The practice of entrepreneurship in the United Arab Emirates has been found to be a good choice for many Indian enterprises that may want to venture into their international markets, set up offices, or even start up in the region. But what every entrepreneur should know when venturing into the UAE is taxation..
There are two things that often confuse people are UAE Corporate Tax and VAT. Although both taxes form part of the United Arab Emirates’ taxation, the two are totally distinct. The Corporate Tax is generally meant for the taxable income of any business while VAT is regarded as an indirect tax charged for certain items.
It will be important for the Indian entrepreneur to understand that the two are completely different forms of taxes.
What Is UAE Corporate Tax?
The Corporate Tax system in UAE was introduced in financial years starting from June 1, 2023.
With regards to Corporate Tax on businesses, the taxable income of up to AED 375,000 is subject to 0% tax, while the income exceeding AED 375,000 is charged at 9%.
It is important to note that the tax is not simply a percentage of the business turnover.
Instead, businesses need to determine their taxable income according to the applicable UAE Corporate Tax rules.
This distinction is important for entrepreneurs because a company generating substantial revenue may have a considerably different taxable income after accounting for allowable expenses and other relevant adjustments.
What Is UAE VAT?
VAT, which stands for Value Added Tax, is quite distinct from Corporate Tax.
VAT was brought into practice by UAE in the year 2018 at a standard rate of 5% on taxable supplies.
VAT is an indirect tax. In a regular business process, the VAT will be charged by the business from the client, collected and accounted for by the business to UAE Federal Tax Authority.
A business operating in UAE needs to get registered for VAT once the value of taxable supplies and imports surpasses AED 375,000 in the relevant period. However, businesses can get registered voluntarily once the threshold of voluntary registration gets exceeded, that is, AED 187,500.
Therefore, VAT registration depends primarily on taxable supplies and imports, whereas Corporate Tax focuses on taxable income.
UAE Corporate Tax vs VAT: The Main Difference
The easiest way to remember the difference is:
Corporate Tax = tax on taxable business income.
VAT = tax on applicable consumption and supplies.
For example, imagine a UAE company provides consulting services and earns AED 1 million in revenue during a financial year.
The company cannot simply assume that its Corporate Tax liability is 9% of AED 1 million. It first needs to determine its taxable income under the Corporate Tax rules.
VAT works differently. If the company’s services are subject to UAE VAT, it may need to charge the applicable VAT to customers, maintain appropriate records, and report the VAT through its VAT returns.
This means the same company can potentially have both Corporate Tax and VAT obligations.
Does a UAE Company Need Both Corporate Tax and VAT Registration?
Not necessarily in every situation, because the requirements and thresholds are different.
A company can be subject to Corporate Tax rules even when it does not meet the threshold for mandatory VAT registration.
Likewise, a business may have VAT obligations based on its taxable supplies while its Corporate Tax position depends on its taxable income and applicable rules.
Entrepreneurs should therefore assess the two taxes separately rather than assuming that registration for one automatically covers the other.
What About UAE Free Zone Companies?
Free zones are especially popular among international entrepreneurs, including Indian business owners.
However, the idea that all UAE free zone companies are automatically tax-free is incorrect.
The UAE Corporate Tax framework provides specific rules for Qualifying Free Zone Persons. A qualifying free zone business can benefit from a 0% Corporate Tax rate on qualifying income, provided it meets the relevant conditions.
The treatment can depend on the nature of the income, activities performed, and other requirements.
Therefore, Indian entrepreneurs should not select a free zone solely because it is advertised as offering “zero tax.” The complete Corporate Tax position should be reviewed before choosing a jurisdiction and business structure.
How Does VAT Affect Indian Entrepreneurs?
VAT can become relevant in several ways for Indian entrepreneurs.
Consider an Indian businessman that registers a business setup in UAE to sell products or provide services in the region. The UAE entity may have VAT obligations depending on its transactions.
In the same vein, for an Indian business sending their products to the UAE, it is essential that they know how the VAT applies to the specific transaction.
International transactions can be determined based on various aspects, including the nature of the goods or services, location of the customer, place of supply, zero-rate and exempt rules.
Given that cross-border VAT may not be easy, it is important to have the right invoices, agreements, and paperwork.
Does UAE Corporate Tax Affect Indian Tax Obligations?
This is one of the most important questions for Indian entrepreneurs.
Establishing a company in the UAE does not automatically mean that an entrepreneur is no longer subject to Indian tax rules.
The individual’s or company’s Indian tax position can depend on factors such as tax residency, business structure, management and control, source of income, and the applicable India-UAE tax treaty.
For example, an entrepreneur who continues to live in India while operating a UAE company should not assume that the UAE company automatically eliminates Indian tax responsibilities.
This is why international entrepreneurs should consider both sides of the structure before incorporating.
What Should Indian Entrepreneurs Check Before Setting Up?
Before establishing a UAE company, Indian entrepreneurs should look beyond the advertised company formation price.
Important considerations include:
- Business activity and licensing requirements
- Mainland versus free zone structure
- Corporate Tax registration and compliance
- VAT registration requirements
- Accounting and bookkeeping
- Corporate banking
- UAE residence and visa requirements
- Cross-border transactions
- India-UAE tax implications
- Annual renewal and administrative costs
A professional review can be particularly valuable when the business will operate in both India and the UAE.
Common Tax Mistakes to Avoid
One common mistake is assuming that a 5% VAT rate means the company’s total tax is 5%. VAT and Corporate Tax operate differently.
Another mistake is assuming that a free zone company automatically has zero Corporate Tax.
There are also entrepreneurs who concentrate more on the cost of incorporation but neglect the accounting costs, tax costs, banking costs, and compliance costs that arise afterwards.
Lastly, some businesses assume that UAE incorporation will help them avoid all the tax obligations they currently have in India. International tax planning is not as simple as selecting a country with a lower tax rate.
Final Thoughts
For Indian entrepreneurs, understanding the difference between UAE Corporate Tax and VAT is an essential part of planning a UAE business.
Corporate Tax generally concerns taxable business income, while VAT is an indirect tax applied to relevant taxable supplies. A company can potentially have obligations under both systems, and registration requirements are determined separately.
The UAE still holds many attractive prospects for international entrepreneurs, yet setting up a successful business there requires more than just getting a trade license. Taxation, accounting, banking, business operations, immigration, and issues specific to the interaction between India and the UAE need to be considered.
A discussion of the present regulations regarding such matters with an experienced tax advisor prior to the establishment of a company in the UAE could prove very useful.
