2022 is the last year for businesses in the UAE to enjoy their profits without sharing it a bit with the government in the form of taxes. After all, it’s “profit” they are all running their companies for. Because higher the business profits greater the success, positive sustainability and market share. But soon corporate tax will blot the tax-free landscape of the UAE. Business enterprises just like oil companies and foreign banks in the UAE will be liable to pay corporate tax in the wake of UAE’s decision to levy a nine per cent federal corporate tax on business profits more than Dh375,000 from June 1, 2023 which means higher the profits higher the taxes. Seems like a stick in the mud? Actually not, if you compare the 9% corporate tax with other countries around the world for that matter such as the United Arab Emirates, Brazil, Venezuela, France, and Japan – it is one of the lowest corporate tax rates in the world. Plus, there are no income taxes in the country so far unlike most nations worldwide.
Calculations of CT Liability
The CT liability can simply be calculated by deducting the portion of taxable income exceeding AED 375,000 (or total profits) from the threshold amount AED 375,000 at 9%. One thing to note here is that accounting profits are different from taxable profits, and corporate tax is applicable on taxable profits. While accounting profit refers to the earnings calculated based on the applicable International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), taxable profit adjusts the accounting profit for tax reporting enabling the organization to slash their tax liability. The time period between 1st day of April and 31st day of March is known as the financial year.
Sometimes called bookkeeping profit, accounting profit is achieved as a result of operating and non-operating activities of the company. Reflecting an entity’s profitability and performance in the future, accounting profit is essentially the actual financial gain that is received after subtracting total expenses from total revenue of the business. It also ascertains how meticulously the resources of a company are allocated. It’s accounting profit that tells the company’s liquidity and solvency to the users of the financial statement.
Taxable profit is the total amount of profit which is taxable as per the tax laws of the specific jurisdiction of the country. Used to contrast between accounting profit and earnings, taxable profit is derived after taking the tax liabilities into account and accounting profit acts as a base for the computation. It includes certain expenses and the calculated amount is updated in the profit & loss account. Businesses world over try their best to reduce the tax liabilities defined within the acceptable tax guidelines resulting in taxable profits higher than accounting profits oftentimes.
Accounting Profit & Taxable Profit
The profit computation principles and guidelines under IFRS and GAAP differ from the basis outlined in the corporate tax and related laws in the UAE which naturally leads to huge differences in the profits and their computation methods. Let’s see how both the terms are different from each other despite being called ‘profit’ for businesses:
- The first and foremost, accounting profits are computed on the accrual basis of accounting unlike taxable profits that are derived by using accrual and cash basis. To better understand the difference, the former shows the accounts receivable once the sale is made while there might not necessarily money is received from the customer while in case of taxable profits, the cash is recorded only when it is actually exchanged or received from the customer to the business, not just on booking.
- While accounting profits in Dubai, UAE are calculated based on the applicable IFRS or GAAP, taxable profits are figured based on the guidelines given in UAE’s corporate tax law and related regulations
- Accounting profit aka bookkeeping profit is the net income that comes after reducing all explicit costs including raw material costs, labour costs, distribution costs, and other production costs/expenses from the organization’s total revenue as outlined by accounting standards or GAAP. On the other hand, taxable profit takes into account tax liabilities including accounting profits and other costs and refers to the profit that is taxable as per income tax guidelines or income tax act
- Computation of accounting profit is an on-going activity as it continuously considers the payments and receivables. On the contrary, taxable profit is a one-time tax that is determined once all amounts are received and paid
- Accounting profit of an organisation aims at recognising the business profitability as a whole while taxable profit zeroes on deriving the tax liability of the company
- Scope wise accounting profit stays within the scope of financial reporting while the extent of taxable profit or income remains up to Tax reporting
- Accounting profit is basically the financial gains leaving out all costs whereas profit on which taxes are levied is termed as taxable profit.
- For depreciation calculations accounting profit uses the straight-line method whereas taxable profit uses the double-declining depreciation method
- Accounting profit uses the FIFO (First In First Out) inventory valuation method whereas taxable profit uses LIFO (Last In First Out) inventory valuation method
- Accounting profits notify the positive or negative financial performance of the business whereas taxable profit determines the tax liability of the organizations
- And last but not least, for the calculation of accounting profits, the current financial year is considered while income from the previous year is taken into consideration in case of taxable profits for that matter. For instance, if the assessment year is 2023-2024, then the previous year will be 2022-2023.
Permanent/Temporary Differences in Tax Accounting
The differences that are permanent in nature have an effect in one period not on the future period/periods. Dividends, capital gains, fines and penalties etc. are the elements that create permanent differences. While one administration might accept these items, others might not. This means the items mentioned above may be accepted under IFRS and GAAP but not considered by the corporate tax law and vice versa. For example, despite being the accounting income, dividends and capital gains are not seen as taxable income, as mentioned in the press release issued by the UAE’s Ministry of Finance. So, the period in which dividends and/or capital gains appear in the accounting profits, for that period, accounting profits would be greater than the taxable profits. Similarly, fines and penalties generally cause permanent differences and are reported as an expense during computation of accounting profits, but these are not generally accepted by the Law as an allowable expense. Due to these different recognition rules, accounting profits of the relevant period would be lower than the taxable profits of the respective period.
The differences that are not permanent in nature are termed as temporary differences. This means that the differences that were created due to some transactions in one period are offset in the subsequent period/periods. The items such as depreciation that cause temporary differences are embraced by both administrations, but the pattern of identifying them varies from one to another. For instance, depreciation is an accounting expense and generally allowable expenses under the corporate tax law as well, but the rate of depreciation and/or method of depreciation calculations may vary from one administration to another. Usually, tax authorities use the straight-line depreciation method, and IFRS requires the same or reducing balance method. In the light of these facts, tax authorities see the pattern of consuming benefits of the assets differently from the useful life required by the IFRS, but over the period, both methods would have the same depreciation amount. Temporary differences can further be classified into: Deductible temporary differences and Taxable temporary differences.
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