Foreign Tax Credit Calculations

The existence of double taxation is a big issue that most companies meet especially when operating in foreign countries. It arises when a company is subjected to tax on its income in the country where such income is generated, and a second time in the country of residence of the business. The foreign tax credit is a policy mechanism that helps to prevent a penalty or in essence the issue of double taxation to taxpayers. In the UAE, the Foreign Tax Credit system plays a key role in interaction with corporate tax law, and understanding how it works can help businesses reduce their tax burden.

What is a Foreign Tax Credit?

Foreign tax credit is generally defined as a facility whereby a taxpayer may offset his tax burden in country A with the taxes that he has paid in country B on income from the same sources. It is an indirect way of removing double taxation by giving users an obligation-free method of paying taxes. In the UAE, the Foreign Tax Credit consists of a tax credit system in which some of taxes are not exempted but instead credited against the taxes that are otherwise payable. This implies that the taxpayer can offset the amount of tax paid on the income derived from a foreign source against the UAE corporate tax chargeable on such income.

Who can claim a Foreign Tax Credit?

The following taxable persons in the UAE are allowed to claim Corporate Tax Credit:

• Resident juridical persons
• Business or business activities performed by the natural person if the total turnover of the business or activity exceeds AED 1 million in the Gregorian calendar year in the UAE
• Foreign source income of a Non-Resident Person having a Permanent Establishment in the UAE and the foreign source income is attributable to the Permanent Establishment

Foreign Tax Credit Calculation

Such double tax relief is subject to a condition that the Foreign Tax Credit cannot exceed the amount of UAE corporate tax that would be payable on the relevant foreign income. The amount of Foreign Tax Credit is the lower of:

• That percentage of foreign source income actually taxed in the foreign jurisdiction which reduced the taxes payable by the taxpayer. Foreign tax paid could be in a foreign currency, and therefore subject to fluctuating rates of exchange compared to the AED. When it is quantified in any other foreign currency, then it must be converted to UAE dirhams under the UAE Corporate Tax Law.
• How much of the UAE corporate tax is payable on the income obtained from the foreign source. Because corporate tax is levied on income on a net basis, the net foreign source income is to be calculated by subtracting economically associated expenditure from the said income. The range of expenditure to be allowed as deduction in computing the taxable income will be based on the Corporate Tax Law of the country.

Table 1: Foreign Tax Credit Calculation

Note: The Corporate Tax Law sets two standard rates of the corporate tax, namely, 0% and 9%. Hence, the Corporate Tax on the foreign source income is to be computed on a weighted average base using the following formula: Corporate Tax due on relevant foreign source income = X*Y/Z, where X = Corporate Tax due on total Taxable Income of the Taxable Person before any Foreign Tax Credit, Y = Relevant foreign source income, and Z = Total Taxable Income of the Taxable Person.

Unutilized Foreign Tax Credit

Any unutilized Foreign Tax Credit cannot be taken forward to future Tax Periods or taken back to earlier Tax Periods as well. Thus, any Foreign Tax Credit which has been claimed but remains unused, will expire. Further, one cannot claim a deduction from taxable profits for the unutilized Foreign Tax Credit.

Income-by-income approach: multiple sources of foreign income

The Foreign Tax Credit cannot be more than the amount of Corporate Tax payable on the ‘‘relevant’’ foreign income. This means that the International Tax Credit is to be computed in relation to individual incomes earned by the company. Therefore, where Taxable Person earns income from several foreign sources it is impossible to use the excess Foreign Tax Credit on one source of foreign income to offset the Corporate Tax payable on another source of income.

FAQs

1. What is a foreign tax credit?

Foreign tax credit is defined as tax credit that enables a taxpayer to offset the amount of tax that they would be required to pay in their home country by the tax they have paid in another country on the same income.

2. How do I calculate foreign tax credit?

The total of the Foreign Tax Credit cannot exceed the amount of UAE corporate tax that is due on the relevant foreign income. The amount of Foreign Tax Credit is the lower of the following:

• The amount of tax that is actually paid on the foreign source of income within the foreign country.
• The part of the UAE corporate tax that is payable on the foreign source income.

3. Can foreign tax credits reduce my corporate tax liability?

Yes, foreign tax credits can be utilised to offset the corporate tax in UAE by the taxes paid on foreign source income in the foreign country up to the extent of UAE corporate tax payable on such income.

4. What documentation is required for claiming foreign tax credits?

A Taxable Person must retain all requisite documents to support a claim for the Foreign Tax Credit. Any Taxable Person who has claimed Foreign Tax Credit for a Tax Period, must submit proof of the tax paid to the foreign tax authority in case of an audit by FTA.

5. Are there any limitations on foreign tax credits?

Yes, there are conditions as to how much foreign tax credits one can claim. For instance, the foreign tax credit cannot be more than the value of the UAE corporate tax on the income derived from the foreign source, and the unused foreign tax credit cannot be transferred to the next tax periods or the prior tax periods.

Conclusion

Foreign Tax Credit system in the UAE is in the list of important elements of corporate tax law; it is important for enterprises to know how this system works to minimize tax burden. Companies should consider seeking the guidance of expert corporate tax consultants in UAE which will enable them to benefit from this international tax credit and lower their tax burdens.