UAE CT: How To Prepare Corporate Tax Return I How to Calculate Taxable Profits and Tax Liability

While discussing the scope of the UAE CT law, we established that every taxable person is liable to pay tax on their taxable income. In this article, we have covered the calculation of taxable income.
There can be two approaches for calculating taxable income (hereinafter referred as “taxable profits”), and it can be classified into direct and Indirect methods.
Under the direct method of calculating taxable profits, we can calculate the taxable profits directly by deducting the cost of goods sold, tax-allowable expenses and other allowable deductions from the gross income of the corporations.
In the indirect method, taxable profit can be calculated by adjusting the accounting profits. The adjustments can be of allowable and disallowable expenses, addition and deletion of income from the accounting profits to arrive at the taxable profits. So, we can establish that “Taxable profits = accounting profit as per financial statements + disallowable expenses - allowable tax expenses + other taxable income - other nontaxable income. This is a very effective and reliable method to compute taxable profits where corporations regularly prepare financial statements. In addition, it is quick to calculate taxable profit as accounting profit is taken from the financial statements, and the break of other numbers is available in the notes to the financial statements.
The question is, out of the two methods mentioned above, which is the best method suitable for the taxable person? Article 20 of the UAE CT Law provides guidance on the selection of the method for determining taxable profits. Clause 20(1) of the UAE CT law states, “The Taxable Income of each Taxable Person shall be determined separately, on the basis of adequate, standalone financial statements prepared for financial reporting purposes in accordance with accounting standards accepted in the State”. Moreover, clause 20(2) of the law requires that the taxable income for a tax period shall be the accounting income for that period and, to the extent applicable, adjusted for various items.
From the above requirement of the UAE CT law, the taxable persons will be liable to prepare the financial statements as per applicable accounting standards in the UAE. We know that International Financial Reporting Standards (IFRS) are effective in the UAE, so the taxable persons will be liable to prepare the financial statements as per IFRS. In the law, there is no compulsion to get the financial statements audited. However, article 54(2) of the UAE law still empowers the Minister of Finance (the Minister) to issue a decision requiring categories of taxable persons to prepare and maintain audited or certified financial statements.
The IFRS requires that the financial statements be prepared by applying the accrual basis of accounting. However, article 20(5)(a) empowers the Minister to prescribe circumstances and conditions under which a person may prepare financial statements using the cash basis of accounting. Once the cash basis of the accounting has been applied, a taxable person can apply to the Federal Tax Authority (FTA) to change its method of accounting from a cash basis to an accrual basis. Once approved by the FTA, changes will be effective from the commencement of the tax period in which the application is made or from the commencement of a future tax period.
While applying the IFRS and UAE CT law, if there is any conflict between these two, the UAE CT law's provisions should always be precedence over IFRS.
Moreover, article 20(2) of the UAE CT law has bound the taxable persons to apply the indirect method to calculate the taxable income, so the taxable persons will be liable to prepare the financial statements as per IFRS and adjust the accounting profits to arrive at the taxable income.
The significant adjustments to the accounting profits can be of unrealized gain or loss, exempt income, reliefs, not allowable expenses, transfer pricing adjustments, tax loss relief, income or expenditure that has not otherwise been considered. Some of these adjustments will be permanent, like fifty per cent of entertainment expenses not allowed, while others of temporary nature, like depreciation patterns, may vary. Permanent differences will only impact the current tax period, while temporary differences will affect the current and future tax periods. We will discuss all these adjustments in our future articles.