UAE Corporate Tax: Business owners should be careful drawing salaries - and bonuses
Corporate tax rules are clear on this point - business owners must factor this obligation
Under UAE corporate tax, owners’ salary remains a contentious - and confusing - issue.
Multiple schools of thought and recommendations exist to justify the salaries drawn by the owners – be it accounting as a salary in the financial statements, or drawing a directorship fee with a significant bonus provided.
No single solution is free from doubts.
While individuals’ salaries remain excluded from corporate tax, business owners should not simply pay themselves a 'salary' or ‘directorship fee’ without factoring in the tax regulations.
‘Connected person’ not only includes the owners, but also the directors of the company
Identifying connected persons
To increase the deductible expenses - and reduce the taxable income - of their companies, the owners are inclined to show them drawing a salary for themselves or family members. Sufficient safeguards exist in the form of transfer pricing benchmarking and anti-abuse rules.
The transfer pricing actually covers ‘a payment or benefit provided’ by a company to its ‘connected persons’. The expression ‘payment/benefit’ is much wider in scope compared to goods/services transactions with connected persons.
‘Connected person’ not only includes the owners, but also the directors of the company; their relatives up to four levels of kinship; and the companies owned or controlled (at least 50 per cent) by them.
It therefore becomes imperative to identify all connected persons and the payments/benefits provided to all such persons for tax regulations.
Corporate tax compliance may apply on individual directors – whether owner or independent - if the aggregate directorship fee exceeds Dh1 million
Is directorship services a business?
Whether directorship fee is paid to an owner, family member or an independent director, individual taxation of such directors could emerge as an additional compliance. Subject to certain exclusions such as wages, an individual deriving an annual turnover exceeding Dh1 million from a business or business activity in the UAE need to register for corporate tax.
Directorship fee is generally not considered as wages/salaries. Business includes vocational, professional and service activities.
The supply of services in the course of business is generally subject to VAT. Effective January 1, 2023, the functions of a member of a board of directors, performed by a natural person appointed as such, for any government entity or private sector establishment, are no longer considered a supply of services for VAT purposes.
As such directorship functions were earlier considered as a supply of service and now excluded from VAT only by way of a special exception - the director functions may still be treated as a business in common parlance. As private companies also engage in the business of providing directorship services, the activity per se performed by an individual could well be treated as a business.
Corporate tax compliance may apply on individual directors – whether owner or independent - if the aggregate directorship fee exceeds Dh1 million.
Transfer pricing - documentation vs compliance
A company is not required to maintain transfer pricing documentation for various transaction categories. One such is transaction with a natural person, to the extent that the parties are ‘acting as if they were independent of each other’.
It means the transaction is in the ordinary course of their business and the parties are not exclusively transacting with each other. Independent directors of a company are likely to act independent of each other and result in reduced transfer pricing documentation.
However, documentation is distinct from ensuring that the transactions are at arm’s length. A directorship fee to owner-directors as well as independent directors should be benchmarked at arm’s length.
Safe harbour
I often come across astounding tax planning suggestions such as paying a significant bonus to the owner-director. Could bonus be paid to owner-directors for functioning as a member of a board of directors? Probably not.
Considering the entrepreneurial growth in the UAE and the prominence of family businesses, the administrative and financial costs of benchmarking the payments to owners could be significant and prone to future litigation.
The owners have no practical way to validate the advice received by them from various quarters. It would be immensely helpful for business owners if a safe harbour - a maximum percentage of revenue - could be specified up to which owners could draw as salaries and/or directorship fee from their businesses.