entity.

Lenders

• It is expected that CIT will not impact on project companies' ability to service their debt under project financings, particularly given where debt service sits in a typical cash waterfall. However, this will to be considered once details of CIT are announced. For example, to determine how reserved amounts and subordinated operation and maintenance (O&M) fees are treated.
• The impact of CIT on foreign banks is likely to be less significant, because the UAE branches of foreign banks are already subject to a 20% corporate tax under the respective banking decrees of each Emirate. It is not clear how the banking decrees will interact with the new proposed CIT, but this will likely be answered in the draft legislation, together with any transitional provisions that apply.
• The UAE's banking decrees do not apply to UAE banks, so the impact of CIT on such banks will likely be more significant.

EPC AND O&M Contractors

• From the perspective of engineering, procurement and construction (EPC) and O&M contractors, any income they earn for services provided or works performed in projects located in the UAE will be subject to CIT. This will impact the potential profitability of projects for contractors and will need to be factored into revenue streams.
• Contractors will also need to carefully consider the way in which payments and expenses are calculated, allocated and paid under the project documents as this will impact parties' respective liabilities under the CIT regime. For instance, whether an abatement applied to a services payment is treated as a reduction in revenue or as an expense could affect an O&M contractor's tax exposure.
• For existing projects, contractors should consider whether change-in-law provisions under the relevant project contracts will provide relief for changes which were not known at the time of contract signing.
• To the extent a free zone (where 100% foreign ownership of firms is permitted) conducts business in mainland UAE, it will be subject to CIT. As such, any contractors incorporated in a free zone but operating onshore via a local branch will likely not benefit from the corporate tax incentives offered to free zone businesses, with respect to CIT.

Next steps

While the specific details of the proposed CIT regime remain unknown, the impact of this new tax will be significant for infrastructure and energy projects in the UAE. We suggest any parties involved in projects start considering the implications now so they can undertake necessary preparations prior to its implementation.

See our earlier briefing for more on the introduction of corporate tax in the UAE