This study focuses on a share premium. The taxation and availability of this instrument in the UAE are considered as well as the rules applicable on the mainland and in a specific free zone. There is no special rule to deal with share premium in the Corporate Tax Law. There are also no direct guidance from the FTA and Minister of Finance either. The international experience has been collected to assess the potential exposure and fill the gap with best practices.
Regulatory issues on the mainland
1. A Share Premium is an amount paid for newly issued shares above their nominal (face) value. Article 198 of the UAE Commercial Companies Law sets out that a Public Joint Stock Company’s ‘capital increase shares shall be issued with a nominal value equal to the nominal value of the original shares’. However, clause 1 of this Article allows a company ‘by a Special Decision, subject to the approval of the [Securities & Commodities] Authority, [to] decide the following:
- Adding an issue premium to the nominal value of the share and specifying its amount in case the market value exceeds the nominal value of the share. The issue premium shall be added to the statutory reserve even if it exceeds half of the capital’.Article 103 explains the reference to a half of the capital. it stipulates that ‘the statutory reserve of a Limited Liability Company shall set aside every year (5%) from its net profits to form a statutory reserve. The partners may decide to stop such allocation if the reserve reaches half the capital’.
- Granting an issue discount on the nominal value of the share and specifying its amount in case the market value is lower than the nominal value of the share. Against the issue discount, a negative reserve shall arise in the equity in the balance sheet to be paid by deduction from the Company’s future profits before approving the distribution of any dividends’.
Articles 103 and 241 of this law explain the reference to the half of the capital. Clause 1 of Article 241 requires a company ‘to set aside every year and allocate to create a statutory reserve (10%) of the net profits of the [Public Joint Stock] Company … unless the Company’s Statute provides for a higher percentage’. However, ‘the general assembly may suspend such deduction whenever the statutory reserve reaches (50%) of the paid capital of the Company, unless the Company’s Statute provides for a higher percentage’.
A similar rule for a Limited Liability Company (LLC) is set by Art. 103. This stipulates that a LLC ‘shall set aside every year (5%) from its net profits to form a statutory reserve. The partners may decide to stop such allocation if the reserve reaches half the capital’.
2. Clause 2 of Article 198 of the Commercial Companies Law requires the submission to the Securities & Commodities Authority of ‘a report from an independent financial consultant accredited before the Authority specifying the method of calculating the issue premium or discount’.
Article 104(1) of this Law sets forth that ‘for all that is not specifically provided for in this Decree-Law, the provisions concerning Joint Stock Companies shall apply to the Limited Liability Company to the extent that they are consistent with its nature. The expression "Competent Authority" shall substitute the term "Authority" wherever it appears’, i.e. the local authority having competence with regard to the affairs of companies in the relevant Emirate shall approve the share premium or share discount.
[1] Article 103 explains the reference to a half of the capital. it stipulates that ‘the statutory reserve of a Limited Liability Company shall set aside every year (5%) from its net profits to form a statutory reserve. The partners may decide to stop such allocation if the reserve reaches half the capital’.
Regulatory issues in free zones
3. Article 5(1) of the Commercial Company Law determines that its provisions ‘shall not apply to companies incorporated in the free zones of the State where a special provision to this effect is stipulated in the laws or regulations of the relevant free zone’. The exception to this rule applies where these ‘laws or regulations of the relevant free zone’ permit free zone companies to conduct their activities in the mainland. Then these companies ‘shall be governed by the provisions of this Decree-Law’.
Therefore, dealing with a share premium for a particular company in a free zone, the law and regulation of this free zone shall be examined first:
- If they disregard federal rules on commercial companies in full, the availability of a share premium and rules on this shall be found in the regulation of this free zone.
- If they do not disregard the relevant provision of federal laws, they are still applicable to a share premium in these companies.
The above laws and regulations or subsequent regulations of the free zone authorities may include a rule on the application of federal rules to fill a gap in local regulation, i.e. to cover cases where the local legislation is silent. If a share premium is such a case, then federal rules remain relevant.
The Federal Commercial Company Law may also be applied where there is no clear rule that it is not applicable ‘in the laws or regulations of the relevant free zone’.
RAKEZ
4. Article 15(a) of the RAK Economic Zone Law No. 2/2017 envisages that all types of companies licensed by the RAKEZ Authority ‘shall enjoy all privileges and exemptions stipulated in the federal laws in accordance with the provisions of these laws’. These rules may offer a route to favorable federal share premium provisions if such provisions are not provided for at the free zone level.
Article 15(b) of this Law sets out that ‘the … Companies or branches of companies licensed by the authority shall not be subject to laws and local regulations in the emirate; unless a law issued by the Ruler of Ras Al Khaimah stipulates the application of these laws on RAK Economic Zone and the Companies licensed by it’. This rule doesn’t disregard federal laws.
However, Regulation 5.1 of the RAKEZ Companies Regulations 2023 issued by the Board of Directors of the RAKEZ Authority provides: ‘The provisions of the Commercial Companies Law are specifically inapplicable if there is any express provision contrary to such law in these Companies Regulations’. Therefore, the federal rules on share capital are still applicable where they do not contradict the RAKEZ regulations.
5. We haven’t found a direct regulation permitting a share premium (allotment of shares to a shareholder for a consideration exceeding the nominal value of the shares). However, Regulation 48(2) provides that ‘a Company shall not declare or pay a Dividend, or make a distribution out of contributed surplus, if there are reasonable grounds for believing that:
- the Company is, or would after the payment be, unable to pay its liabilities as they become due; or
- the realizable value of the Company’s assets would thereby be less than the aggregate of its liabilities and its share capital and share premium accounts’.
Besides, Regulation 33(5)(c) requires the auditor to confirm that ‘the present cash value of the consideration to be provided for the Shares is not less than the Share value to be credited for the issue of the Shares’. Hence, there is no prohibition on the consideration being higher than the value of the allotted shares.
6. This leads us to believe that a company registered in RAKEZ may allot its shares for a price exceeding their face value.
The cited rules from the RAKEZ Companies Regulations 2023 demonstrate that the allowance of a share premium, given by Art. 198(1) of the Federal Law on Commercial Companies, doesn’t contradict the RAKEZ regulation. Therefore, the application of the federal rule doesn’t breach Regulation 5.1 cited above.
Finally, Art. 5(1) of the RAK Economic Zone Law may lead a company incorporated in Rakez to ‘enjoy [the] privilege’ of issuing shares with a share premium ‘stipulated in the federal laws in accordance with the provisions of these laws’. This rule doesn’t disregard federal laws.
DIFC
7. DIFC is a financial free zone. Article 1 of the Federal Decree No. 35 of 27 June 2004 “On the establishing of financial free zone in the Emirate of Dubai”.
3(2) of Federal Law No. 8/2004 “On Financial Free Zones” ordains that ‘All financial zones and activities shall be subject as well to the provisions of the Federal Laws, with the exception of the civil and commercial federal laws’.
Therefore, the above rules of the Federal Commercial Companies Law are not applicable to the DIFC.
Besides, according to Article 22 of the DIFC Dubai Law No. 5/2021 the ‘Centre Establishments shall carry out their activities in or through the Centre, according to the provisions of this Law, Centre's Laws, Centre's Regulations, and legislation in effect in the Emirate that is applicable in the Centre’. Except for legislation relating to environmental fields, and those involving the public health and safety, and food control applicable in the Emirate, the … Centre Establishments…, shall not be subject to legislation issued by the Government, or by any local government entity in the Emirate, unless the Centre is included in their provisions by a special provision’.
8. Article 35(1) of the DIFC Companies Law No. 5 (2018) determines that ‘a Share may not be allotted by a Company at less than its nominal value. An Allotment of a Share that does not have a fixed nominal value, or is allotted at less than its nominal value, is void’. Hence, allotment at a premium is not prohibited in DIFC.
In DIFC, a Statement of Capital includes not only ‘the aggregate nominal value of those Shares’ but also ‘the amount Paid Up and unpaid (if any) on each Share (whether on account of the nominal value or by way of premium)’. Article 60 of DIFC Companies Law No. 5 (2018)
ADGM
9. ADGM is also a financial free zone. Hence, the above rules of Federal legislation are also not applicable to ADGM (see above).
Section 501(3) of the ADGM Companies Regulation 2020 sets out that ‘shares in a limited company have no nominal value’. Instead of this, reference is made to ‘the maximum amount of shares that may be allotted under it and the minimum issue price for those shares’. ADGM Companies Regulation 2020, Sec. 510(3)
The amount of Share Capital is to be established from a “Statement of capital”. Such Statement includes the “total number of shares of the company”, “the aggregate issue price of those shares” and “the amount to be paid up and the amount (if any) to be unpaid on each share”.Ibid, Section 514.
Thus, in ADGM there will be no difference at all between the nominal value and the consideration to be collected from the shareholder. The company's capital will be determined based on the placement price.
Corporate tax for share premium
10. There is no direct exemption of a share premium from Corporate Tax.
10.1. In the financial statements, a premium shall be recognized as equity and may not be included in the Company's profit and loss statement (CF.4.68 IFRS Conceptual Framework for Financial Reporting).
This matters because Article 20(2) of the Corporate Tax Law sets out that “the Taxable Income ... shall be the Accounting Income ..., adjusted ...". Accounting Income is defined in Article 1 of the Law as “accounting net profit or loss ... as per the financial statements". Thus, the starting point of the report is the “net profit or loss” indicator of the income statement. There can be no share premium in it.
The same Article provides that accounting data shall be adjusted in accordance with the Law, decisions of the Cabinet or the Ministry of Finance. There is no provision in them for adjustments for a share premium.
The closest (for adjustment) position is envisaged in Article 3(1) of Ministerial Decision No. 134 of 29 May 2023. This prescribes that accounting income shall be adjusted to “include any realized or unrealized gains and losses that are reported in the Financial Statements insofar as they would not be subsequently recognized in the statement of income”. A share premium will never be included in the “statement of income”.
However, it is not included in the “realized or unrealized gains and losses”. Neither IFRS nor IAS allows a share premium to be recognized as “realized or unrealized gains” in the financial statements. Para 78 of the IAS 1 “Presentation of Financial Statements” deems a share premium to be one of ‘various classes equity capital and reserves’ along with other classes ‘such as paid-in capital … and reserves’.
10.2. The above may be substantiated with the same arguments as given by the UK House of Lords (now the Supreme Court) in the Judgment in the case of Lowry (H M Inspector of Taxes) v Consolidated African Selection Trust, Ltd. of 8 May 1940.
As per para 14 of this Judgment, ‘upon an issue of shares the assets of the company are increased by the amounts obtained from the subscribers. These amounts are obviously not profits or gains of the trade [Business or Business Activity in terms of the UAE Corporate Tax], and they are not liable to be brought into the accounts for income-tax’.
‘It may be said that these amounts are of the nature of capital, but I prefer for the present purpose to say that beyond all doubt they are not profits and gains arising or accruing from a trade... What I have said is equally true whether the shares are allotted at par or at a premium’.
The sum … which in this case the company might hypothetically have received for premiums was not an item in its profits and gains. In the ordinary course such a sum would be carried to a reserve account in the balance sheet: but carrying it to some account in the profit and loss account would not have affected the matter. It would not be an item of profit of the trade. Indeed the issue of shares by a limited company is not a trading transaction at all. The corporate entity becomes pro tanto larger; but the receipts of the trade on the one hand and the amount of the costs and expenditure necessary for earning these receipts on the other remain unaltered; and it is the difference between these two sums which is taxable under Schedule D. It is well settled that profits and gains must be ascertained on ordinary commercial principles, all this fact must not be forgotten….’
In para 15, the Court opines that ‘the company cannot, even if it would, deal in its own shares, and the latter do not partake in any sense of the nature of stock-in-trade. The issue of shares by a company, whether at par or over, does not affect the profits or gains of the company for the purposes of income-tax’.
Definitely, the FTA is not obliged to follow this precedent. However, these arguments are apt in any jurisdiction whose legislation doesn’t contain provisions to rebut them. In my view, the UAE Corporate Tax regulation doesn’t have provisions that would make the cited considerations irrelevant.
10.3. However, the FTA may disagree in cases where the consideration received for the issuing of shares exceeds the face value and fair market value of the allotted shares.
For example, the Income Tax Department in India clarifies that in such case the consideration received by “a closely held company” exceeding the fair market value of the share shall be taxable in the hands of the issuer company. Section 56(2)(viib) of the Income-tax Act, 1961
In Turkey, the taxability of a share premium could have been a controversial issue if there were no special exemption for dealing with it: “The designation of share premiums as legal reserves, with the potential for distribution among shareholders as dividends, might prompt inquiries into whether these premiums should be categorized as income
While legal scholars have engaged in debates regarding whether premiums qualify as income, the prevailing consensus leans towards viewing share premiums as distinct from income, owing to their classification as capital payments linked to share valuation. Despite tax law regulations categorizing share premiums as income, they are nonetheless exempt from corporate income tax… Corporate tax legislation aligns the taxation of share premiums solely with their distribution to individual shareholders in the form of dividends’. M. Özkan Özdoğan and Alper Katırcı “Turkey: Capital Increase With Share Premium And The Effects Of Additional Tax On Startup Companies”, 18 October 2023
In the past, a share premium was used as a strategic tax planning tool in Thailand in order to inject funds from a parent company into deficit subsidiary companies without giving rise to income
Eventually, the Thai Revenue Department (TRD) successfully challenged this concept in cases No. 5812/2557 and No. 2050/2559.
In case No. 5812/2557, the Thai Supreme Court regarded the share premium as a subsidy and subject to corporate income tax. The Decision is based on the fact that the company was in deficit status with huge losses, faced insolvency, and there were no reasons for new shares to be issued with a large amount of a premium. In 2016, the Supreme Court, in Case No. 2050/2559, also ruled in favor of the TRD. Given that the share premium was paid in an excessive amount, it was regarded as a taxable subsidy from the parent company.https://digital.car.chula.ac.th/cgi/viewcontent.cgi?article=8049&context=chulaetd
29 May 2023. This stipulates that ‘where the amount of consideration paid by the transferee is lower than the Market Value, and where the transferor has included the difference between the Market Value and the consideration in its Taxable Income’ the income of the Transferee shall be adjusted as follows:
- ‘In cases other than upon realisation, to exclude any change in value of the asset or liability, to the extent that the adjustment amount relates to a change in the value between the Market Value of that asset or liability and its net book value as recognised by the transferee upon transfer.
- Upon the realisation of an asset or a liability by the transferee, to reduce an amount of gain by the difference in the Market Value and the net book value at the time of transfer, other than any net amount that has not been included in the Taxable Income under subparagraph (1) of this paragraph’.
This may have a favorable outcome where the shareholder is a UAE resident that is subject to Corporate Tax and where such shareholder has included the share premium part (exceeding the Market Value) in its Taxable Income in the UAE. Otherwise, the situation lies outside the scope of this adjustment. For example, if a shareholder is not subject to Corporate Tax in the UAE because he/she/it is not a Corporate Tax resident, then such shareholder doesn’t determine Taxable Income as defined in Article 1 of the Corporate Tax Law.
The FTA illustrated favorable adjustment in Example 10 of the FTA’s Accounting Standards Corporate Tax Guide Corporate Tax Guide “Accounting Standards and Interaction with Corporate Tax” No. CTGACS1 issued by the FTA on 6 November 2023.:
‘Company A must make an adjustment in the calculation of its Taxable Income to in-clude AED 3 million (being the difference between the Market Value and the consid-eration paid by Company B)’. Company A will hardly do it with invested property even if it is the UAE Corporate Tax Resi-dent.
‘At the time of the transfer, Company B recognises the net book value of the yacht as AED 7 million (being the consideration paid) in its Financial Statements.
Company B subsequently re-values the yacht to the Market Value of AED 10 million, recognising an unrealised gain of AED 3 million for accounting purposes. When calculating its Taxable Income for the relevant Tax Period, Company B (whether or not it has made an election to use realisation basis) should exclude the unrealised gain of AED 3 million since such amount has already been recognised by Company A and taxed.
If in the future Company B sells the yacht for AED 11 million and makes a gain of AED 1 million then the taxable gain for Company B will, therefore, be AED 1 million.’
As in this example, the consideration received for the shares is also below the fair market value but is not taxed due to the special adjustment. The rule on this adjustment is tied in with the fact that the transferor includes the difference with the market value in the taxable income. If this is not the case, the recipient is in a position to include this difference in its Taxable Income.
10.5. The participation exemption granted by Article 23 of the Corporate Tax Law may not cover the mismatch between the market value of the issued shares and consideration paid for it by a shareholder. Clause 5(b) of this Article exempts only ‘gains or losses on the transfer, sale, or other disposition of a Participating Interest (or part thereof) derived after expiry’ of the 12-month period of holding. This condition is not met in the situation in question since the shares have just been issued.
The same condition is prescribed by Art. 2(3)(d) of Ministerial Decision No. 265: income generated by shares held for at least 12 months is subject to the 0% Corporate Tax Rate. Thus, the income in question doesn’t qualify for the 0% rate and therefore may be zero-rated only if, when aggregated with other non-qualifying income, it doesn’t exceed the De Minimis thresholds. If it does, then the company will be wholly deprived of 0% for all its income from this and the 4 subsequent years. Article 5(2) of Ministerial Decision No. 265 of 27 October 2023.
10.6. The above risks may be mitigated through the application of the Reliefs for Transfers Within a Qualifying Group.
As per Art. 26(1) of the Corporate Tax Law, ‘no gain or loss needs to be taken into account in determining the Taxable Income in relation to the transfer of one or more assets or liabilities between two Taxable Persons that are members of the same Qualifying Group’.
Article 27 of Corporate Tax Law provides for ‘Business Restructuring Relief’.
However, both reliefs are applicable only where “taxable persons” are involved. If the overpaying shareholder is not a tax resident of the UAE and is not subject to Corporate Tax in the UAE as Article 1 defines a “Taxable Person”, these Reliefs are not available.
Besides, Article 26(2)(a) of the Corporate Tax Law circumscribes a “Qualifying Group” with “the Taxable Persons are juridical persons that are Resident Persons, or NonResident Persons that have a Permanent Establishment in the State”. These conditions are also not met for a shareholder who is not resident in the UAE and doesn’t have a Permanent Establishment therein. Article 27(2)(b) of the Corporate Tax Law stipulates a similar provision for Business Restructuring Relief.
10.7. The mismatch between the fair market value of the issued shares and consideration received for them from the shareholder may also disqualify the issuing company from applying the 0% Corporate Tax rate in a free zone. Article 18(1)(d) of the Corporate Tax Law defines a Qualifying Free Zone Person as ‘a Free Zone Person that … complies with Articles 34 and 55 of this Decree-Law’. Article 34 sets forth that:
- ‘In determining Taxable Income, transactions and arrangements between Related Parties must meet the arm’s length standard as specified in Clauses 2, 3, 4 and 5 of this Article and any conditions that may be prescribed in a decision issued by the Authority.
- A transaction or arrangement between Related Parties meets the arm’s length standard if the results of the transaction or arrangement are consistent with the results that would have been realised if Persons who were not Related Parties had engaged in a similar transaction or arrangement under similar circumstances…
- Where the result of the transaction or arrangement between Related Parties does not fall within the arm’s length range, the Authority shall adjust the Taxable Income to achieve the arm’s length result that best reflects the facts and circumstances of the transaction or arrangement…
- 11. Where a foreign competent authority makes an adjustment to a transaction or arrangement involving a Taxable Person to meet the arm’s length standard, such Taxable Person can make an application to the Authority to make a corresponding adjustment to its Taxable Income.’
These provisions read with Art. 18(1)(d) may be interpreted as rationale for asserting that the excess part of a share premium is not consistent with the Arm’s Length principle even if the parties to these transactions adjust the results of such transactions with the Arm’s length principle.
Furthermore, Section 4.3 of the FTA’s Transfer Pricing Guide clarifies that ‘it is important to note that the absence of a formal pricing arrangement or legal agreement between the transacting Related Parties or Connected Persons does not mean that there is no such arrangement in place. In instances where a transfer of property takes place or a service is provided without a formal arrangement or without remuneration or at remuneration below Market Value, the Arm’s Length Principle should always be applied to determine whether such a transaction or arrangement would have taken place between independent parties under similar circumstances and at what value’.
The premium exceeding the fair market value of the allotted shares ensues from the special relationship between the shareholder and the Company. Such excess hardly ‘would have taken place’ between independent parties. Therefore, the FTA may conclude that compliance with Article 34 is not only an issue of calculating tax revenue but also involves the pricing of a transaction itself. In such interpretation, TP adjustment is an instrument to rectify results of non-compliance with Arm’s Length requirements.
Such interpretation is rather a risk than an imminent event. A taxpayer may offer another interpretation where the compliance with Arm’s Length includes a voluntary adjustment of the revenue for the transaction that is inconsistent with Arm’s length, and the FTA may accept this. However, this risk should be factored in when weighing this option and alternatives.
If this risk is realized, the taxpayer will be deprived of the 0% Corporate Tax rate for the whole set of its activities for 5 years. Article 5(2) of the Ministerial Decision No. 265 of 27 October 2023.
Disclaimer
Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.
The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law.
See the full press release here.
You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have status of the author’s opinion only. Like any human job, it may contain inaccuracy and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.
- Regulatory issues on the mainland
- Regulatory issues in free zones
- RAKEZ
- DIFC
- ADGM
- Corporate tax for share premium
- Disclaimer
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