Pre-grouping Tax Losses, Management, and Use in UAE Corporate Tax for Tax Groups

Pre-grouping tax losses refer to the tax losses incurred by a subsidiary before becoming part of a tax group. In other words, they arise when a subsidiary’s deductible expenses exceed its taxable income during a specific financial period prior to its inclusion in the group. The UAE Corporate Tax Law provides a structured mechanism for the carryforward and offset of such losses, subject to certain conditions.

The treatment of pre-grouping tax losses is particularly significant for tax groups, as these losses can influence the group’s overall tax liability and strategic tax planning. Understanding and effectively managing these losses is essential to optimizing tax efficiency and compliance within the UAE Corporate Tax framework.

Key Rules for Managing Pre-grouping Tax Losses

The UAE Corporate Tax Law has several rules on the carry-forward of pre-grouping tax losses within Tax Groups. The rules ensure that losses are fairly used and comply with regulatory requirements.

1. Carried Forward Period

Tax losses incurred prior to group formation will be carried forward for five years from the time they are incurred. This is quite a restriction in that making use of the losses within a short period minimizes time loss.

2. Attribution to the Subsidiary

These tax losses from the pre-grouping period may only be set off against the taxable income of the Tax Group if that income is due to the subsidiary that incurred the losses.This should ensure that losses are apportioned proportionally and do not provide a benefit to unrelated entities within the group.

3. 75% Limitation

In any tax year, the Tax Group's taxable income can be reduced by a maximum of 75% using carried-forward tax losses, including pre-grouping losses. This cap prevents excessive tax avoidance and ensures that businesses contribute a minimum level of taxable income.

4. Priority of Utilization

Pre-grouping tax losses are absorbed before any other carried-forward losses of the Tax Group. This is to ensure that the losses relating to specific subsidiaries are absorbed first to avoid their expiry.

Readmore: Subsidiary Exit or Tax Group Dissolution

Calculation of Available Pre-grouping Losses

The amount of pre-grouping tax losses available for use in a year is calculated as the lower of:

• The tax of the Tax Group that is attributed to the subsidiary that incurred the losses.
• The total amount of pre-grouping tax losses accumulated by the subsidiary.

This step ensures that pre-grouping losses are applied on a proportionate basis without exceeding the taxability of the income generated by the relevant subsidiary.

Examples in Application of Pre-grouping Tax Losses

To add more clarity, apply pre-grouping tax losses as illustrated below:

Example 1: Complete Utilization of Pre-grouping Tax Losses

• Subsidiary A joins a Tax Group with pre-grouping tax losses of AED 2 million.
• Subsidiary A reports taxable income of AED 2 million in the first tax period.
• The pre-grouping tax losses are fully utilized, and taxable income is reduced to AED 0.

Example 2: Partial Use of Pre-grouping Tax Losses

• Subsidiary B brought forward losses of AED 3 million prior to consolidation to the Tax Group.
• During the current tax year, Subsidiary B makes AED 1.5 million taxable income.
• Only AED 1.5 million losses brought forward can be used and the remaining AED 1.5 million can be carried forward to subsequent tax years.

Example 3: Application of the 75% Limitation

• The Tax Group taxable income is AED 10 million.
• Subsidiary C's pre-grouping tax losses amount to AED 5 million.
• Under the restriction, the carried-forward loss could only amount to AED 7.5 million based on the application of the 75% restriction of AED 10 million.
• Assuming that other carried-forward losses exist outside of the Tax Group, these latter should be aligned within the applicable limit of 75%.

Readmore: Key Changes in Ministerial Decision on Tax Groups

Rules for Using Pre-grouping Tax Losses

1. Offset Rules
   • Pre-grouping tax losses need to be applied against taxable income before any other losses carried forward. The rationale is fairness and observance of the law.
2. Grouping Allocations
   • If the pre-grouping losses are not exhausted in a tax year, then the Parent Company selects what percentage of the loss is carried forward and what percentage can be used in any future years.
3. Reporting Requirements
   • The Parent Company will make proper records and records of the tax losses that accrued before the groupings, for proper reporting in the tax returns of the group. These would include:
     • Keeping the loss brought forward the record of each subsidiary.
     • Indication of the offsetting of the loss on taxable income.

Pre-grouping Tax Losses Impact on Tax Group Strategy

Management of the tax loss that was incurred prior to grouping has a direct bearing on the tax strategy of any Tax Group:

1. Pre-grouping losses will minimize taxable income and, thus, corporate tax liabilities of the tax groups.
2. Compliance Needs
   • Proper records will have to be maintained in the Parent Company, with regulatory compliance, thus having a higher administrative burden.
3. Strategic Timing of Including Subsidiaries
   • Subsidiaries should be brought into the Tax Group at strategic appropriate times to optimize pre-grouping losses. For instance, grouping when there is taxable income helps bring maximum benefits in tax considerations.

Limitations and Challenges

Though pre-grouping tax losses offer some excellent scope for tax planning, it is subjected to certain limitations:

1. Complexity of Management
   • Tracking and reporting pre-grouping losses are subjected to good financial systems and coordination among subsidiaries.
2. 75% Limitation
   • The loss utilization restriction does not allow businesses to fully use losses to offset taxable income. This may leave untapped losses.
3. Entity Coordination
   • Entity coordination should be effective in subsidiaries so that the pre-grouping losses are applied as well as reported.

Implications If Pre-grouping Losses Outweigh Taxable Income

If the losses before consolidation are larger than the taxable income that can be absorbed in a period, the parent identifies which of the subsidiaries' losses will be carried forward into subsequent periods to absorb if and when the subsidiary fails to qualify. They are thus available to be used in future tax periods should the subsidiary continue to qualify under tests of ownership continuity and the same business.

Conclusion

Businesses are advised to seek the expert services of premier Tax Consultants in UAE, such as Farahat & Co. to seamlessly determine taxability and ensure compliance with the corporate tax law. Contact us today and we shall be glad to assist you.