Overview of taxation of Dividend income under the Corporate Tax Law

Under the Corporate Tax Law, Dividends and other profit distributions received from a juridical person that is a Resident Person are exempt with no further conditions. Dividends and other profit distributions received from a foreign juridical person are exempt under the Participation Exemption, provided the relevant conditions are satisfied.

The purpose of the exemption from Corporate Tax is to prevent Dividends and other profit distributions from potentially being subject to double taxation.

What is a Dividend?

A Dividend is not defined in the Corporate Tax Law. However, Ministerial Decision No. 116 of 2023 provides a definition of “Dividend”. While the Ministerial Decision is issued specifically in relation to the Participation Exemption, the FTA will apply the same definition to Dividends from a juridical person that is a Resident Person under Article 22(1) of the Corporate Tax Law.

The definition of a Dividend includes a number of important concepts listed below, each of which will be addressed separately:

• Ordinary Dividend: Any payment or distribution that is declared or paid on or in respect of shares or other rights to participate in the profits of the issuer of such shares or rights, payable out of profits or retained earnings or from any account or legal reserve or from capital reserve or revenue
• Dividend in kind: Dividend in kind includes stock dividends, bonus shares (for example scrip dividends), and other forms of actual or constructive profit distributions. Thus, a Dividend can take the form of cash, securities, or other property or assets
• Other distributions: Any payment or benefit made in connection with the acquisition of shares by the issuing entity, or redemption or cancellation of shares or termination of other ownership interests or rights which in substance constitutes a distribution of profit will be treated as a Dividend
• Non-arm’s length payments: Any payment or benefit that arises to a Related Party or Connected Person (who is a shareholder) as a result of a transaction or arrangement which does not comply with the arm’s length principle will constitute a distribution of profit in substance and accordingly, qualify as a Dividend, to the extent to which it is not at arm’s length

Ordinary Dividend

This refers to a payment or distribution that is declared or paid in respect of shares or other rights to participate in the profits of the issuer.

What is a Share?

The term “share” refers to a unit of ownership in a company which may entitle the holder to a number of rights including the right to vote, the right to participate in a distribution of the company’s profits, and the right to a return on the company’s capital. The particular rights attaching to a share will depend on the constitutional documents of the company.

Other rights to participate in Profits

Other rights to participate in profits” can cover instruments (other than shares) issued by entities, which grant holders the right to participate in the relevant entity’s profits. This concept makes provision for distribution of profits of other entities which are juridical persons, but are not companies, to also benefit from the exemptions under Article 22 of the Corporate Tax Law, provided all other requirements are met. For example, a member’s interest in an incorporated partnership or units of a trust where such entities are treated as a separate legal person according to the law under which they are incorporated. Other rights to participate in profits” also includes instruments such as Membership and Partner Interests as well as Islamic Financial Instruments referred to in Ministerial Decision No. 116 of 2023.

“In respect of” shares or rights to participate in profits

The phrase “in respect of” as used in the definition of Dividend, is the reason something is done or a benefit is granted to a Person, in their capacity as a shareholder or holder of the right to profits.

Profits out of which Dividends are distributed

Subject to applicable governing corporate laws and regulations, a Dividend can be paid out of current year profits or retained earnings, or from any account or legal reserve, or from capital reserves or revenue. This does not affect the treatment for Corporate Tax purposes.

Payments that do not qualify as a Dividend

As defined, a return on debt-claims does not qualify as a Dividend. Accordingly, income from convertible debentures or bonds cannot be considered a Dividend, until and unless the instruments are actually converted into shares.

Some debt-claims, such as bonds and debentures, carry an indirect right to participate in a debtor’s profits. Generally, income from such debt-claims does not qualify as a Dividend if the terms of the arrangement evidence a loan arrangement, for example, where loans merely carry a right to Interest dependent or contingent, to some limited extent, on the profits made by the debtor but do not have any other characteristics of a share or other form of ownership interest in a juridical person.

However, Interest on a loan may qualify as a Dividend insofar as the lender effectively shares the risks run by the company, i.e. when repayment depends largely on the success or otherwise of the company’s Business and the loan is therefore classified as equity under the Accounting Standards applied by the Taxable Person. The question as to whether the lender shares the risks run by the company and whether this means that the Interest on the loan is in substance a Dividend must be determined in each individual case in light of all the relevant facts and circumstances.

Dividend in kind – General

A Dividend will usually take the form of a cash amount. However, as defined, it can also take a different form, such as securities or other properties, or some other asset of the entity making the distribution. This is referred to as a Dividend in kind. In the case where a Dividend in kind is received, the value of the Dividend in the hands of the Taxable Person is the value recorded in its Financial Statements prepared as per the applicable Accounting Standards, as long as the value is recorded at Market Value.

Issuance of bonus shares

Bonus shares usually refer to additional shares that a company allocates to its existing shareholders out of its profits or reserves, without receiving new consideration from the shareholders. Since bonus shares are in effect a payment out of a company’s profit and reserves, they meet the definition of a Dividend.

Other distributions

In substance distributions  

As per the definition of Dividend, a payment or benefit made in connection with the following would be considered a Dividend to the extent it constitutes, in substance, a distribution of profit:

• The acquisition by a company of its own shares (buy-back of shares);
• The redemption of shares;
• The cancellation of shares (capital reduction); or
• The termination of other ownership interests or rights.

Non-arm’s length: constructive Dividend

Constructive Dividends are payments or benefits received by a shareholder as an assignment of income, despite the absence of a formal distribution. This could arise, for example, as a result of a transaction under which a parent company receives compensation that exceeds the fair value of the goods or services provided by it, to its subsidiary. As defined, any payment or benefit that arises to a Related Party or Connected Person (who is a shareholder) as a result of a transaction or arrangement which does not comply with the arm’s length principle will constitute a distribution of profit in substance and accordingly, qualify as a Dividend, to the extent to which it is not at arm’s length.

Taxation of Dividends and other profit distributions

Personal Investment income (natural person only)

For a natural person, whether resident or non-resident, Personal Investment activities are excluded from the definition of Business or Business Activity for Corporate Tax purposes.  Hence, where Dividend income received by a natural person is Personal Investment income, it is not Taxable Income for Corporate Tax purposes.

Dividend from a Resident Person

• A Dividend received from a juridical person that is a Resident Person is always Exempt Income for Corporate Tax purposes with no further conditions.

Foreign Dividends

A foreign Dividend is a Dividend received from a foreign juridical person that is a Non-Resident Person. A foreign Dividend is Exempt Income for Corporate Tax purposes if the conditions of the Participation Exemption are satisfied.

If the conditions are not satisfied, the foreign Dividend will be included in the Taxable Income of a juridical person that is a Resident Person. In the case of a Resident Person who is a natural person, the foreign Dividend will similarly be included in the Taxable Income if it is attributed to a Business or Business Activity, unless it represents Personal Investment income.

In the case of a juridical person that is a Non-Resident Person, foreign Dividend income is subject to Corporate Tax only insofar as it is attributable to a Permanent Establishment of that Non-Resident Person in the UAE. However, it will be Exempt Income if the conditions of the Participation Exemption are satisfied.