Foreign Tax Credit and Foreign-Sourced Income for UAE QFZPs

Understanding Foreign Tax Credit (FTC) under UAE Corporate Tax Law

Foreign companies are often attracted to UAE Free Zones due to its relatively ease of doing business and industry-specific infrastructure. They are able to stay competitive and efficient, especially in the case of maximizing profits under the UAE Corporate Tax regime.

Free Zones are sometimes set up with export-oriented, regional or international activities in mind. Usually, multinational corporations set up legal entities to give them access to regulators, similar trade partners, and other infrastructure and services specific to their growth.

In order to avoid any charges of tax avoidance, it is helpful to understand how the QFZP status works and also how foreign tax treatment is managed.

Bear in mind that direct taxes on foreign activities have no effect on QFZP status; however, income from Excluded Activities is considered to be non-qualifying revenue and is taken into account when the de minimis threshold is being assessed, even if that income is earned either inside or outside the UAE.

The same Qualifying Income rules determine the applicable UAE Corporate Tax rate (0% or 9%), whether the income is earned from foreign or domestic sources.

An example of income attributable to foreign sources includes:

• Providing services to overseas clients
• Other sales for customers outside the UAE
• Overseas investments or operations

What is foreign-source income?

In general, foreign-sourced income is accepted as qualifying income if:

• Income arises from qualifying activities
• Income falls within one of the qualifying income categories
• Income is earned in line with substance requirements set by FZ conditions
• Income is not connected with any Excluded Activity

Possible examples include:

• Services provided to overseas customers
• Export sales to customers outside the UAE
• Treasury and financing income from foreign group companies
• Royalties received from overseas
• Foreign branch income (depending on structure)
• Overseas investments
• Dividends from foreign companies
• Interest earned from foreign borrowers

Many businesses incorrectly assume that foreign location alone does not determine tax treatment.

The Corporate Tax Law first determines:

• who earned the income
• what activity generated it
• whether the activity qualifies
• whether it is qualifying or non-qualifying revenue

Knowing how to claim foreign tax credit can help minimize tax burdens on the same “foreign income”; meaning, the UAE government under certain requirements allow local UAE companies to offset taxes paid abroad.

Understanding Foreign Tax Credit (FTC)

Foreign tax paid has no impact on whether income is qualifying income or non-qualifying revenue. Foreign tax affects only whether a Foreign Tax Credit may later be available against UAE Corporate tax payable

Foreign Tax Credit (FTC) is a relief mechanism under UAE Corporate Tax regime that allows certain foreign taxes paid on foreign income to reduce UAE Corporate Tax payable on the same income. Its sole purpose is to avoid double taxation where the same income is taxed both overseas and in the UAE.

Eligibility Condition: Foreign Tax Credit works for Tax Residents with Worldwide Income

UAE resident and non-resident companies with a Permanent Establishment in the UAE are subject to corporate tax on their worldwide income, including foreign-sourced revenues such as foreign branch profits, dividends, royalties, or service income.

UAE Corporate Tax applies to taxable persons, including Resident Persons (i.e. UAE-incorporated juridical persons). Certain natural persons carrying on a business or business activity with annual turnover exceeding AED 1 million are subject to Corporate Tax, and can thus qualify for a foreign tax credit in the UAE. Income from employment wages, personal investments, and non-business foreign earnings are excluded.

A QFZP does not automatically benefit from FTC merely because foreign withholding tax was deducted.

In the FTA guidance, if a QFZP:

• earns foreign interest income
• foreign country withholds tax
• income is derived as Qualifying Income, thus
• the Qualifying Income is taxed at 0%

As a result, no Foreign Tax Credit is available because there is no UAE Corporate Tax payable against which the credit can be used.

This is an excellent practical example to include because it explains why FTC and the QFZP regime do not always interact.

Maximum Foreign Tax Credit in UAE

The foreign tax credit is limited to the lower of the foreign tax paid or the UAE corporate tax due on the same income, meaning businesses must calculate this carefully to avoid losing potential credits.

What happens to unused foreign tax credit?

A FTC cannot create a refund, as it cannot exceed UAE tax payable.

If foreign tax exceeds UAE Corporate Tax:

• excess foreign tax paid is lost;
• it cannot be refunded;
• it cannot be carried forward;
• it cannot be carried back to another tax period.

Benefits of Foreign Tax Credit (UAE Tax Laws)

Taxpayers must convert foreign taxes paid and relevant foreign income into Dirhams (AED) using recognized and consistent exchange rates.

This affects foreign tax credit computation, taxable income calculations, and the resulting tax payable.

Avoid Double Taxation when Filing your UAE Corporate Tax Return

The UAE allows unilateral tax credits even without a specific tax treaty with the country where the tax was paid; however, exploring the UAE’s extensive DTA network can help reduce withholding-tax rates at the source.

Businesses should maintain evidence including:

• withholding tax certificates
• foreign tax assessments
• proof of payment
• supporting calculations
• records showing the foreign income
• exchange-rate calculations used

What happens if your UAE business paid foreign tax on the same income?

The tax implications on foreign tax paid do not override UAE rules. Even if a QFZP pays tax in another country, it does not change whether the income becomes qualifying or non-qualifying revenue.

Essentially, UAE corporate tax classification will apply first. Decisions or tax treatment applied by relevant foreign tax authorities do not override the UAE Corporate Tax rules for determining whether income is Qualifying Income or non-qualifying revenue.

Calculating foreign tax credit claims and how this affects your UAE corporate tax liability

1. Determine whether it is Qualifying Income or non-qualifying under the QFZP regime. Remember that non-qualifying revenue must be within de minimis threshold
2. Calculate UAE Corporate Tax payable on that income (if any).
   • Starting from accounting profit, make the adjustments on exempt income, non-deductible expenses, and other tax adjustments that apply
   • Arrive at the taxable income.
   • Calculate the payable using the tax rates
3. Determine foreign-source income and if foreign taxes qualify.
4. Calculate foreign tax already paid. Remember that any unutilized foreign tax credit cannot be carried forward to current and future tax periods.
5. FTC equals the lower of:
   • foreign tax paid, or
   • UAE Corporate Tax due on that income.

Example 1

• UAE Free Zone software company
• Provides software services to a German customer
• Activity qualifies
• Income is Qualifying Income
• Germany imposes withholding tax
• UAE tax rate on that income remains 0%

Result: No FTC because no UAE Corporate Tax is payable on the Qualifying Income

Example 2

• QFZP earns income from an Excluded Activity overseas.
• Income becomes non-qualifying.
• Income is subject to UAE Corporate Tax.
• Foreign tax was already paid.

Potential outcome:

FTC may be available, subject to the statutory conditions and the limit that the credit cannot exceed the UAE Corporate Tax due on that same income

Can foreign sales tax be claimed as a UAE Foreign Tax Credit?

Businesses often confuse foreign sales tax, VAT, or GST with foreign income tax. However, the UAE Foreign Tax Credit generally applies to qualifying foreign income taxes rather than indirect taxes collected on the sale of goods or services.

Strategic Tax Planning

The UAE Corporate Tax regulations include a Foreign Tax Credit (FTC) mechanism to help reduce double taxation where the same income is taxed both in a foreign country and in the UAE.

Businesses can claim a foreign tax credit where the conditions under the UAE Corporate Tax Law are satisfied. The credit is generally limited to the amount of UAE Corporate Tax payable on the relevant foreign income.

Businesses operating internationally should consider how foreign-sourced income is taxed both overseas and in the UAE when planning cross-border operations.

Foreign Tax Credit supports tax efficiency and not tax avoidance

Where the UAE has a Double Taxation Agreement (DTA) with a foreign country, treaty provisions may reduce foreign withholding taxes at source. However, a Foreign Tax Credit may still be available under the UAE Corporate Tax Law even if no treaty applies, subject to the relevant conditions.

Maintaining proper documentation, such as withholding tax certificates and proof of taxes paid in foreign jurisdictions, is essential for claiming the foreign tax credit and ensuring compliance with UAE tax regulations.

Businesses with cross-border operations may benefit from seeking professional foreign tax credit advisory, as UAE Corporate Tax rules can be complex to apply for a Qualifying Free Zone Person (QFZP).