Page 8 - ICAI UAE TAX UPDATE_JULY 2024

4 ARTICLES FROM MEMBERS

4.1 Navigating the UAE Thin Capitalization Rules:

All You Need to Know

CA Naveenkumar Kabra

1. The Story Behind Thin Capitalization and its Adoption in the UAE

• The Base Erosion and Profit Shifting (BEPS) project was initiated by the Organisation for Economic Co-operation
and Development (OECD) and the G20 countries.
• In line with BEPS Action Plan 4, which aims to limit base erosion involving interest deductions and other financial
payments, Chapter 9 of the Federal Decree-Law No. 47 of 2022 (UAE CT Law) incorporates Article 30 - General
Interest Deduction Limitation Rule.
• Additionally, Article 31 - Specific Interest Deduction Limitation Rule has been included in the UAE CT Law to
address Thin Capitalization where a Taxable Person mainly acts as a conduit, using debt received from a related
party for the specified benefit of another related party.

2. What is Thin Capitalisation?

• Thin capitalization: Companies are financed with high debt relative to equity, making them highly leveraged or
geared.
• Impact on taxes: High debt results in higher interest payments, reducing taxable profit.
• Purpose of thin capitalization rules: Prevent profit shifting through excessive debt and protect a country’s tax base.
• UAE CT Law, Article 30: Broadly limits interest claims on all types of interest, both domestic and cross-border.

3. Key Issues in Thin Capitalization Highlighted by the OECD

Multinational groups can achieve favourable tax results by adjusting debt levels in group entities, leading to BEPS
risks in three scenarios:
1. Placing higher third-party debt in high-tax countries.
2. Using intragroup loans to generate interest deductions exceeding actual third-party interest expenses.
3. Using third-party or intragroup financing to fund tax-exempt income generation.

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UA E TAX UPD ATE NEWSLET TER ISSUE 04 - July 2024