Facts
A company is registered in a UAE free zone that has publicly declared its recognition as a Qualifying Free Zone for corporate tax purposes.
The company plans to enter into a transaction with an independent party to purchase debt (the right to claim repayment of a previously issued loan). The debt will be acquired at a discount. The loan agreement has a duration of more than 12 months, and the company intends to hold the loan until maturity. The borrower under the acquired debt is also an independent entity.
The company is assessing the conditions for applying the zero corporate tax rate. To comply with the de minimis rule, it must determine whether income from this transaction qualifies for the zero corporate tax rate.
Question
Does the income from this transaction—specifically, the discount upon purchase, interest received from the independent borrower, and potential income from reselling the debt after 12 months—qualify for the zero corporate tax rate?
Summary
Following the analysis below, we have reached the following conclusions:
- In our opinion, the company may classify these transactions as holding securities for investment purposes, thereby applying the zero Corporate Tax rate.
- There is a risk that the UAE Federal Tax Authority (FTA) may disagree. This risk can be mitigated if the company securitizes the debt, for example, by converting it into a negotiable instrument such as a promissory note or bill of exchange.
- As with all scenarios where there is no clear-cut guidance in the law, regulations, public clarifications, or authorized guides, there is a risk of disagreement with the FTA. Therefore, it is advisable to seek verification of the above position through a private clarification with the FTA. When doing so, the taxpayer must present a favorable tax position, propose alternatives (where applicable), and provide a detailed analysis of these positions. A relevant tax opinion should also be submitted. The arguments outlined below can support a favorable interpretation, but additional arguments tailored to the specific facts of each case should be thoroughly developed and included in the technical position.
Analysis
1. A company registered in a Qualifying Free Zone can apply the 0% Corporate Tax rate only if it meets the relevant conditions. One of these conditions is that income must be derived from Qualifying Activities. Such income must constitute more than 95% of total revenue, and non-qualifying income must not exceed AED 5 million per tax period (year). This is known as the de minimis rule:
- If the de minimis rule is met, non-qualifying income remains subject to the 0% tax rate.
- If it is not met, all income—including qualifying income—is subject to the 9% tax rate. Exceeding the de minimis threshold results in the loss of zero tax rate eligibility for the company during the period of non-compliance and for the subsequent four years.[1]
2. According to Article 2(1)(d) of Ministerial Decision No. 265 of 27 October 2023, holding “other securities” for investment purposes qualifies for the 0% Corporate Tax rate. Article 2(3)(d) defines “other securities” as ‘Negotiable or non-negotiable financial instruments, including, derivative instruments, financial commodities, and other investment instruments that are or can be traded in a public or private market or that are convertible or exchangeable into a security or which confer a right to purchase a security, with the exception of the holding of financial or investment instruments that are issued pursuant to a securitization of receivables from a non-financial asset’.
This effectively equates securities and financial instruments.
3. Paragraph 11 of IAS 32 “Financial Instruments: Presentation” defines a financial instrument as ‘any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity’.
It further states that a financial asset includes ‘a contractual right … to receive cash or another financial asset from another entity…’.
Loans are explicitly listed as financial instruments under IFRS 9 “Financial Instruments”, which covers transactions similar to those in this case:
- Example 1 in IFRS 9 (B4.1.4) discusses a business model where loans are acquired for subsequent repayment.
- Paragraph B4.1.30(c) mentions loan purchase and sale transactions.
- Paragraphs 2.1(g) and 2.3 of IFRS 9 confirm that loans fall within the financial instruments framework, whether in full or partially.
Even if loans are not fully covered under IFRS 9, they still qualify as financial instruments under IAS 32:11. Thus, acquired loan rights may be considered financial instruments.
4. However, this classification alone is insufficient to apply the zero tax rate. Additional verification is required to ensure that the loan agreement does not contain restrictions on further debt resale. If such restrictions are absent, we believe the income qualifies as Qualifying Income.
5. There is a risk that the FTA may disagree with this classification. To mitigate this risk, the company may consider securitizing the acquired loan. For example, instead of assigning the loan rights, the borrower could issue a promissory note or bill of exchange to the creditor, who would then transfer the note to the company.
Article 529 of the UAE Commercial Transactions Law states that “any bill of exchange shall be negotiable by indorsement…”. Accordingly, this would create another match with the term used in the above-mentioned tax definition of “securities”. Holding an asset obtained as a result of the “securitization of receivables from a non-financial asset” also clearly falls under this definition. In this regard, it would be reasonable to accompany the issuance of the a bill of exchange with an agreement on the “securitization of receivables from a loan” to further strengthen the argument for qualifying the income.
The recitals to Book 4 of the Commercial Transactions Law define a promissory note and bill of exchange as “commercial paper”, also including the characteristic of being “negotiable”. The Central Bank (CBUAE) in its Decision No. IA-BOD-RES 32/2017 sets forth that a term “Financial Asset” includes ‘a security (for example, a share of stock in a corporation; partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust; note, bond, debenture, or other evidence of indebtedness)… The term "Financial Asset" does not include a non-debt, direct interest in real property». A bill of exchange (promissory note) is precisely such “evidence of indebtedness”, explicitly mentioned as an example of a “security”.
Hence, by converting the debt into a promissory note or bill of exchange before resale, the company will effectively hold a debt security thereby reinforcing its claim for the zero percent rate under Clauses 1(d) and 3(d) of the Article 2 of the Decision No. 265.
[1] Ministerial Decision No. 265 of 27 October 2023, Article 3.
The disclaimer
Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.
The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law. See the full press release here.
You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have the status of the author’s opinion only. Furthermore, it is not legal or tax advice. Like any human job, it may contain inaccuracies and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.
