In Corporate Tax, tax is calculated based on Taxable Income earned by the Taxable person during a Tax period. This means that the higher taxable income would result in a higher tax payable, and conversely, a decrease in taxable income will lead to a lower tax payable. UAE Corporate Tax (CT) allows deductibility of expenses incurred for the purpose of business. One of the major expenses for any business is Salary. Business may think of reducing their Taxable Income by paying higher salaries, wages, or fees to the owners, shareholders, directors, etc as there is currently no tax on Natural Person’s wages or salary in UAE. In this article, we will discuss the implication of Corporate Tax on various forms of remuneration such as salary, wages, director’s fees, etc.

Taxability of personal income

As a relief for small taxpayers doing businesses in UAE, the UAE Government introduced a revenue threshold of AED 1 million which states that a Natural Person will be subject to Corporate Tax in UAE only where the total Turnover derived by such person from Business Activities conducted in UAE exceeds AED 1 million in a calendar year.

The Government further clarified that for a natural person, income from the following categories is not considered as arising from a Business or Business Activity, and is disregarded when determining Turnover threshold and not subject to Corporate Tax:

·       Wage,

·       Personal Investment income, and

·       Real Estate Investment income.

Paying salary to yourself from your business income surely seems like an appealing route to reduce the Taxable Income of your business resulting in less tax. However, safeguards such as anti-abuse rules and Transfer Pricing are there in the UAE CT law to prevent such manipulation of business transactions.

Anti-Abuse rules under UAE CT Law states that if the main purpose or one of the main purposes of a transaction or arrangement is to is to obtain a corporate tax advantage inconsistent with the tax law and such transaction or arrangement has no valid commercial reason, the transaction could be disregarded.

What does the CT Law say on drawing salary?

Article 33 of UAE CT Law of the Corporate Tax Law disallows deductions for certain types of expenditure. This includes a specific disallowance for amounts withdrawn from a Business by a natural person. Clause 4 of Article 33 of UAE CT Law specifically disallows “Dividends, profit distributions or benefits of a similar nature paid to an owner of the Taxable Person”. Let us understand this with an example -

A natural person, Mr. A conducts a Business through a sole proprietorship in the UAE and is registered under UAE Corporate Tax. For the Tax Period ended 31 December 2024, Mr. A withdrew AED 300,000 from his business and recorded this withdrawal as an annual salary cost.

Since Mr. A is running a sole proprietorship Business, no deduction is allowed for the AED 300,000, as Mr. A and the Business are one and the same Taxable Person even if the salary would have been an arm’s length salary.

The Explanatory Guide issued by Tax Authority also states that amounts withdrawn by a natural person from their sole proprietorship Business – even if described as Wage or salary – cannot be deducted in calculating the Taxable Income arising from that Business.

Payment to Connected Persons (including director fees)

While the UAE CT Law does not contain any provision related to the Director fees, the UAE Tax Authority provided clarification on Director fees in their Explanatory Guide. According to para 3.8.1 of the Explanatory Guide, a natural person appointed as a director may receive fees and other similar payments for carrying out this role, either in the course of their employment or as an independent party appointed to a board of directors. Generally, director fees will not be considered as a Business or Business Activity, and therefore would not be subject to Corporate Tax.

 Let us understand this better with an example -

"A natural person, Mr. B, holds a senior management position in the company based in UAE. In addition to his employment responsibilities, he is also a member of the board of directors.

As an employee, Mr. B receives a market rate salary for his executive role, which

is determined by his employment contract and is subject to applicable employment laws.

As a board member of the company, Mr. B also receives fees from the company

for attending board meetings.

The salary received by Mr. B is in the nature of Wage and accordingly is not subject to Corporate Tax.

In addition, the remuneration received by Mr. B in their capacity as a member of the board of directors in the circumstances as set out above, would typically be considered a Wage in the same way as an employee's salary and accordingly is not subject to Corporate Tax."

As discussed above, since remuneration paid to the Director or employee is not subject to Corporate Tax, there can be another school of thought that why not pay remuneration or directorship fee to yourself or your family member to reduce the taxable income of your business entity. This is where the concept of “Payment to Connected Persons” comes into play.

As per Article 36 of the CT Law, any “payment or benefit provided by a Taxable Person to its Connected Person shall be deductible only if and to the extent the payment or benefit corresponds with the Market Value of the service, benefit or otherwise”.

The said Article further states that connected persons not only includes business owners but also the director or officers (e.g. Chief Executive Officer (CEO), Chief Financial Officer (CFO), etc.) of the business and their relatives up to four level of kinships. A natural person will not have an owner, director, or officers, hence, this Article seems to be applicable to Juridical Persons operating in UAE. The explanatory guide issued by the Tax Authority also states that a payment made by a Taxable Person to its connected person in excess of Market Value is not a deductible expense.

Conclusion

While individual salaries remain exempt from UAE Corporate Tax, complying with arm's length principle for payments to owners, directors, officers, etc. and maintaining proper documentation are paramount. Hence, it is of vital importance for business entities to identify all the connected persons and list the payments/transactions will all such persons. For every payment to connected persons, the businesses should have sufficient documentary evidence to establish that a similar remuneration would have been paid to a third-party performing similar functions; or the connected person would have earned from a third party for performing similar functions.