New UAE Interest Deduction Tax Guide
Corporate Clients | Tax Alert
15 April 2025
15 April 2025
On April 7, 2025 the UAE Federal Tax authority (FTA) released its new Corporate Tax Guide (CTGIDL1) on the Interest Deduction Limitation Rules.
The Corporate Tax Law establishes the four-step hierarchy of rules regarding the deductibility of interest:
The Guide broadly defines “interest” for tax purposes and sets out the rules for the deductibility of interest of a taxable person. The Guide is more than 70-pages long and goes into a lot of details when considering different aspects of interest expense, providing examples of how interest should be treated.
Below we summarize the key takeaways from the Guide. Although the Guide is not meant to introduce any new rules and is not binding on taxpayers, it gives a useful insight into the understanding of the FTA as to how interest deduction should apply in practice.
The Corporate Tax Law establishes the four-step hierarchy of rules regarding the deductibility of interest:
- General principles of deductibility of expenditure,
- Arm’s length principle,
- Specific interest deduction limitation rule, and
- General interest deduction limitation rule.
The Guide broadly defines “interest” for tax purposes and sets out the rules for the deductibility of interest of a taxable person. The Guide is more than 70-pages long and goes into a lot of details when considering different aspects of interest expense, providing examples of how interest should be treated.
Below we summarize the key takeaways from the Guide. Although the Guide is not meant to introduce any new rules and is not binding on taxpayers, it gives a useful insight into the understanding of the FTA as to how interest deduction should apply in practice.
Interest definition
For the purposes of the UAE Corporate Tax Law the term “Interest” has its proper meaning which differs from the IFRS approach, and may include (i) any amount accrued or paid for the use of money or credit, (ii) discounts and premiums, (iii) profit paid in respect of an Islamic financial instrument, (iv) other payments economically equivalent to Interest.
The Guide suggests that interest should include various expenses associated with borrowing such as guarantee fees, commitment fees and even legal fees.
Discounts and premiums
Discounts and premiums on bonds are generally treated as interest for corporate tax purposes as they represent the cost of borrowing or return on lending.
Payments economically equivalent to interest
For the purposes of the UAE Corporate Tax Law the term “Interest” has its proper meaning which differs from the IFRS approach, and may include (i) any amount accrued or paid for the use of money or credit, (ii) discounts and premiums, (iii) profit paid in respect of an Islamic financial instrument, (iv) other payments economically equivalent to Interest.
The Guide suggests that interest should include various expenses associated with borrowing such as guarantee fees, commitment fees and even legal fees.
Discounts and premiums
Discounts and premiums on bonds are generally treated as interest for corporate tax purposes as they represent the cost of borrowing or return on lending.
Payments economically equivalent to interest
Any penalties or higher interest charges resulting from the default is treated as interest expenditure/income as well as the “standard” interest for the lender and borrower.
Another novelty is the treatment of income from collective investment schemes that invest more than 50% in cash or cash equivalents (e.g. money markets) as interest income, not dividend income even if part of the return arises from equities. In other cases the income may be treated as dividend.
The return component (e.g. from mortgage-backed securities) attributable to interest from the underlying loans is treated as interest income.
The margin in a repo should also be treated as interest, even though it may be structured as a capital gain.
The return or profit on a stock lending transaction is treated as interest.
Manufactured dividend income received by the lender of the stock (transferred by the borrower) shall be treated as dividend for corporate tax for the lender (being potentially not taxable under participation exemption subject to certain conditions). Conversely, if dividends are to be retained by the borrower, then such dividends should be treated under the “normal corporate tax rules’, including being potentially exempt.
Manufactured dividend income received by the lender of the stock (transferred by the borrower) shall be treated as dividend for corporate tax for the lender (being potentially not taxable under participation exemption subject to certain conditions). Conversely, if dividends are to be retained by the borrower, then such dividends should be treated under the “normal corporate tax rules’, including being potentially exempt.
Payments under certain derivatives (e.g. interest rate swaps or other instruments managing financing cost exposures) can be treated as interest as well, if they are economically linked to a debt instrument.
Securitisation involving the transfer of financial assets into an SPV is treated as a financing transaction. The interest component of the underlying assets flows through to the investor as taxable interest income.
SPVs should treat both incoming and outgoing payments as economically equivalent to interest and subject to interest rules.
SPVs should treat both incoming and outgoing payments as economically equivalent to interest and subject to interest rules.
As finance lease payments are economically similar to a loan repayment, they give rise to interest expenditure for the lessee and interest income for the lessor. If a right-of-use asset is recognised by the lessee under IFRS, any finance component of the lease payments should be treated as interest expenditure. If IFRS requires the lessor to record a respective finance component, this finance component should be treated as interest income.
Non-finance lease (i.e. an operating lease under accounting standards), may still contain a finance element that must be treated as interest for Corporate Tax purposes.
Non-finance lease (i.e. an operating lease under accounting standards), may still contain a finance element that must be treated as interest for Corporate Tax purposes.
Amounts paid in connection with factoring are treated as interest expenditure for tax purposes, as factoring constitutes a financing transaction. The interest qualification applies regardless of how the transaction is recorded for accounting purposes.
Foreign exchange gains or losses that are related to interest or other payments economically equivalent to interest are treated as interest for tax purposes.
Borrowing cost attributable to the acquisition, construction or production of an asset are capitalized based on the IFRS. This covers interest part as well, which increase the cost base of the asset for depreciation purposes. At the same time any amount of income and expenditure attributable to capitalised interest in accordance with the accounting standards followed by the taxable person (i.e. IFRS or IFRS for SMEs) should be treated as part of net interest expenditure in the tax period in which the capitalised interest is amortised over the useful life of the related asset, and not in the tax period in which the interest is incurred and capitalised.
Where a hybrid instrument (e. g. preference shares, convertible instruments, and profit-participating loans) is classified as debt under IFRS, payments are treated as interest. If it is classified as equity, the return is considered a dividend.
Any charges in respect of a breach of statutory obligations regardless of how they are calculated are not considered deductible expenditure for corporate tax purposes. Any interest element also will not be treated as interest.
However, late payment charges on commercial contracts may qualify as interest unless the charges are specified as a fine or penalty (in the form of one-off fixed payment) in a relevant contract.
However, late payment charges on commercial contracts may qualify as interest unless the charges are specified as a fine or penalty (in the form of one-off fixed payment) in a relevant contract.
Therefore, in all of the aforementioned cases, the rules regarding the deductibility of interest will apply to the interest component.
Interest expenditure related to deriving exempt income
The Guide clarifies that while expenditure associated with earning exempt income is generally not deductible, an exception applies for interest expenditure. Where such interest relates to income from dividends and profit distributions, participating interests, a foreign permanent establishment, or income from international transport operations, it may still be deductible provided it satisfies both the general and specific interest deduction limitation rules. For instance, interest on borrowings used to acquire a participation that generates exempt dividend income may be deducted subject to these limitations.
Specific interest deduction limitation rule
Specific interest deduction limitation rule disallows the deductibility of interest on financing obtained from related parties or connected persons where the primary purpose is to gain a corporate tax advantage (“the main purpose test”). In the case the taxable person can demonstrate that the main purpose of the arrangements was not to obtain a corporate tax advantage, the rule will not apply.
The Guide introduces a key presumption for non-resident lenders which implies that if a related party lender is a non-resident and is not subject to corporate tax (or an equivalent tax at a rate of at least 9%), then the interest deduction is presumed to create a tax advantage. As illustrated in the Guidethis presumption applies not only where there is no tax, but also where the effective tax rate paid by the lender is below 9%. In such cases it is essential for the taxpayer to demonstrate that the financing is driven by commercial purposes and is not designed to gain a corporate tax advantage. Tax authority clarifies, that the interest on the loan from the related party used to finance the buy-back of the borrower’s shares from the lender is considered non-compliant with the main purpose test.
The Guide clarifies that while expenditure associated with earning exempt income is generally not deductible, an exception applies for interest expenditure. Where such interest relates to income from dividends and profit distributions, participating interests, a foreign permanent establishment, or income from international transport operations, it may still be deductible provided it satisfies both the general and specific interest deduction limitation rules. For instance, interest on borrowings used to acquire a participation that generates exempt dividend income may be deducted subject to these limitations.
Specific interest deduction limitation rule
Specific interest deduction limitation rule disallows the deductibility of interest on financing obtained from related parties or connected persons where the primary purpose is to gain a corporate tax advantage (“the main purpose test”). In the case the taxable person can demonstrate that the main purpose of the arrangements was not to obtain a corporate tax advantage, the rule will not apply.
The Guide introduces a key presumption for non-resident lenders which implies that if a related party lender is a non-resident and is not subject to corporate tax (or an equivalent tax at a rate of at least 9%), then the interest deduction is presumed to create a tax advantage. As illustrated in the Guidethis presumption applies not only where there is no tax, but also where the effective tax rate paid by the lender is below 9%. In such cases it is essential for the taxpayer to demonstrate that the financing is driven by commercial purposes and is not designed to gain a corporate tax advantage. Tax authority clarifies, that the interest on the loan from the related party used to finance the buy-back of the borrower’s shares from the lender is considered non-compliant with the main purpose test.
How BaOne can help
Navigating the UAE’s interest deduction rules may be complicated. We work alongside clients to ensure their financing structures fully comply with the UAE Corporate Tax regime.
We assist with:
Navigating the UAE’s interest deduction rules may be complicated. We work alongside clients to ensure their financing structures fully comply with the UAE Corporate Tax regime.
We assist with:
- Corporate tax calculation end ensuring compliance with interest deduction rules;
- Advising on the application of interest deduction rules within various types of transactions;
- Assisting in developing of tax strategies taking into account the insights provided in the Guide;
- Assessing the tax implications that may arise in transactions involving the interest component.
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