Understanding Deductible and Non-Deductible Expenses in UAE Corporate Tax

In June 2023, the UAE introduced its federal corporate tax laws, marking a major shift in the country's tax landscape. While these regulations aim to strengthen the nation’s fiscal position and align with global standards, they also present new challenges for businesses. One of the most crucial aspects of compliance is understanding which expenses are deductible and which are non-deductible—a distinction that can significantly impact a company’s taxable income.

For businesses in the UAE, making the right deductions is essential for minimising tax liability and avoiding potential audits or penalties. Misclassifying expenses can lead to costly mistakes and unnecessary financial strain. On the other hand, understanding and applying the right deductions can reduce a company’s overall tax burden and improve cash flow.

In this comprehensive guide, we will explore the deductible and non-deductible expenses under the UAE’s corporate tax law, which expenses can be claimed, how to stay compliant, and how to optimise your tax strategy moving forward.

What Are Deductible Expenses?

Deductible expenses are business-related costs that a company can subtract from its total income, thereby reducing its taxable income. Under the UAE corporate tax law, a business can only claim expenses that are deemed "wholly and exclusively" incurred for business purposes. This means that the expense must be directly related to the day-to-day operations, growth, or maintenance of the business and must contribute to generating income.

Common Examples of Deductible Expenses in UAE

1. Operating Costs

• Rent: Office or warehouse rent, including expenses related to maintaining business premises.
• Utilities: Expenses for electricity, water, and internet services used for business operations.
• Salaries and Wages: Payments made to employees, including benefits and bonuses.
• Employee Training: Costs associated with upskilling employees to improve business efficiency.
• Supplies: Costs for purchasing materials or products directly used in business activities.

2. Capital Allowances

Depreciation: The gradual reduction in value of fixed assets like machinery, vehicles, and equipment. Depreciation is often deductible over the asset’s useful life.

3. Business Travel Expenses

Travel expenses, including flights, accommodation, and meals, when incurred for business purposes.

4. Interest on Business Loans

If a business has borrowed money to finance its operations, the interest payments on such loans are typically deductible.

5. Research and Development (R&D) Costs

Expenses related to innovation or the development of new products/services, which help improve business performance and competitiveness.

6. Marketing and Advertising

Costs incurred in promoting the business, such as digital ads, printed materials, or event sponsorship.

By deducting these expenses from the total revenue, businesses can lower their taxable income and ultimately reduce their tax liabilities. The tax authorities will typically require businesses to provide proof that these expenses were incurred for legitimate business purposes.

What Are Non-Deductible Expenses?

Non-deductible expenses refer to business costs that cannot be subtracted from a company’s taxable income when calculating its corporate tax liability. Essentially, these are expenses that the UAE tax law does not allow businesses to claim as deductions, regardless of their relevance to the day-to-day operations of the business.

The key characteristic of non-deductible expenses is that they do not directly contribute to the generation of business income or are considered outside the scope of what the tax authorities deem eligible for deduction. While businesses may incur these costs during their operations, claiming them on tax returns would not reduce the overall taxable income.

Common Non-Deductible Expenses in UAE

1. Personal Expenses

Expenses that are unrelated to business activities and are for personal use of the business owner or employees. For example, personal travel or non-business-related meals.

2. Fines and Penalties

Costs incurred due to legal infractions, such as fines for traffic violations, regulatory breaches, or non-compliance with business laws. These cannot be deducted from taxable income.

3. Capital Expenditures

Large investments in assets (like purchasing a building or equipment) are not deductible in their entirety. While these costs may be depreciated over time, the initial expenditure is not immediately deductible.

4. Entertainment Expenses

Certain entertainment costs, such as those related to luxury entertainment (e.g., lavish gifts, extravagant meals), are generally not deductible. However, moderate entertainment expenses that are directly related to business meetings may be eligible for deduction under specific conditions.

5. Non-Business Donations

While charitable contributions are generally seen as a positive aspect of corporate responsibility, they are not deductible for tax purposes unless they are directly tied to business promotion.

Key Rules for Deductibility Under UAE Corporate Tax Law

Under the UAE's federal corporate tax system, businesses can deduct various types of expenses from their taxable income, but only if they meet specific conditions outlined in the Corporate Tax Law. Here are the key rules for deductibility:

1. Wholly and Exclusively for Business Purposes

• To qualify for a deduction, the expense must be incurred wholly and exclusively for business purposes. If an expense has both personal and business purposes, only the portion attributable to business activities is deductible.
• Example: If a florist uses a van for both personal errands and business deliveries, only the proportion of expenses related to business use (e.g., 60% of van usage) is deductible. The remaining 40% related to personal use must be added back to taxable income.

2. Capital vs. Revenue Expenditure

• Capital expenditures (e.g., purchasing long-term assets like machinery or buildings) are not deductible for corporate tax purposes. However, the depreciation of capital assets over their useful life can be deducted.
• Revenue expenditure (e.g., routine operating costs such as salaries, supplies, and utilities) is generally deductible.
• Example: A company buying a vehicle for business use would treat the purchase as a capital expense, but the costs for maintaining and operating the vehicle would be deductible as revenue expenses.

3. Apportioning Mixed Expenditures

• If an expense is partly for business and partly for non-business purposes, businesses must apportion the cost. Only the portion directly related to generating taxable income is deductible.
• Example: If a business incurs an expense like office rent, and part of the space is used for personal purposes, only the proportion related to business activities is deductible.

4. Interest Expenditure

Interest paid on loans taken for business purposes is generally deductible. However, there are limitations:

• General Interest Deduction Limitation Rule: If net interest expenditure exceeds AED 12 million, only 30% of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) is deductible.
• Example: If a business incurs AED 50 million in interest and its EBITDA is AED 130 million, it can only deduct AED 39 million of that interest (30% of EBITDA), with any excess carried forward for up to 10 years.

• Interest from Related Parties: Interest on loans from related parties (e.g., loans from parent companies or affiliates) may not be deductible if the loan is for non-business purposes, such as funding dividend payments. Exceptions apply if the loan is not used to create a tax advantage.

5. Entertainment Expenditure

• Entertainment costs, such as meals or events for customers or business partners, may be deductible, but only 50% of the costs are allowed.
• Example: If a company spends AED 100,000 on entertaining clients, only AED 50,000 is deductible. However, if the expenditure is for staff entertainment (e.g., a company party), it can be fully deductible, unless the event is personal in nature (e.g., a wedding).

6. Proper Documentation

Businesses must maintain clear and proper documentation for all expenses to ensure deductibility. This includes invoices, receipts, or other records proving the expense was incurred for business purposes.

7. Timing of Expenses

• Expenses must be claimed in the fiscal year they are incurred. Businesses should align their expense claims with their accounting periods to avoid issues during audits.

These rules are designed to ensure that deductions are consistent with the intent of the tax law, preventing abuse while allowing businesses to reduce taxable income based on legitimate business expenses.

Implications of Incorrectly Deducting Non-Deductible Expenses

Incorrectly claiming non-deductible expenses can lead to serious consequences for businesses in the UAE. As outlined in the UAE Corporate Tax Guide (September 2023), the tax authority has established strict rules regarding what can and cannot be deducted. Here are the key implications businesses may face if they fail to comply:

1. Tax Penalties

• The UAE Federal Tax Authority (FTA) imposes penalties for incorrect claims, including the deduction of non-deductible expenses. If a business incorrectly deducts expenses that are deemed non-deductible, the FTA can impose financial penalties. 
• The FTA may assess these penalties after reviewing the tax return, often through audits or assessments. The penalty structure can vary depending on the nature and severity of the non-compliance. 

2. Increased Scrutiny and Audits

• Incorrectly deducting non-deductible expenses can raise red flags with the FTA, leading to further scrutiny of your financial records. Businesses that engage in improper deductions may be subject to a more detailed audit process.
• During an audit, the FTA will review the business's financial statements, supporting documentation, and expense records to determine whether the deductions claimed are legitimate. This process can be time-consuming, costly, and disruptive, requiring businesses to spend additional resources to cooperate with the FTA and provide further evidence.

3. Reputational Damage

• While the direct financial penalties and audit costs are significant, businesses also face the risk of reputational damage. Repeated errors in tax filings, or a history of incorrect deductions, can negatively impact a company's relationship with the FTA and other stakeholders, such as investors and clients.
• The perception of non-compliance or carelessness in handling financial records can erode trust, which may affect the business’s ability to secure future financing, maintain customer relationships, and grow sustainably within the market. 

4. Potential Disqualification of Deductions

• When the FTA identifies improperly claimed expenses, it may disallow those deductions, meaning the business would lose the potential tax savings from those deductions. Disqualified deductions could lead to an increase in taxable income, meaning the business will owe more in corporate taxes than originally calculated.
• This not only affects the business's immediate tax liabilities but also has implications for future filings. If the FTA identifies repeated or systemic errors, the business could face more stringent oversight in subsequent tax periods.

To avoid the negative consequences of incorrect deductions and ensure compliance with tax regulations, businesses must adopt a strategic approach to maximise their deductions. 

How Businesses Can Maximise Deductions

To ensure that they are claiming all eligible deductions and staying compliant with UAE tax laws, businesses can implement the following strategies:

1. Apportion Mixed Expenditures: Implement a system to accurately track and separate personal and business-use expenses (e.g., vehicle mileage logs) to ensure proper deduction.
2. Depreciation on Capital Expenditures: Classify assets correctly and apply appropriate depreciation methods. Plan purchases to optimise deductions over time, and explore accelerated depreciation options if available.
3. Intercompany Loan Structuring: Ensure loans from related parties are used strictly for business purposes. Avoid using such loans for non-deductible activities like dividends.
4. Entertainment Expenses: Only claim deductions for entertainment costs that benefit clients directly and are related to business activities. Separate client entertainment from employee-related expenses.
5. Maintain Proper Documentation: Keep thorough records (receipts, invoices, contracts) to substantiate deductions, especially for mixed-use expenses, capital assets, and interest payments.
6. Carryforward Deductions: Track unused deductions (e.g., depreciation or interest) and carry them forward to future tax years if applicable.
7. Seek Professional Advice: Consult with tax advisors or use tax software to ensure compliance, maximise deductions, and avoid mistakes in filing under the new corporate tax law.

Stay Updated on Corporate Tax Law Changes

• To mitigate the risks associated with incorrect deductions and non-compliance, businesses should stay informed about the latest updates to UAE corporate tax laws. Regularly reviewing amendments, especially those related to deductions and VAT treatment, will help businesses avoid mistakes during tax filing.
• Proactively monitor tax law changes and adjust your tax strategies accordingly. This will ensure that your business remains compliant and can take advantage of any new opportunities for tax savings while avoiding penalties and the risk of audits.

To illustrate the importance of correctly categorising expenses, let's look at some case studies highlighting common deductible and non-deductible expenses for businesses. These examples will clarify how businesses can avoid costly mistakes.

Examples: Deductible vs. Non-Deductible Expenses

Example 1: Employee Salaries and Travel Expenses

• Deductible: Salaries and wages paid to employees are deductible, as they are a necessary business expense. Similarly, travel costs, such as flights and accommodation for business trips, can be deducted if they are substantiated with valid receipts.
• Non-Deductible: However, any portion of these expenses related to personal activities, such as a holiday added to a business trip, is non-deductible.

Example 2: Corporate Gifts and Entertainment

• Deductible: If a business spends money on gifts for clients, such as a branded product, this can be considered deductible, provided it is reasonable and serves a clear business purpose.
• Non-Deductible: On the other hand, lavish meals or entertainment for clients that exceed a reasonable amount may not qualify for deduction under UAE law.

Example 3: Business Expansion

• Deductible: Rent paid for a new office space used exclusively for business operations is deductible.
• Non-Deductible: Capital expenditure on purchasing property, such as buying a new office building, would not be deductible as a whole. Instead, depreciation could be claimed over the life of the asset.

How Alaan Can Help with Managing Business Expenses and Maximising Tax Deductions

Alaan is an all-in-one spend management platform designed to streamline business financial operations and ensure tax compliance. Here’s how Alaan can help your business stay on top of its financial game:

1. Identify Tax-Deductible Expenses

Alaan helps businesses track and categorise their expenses, making it easier to identify which costs are eligible for tax deductions. With detailed expense tracking, businesses can ensure they are not missing out on potential deductions. The platform categorises and flags expenses, providing real-time insights that help ensure accurate tax filings and compliance with UAE corporate tax laws.

2. Manage Cash Flow in Real-Time

Alaan's real-time cash flow monitoring feature gives businesses a clear, up-to-date view of their financial position. By tracking income and expenses in real time, businesses can ensure they are making informed decisions about spending and investments, all while staying within budget. 

3. Get Valuable Insights into Company Spending

Alaan provides businesses with detailed insights into where their money is being spent. The platform generates comprehensive reports that break down expenses by category, department, or project, giving business owners a clear understanding of their financial outflow. 

By integrating Alaan into your financial workflow, your business can optimise its spending, improve cash flow management, and maximise eligible tax deductions—all while ensuring compliance with the latest corporate tax laws in the UAE.

Conclusion

As the UAE's tax laws continue to evolve, businesses that effectively manage their expenses will not only reduce their tax liability but also avoid penalties and audits that can disrupt operations. By staying informed about the latest updates in corporate tax law and implementing robust expense management systems, companies can maximise their eligible deductions and improve their overall financial strategy.

Looking ahead, tools like Alaan’s expense management platform can be a game-changer. With real-time tracking, automated expense categorization, and seamless integration with accounting systems, Alaan makes it easier for businesses to stay on top of their expenses while ensuring compliance. 

Book a free demo today to see how our platform can help you save time, reduce errors, and optimize your tax strategy for growth.