Understanding Tax Legislation in the United Arab Emirates: A Simple Guide

Introduced by Federal Decree-Law No. 47 of 2022, the Corporate Income Tax (CIT) regime in the UAE imposes a 9% tax on taxable income exceeding AED 375,000 for financial years beginning on or after June 1, 2023.

Among the most misunderstood aspects are the concepts of “connected persons” and “related parties.” Although these terms may initially seem interchangeable, confusing them can lead to costly compliance errors, denied deductions, and even audits by the Federal Tax Authority (FTA).

Defining related parties

Related parties (“Related Party”) are described in Article 35 of the Corporate Tax Law. This category includes entities or individuals with close ownership, control, or family ties that may influence transaction prices.

Related parties: who is concerned?

More specifically, related parties include:

• Two or more individuals related by blood or affinity up to the fourth degree of kinship (for example, siblings, cousins, or parents-in-law through marriage or adoption).

• An individual and a legal entity in which the individual owns at least 50% or exercises control.

• Two or more legal entities under common ownership or control of at least 50%.

• Partners in an unincorporated partnership.

• An enterprise and its permanent establishment (PE), whether domestic or foreign.

• Trustees, founders, settlors, or beneficiaries of a trust or foundation, as well as their related parties.

Control concept and arm's-length principle

Control is broadly defined as the ability to influence decisions, such as holding 50% or more of the voting rights, board seats, or rights to profits, or exercising significant influence over operations.

The arm's-length principle, aligned with OECD guidelines, requires transactions between related parties to reflect market conditions to prevent artificial profit shifting.

Understanding connected persons: a narrower but stricter category

Connected persons ("Connected Party"), detailed in Article 36, represent a subset focused on key decision-makers and their close associates.

Connected persons: who is covered?

This includes:

• Individuals who directly or indirectly own or control the taxable entity.

• Directors, officers, or senior executives.

• Partners in the same unincorporated partnership.

• Family members or related parties of the above individuals.

Specific tax treatment

Unlike related parties, which focus on ownership ties, connected persons target those with direct managerial influence.

Payments or benefits granted to connected persons - such as salaries, bonuses, or reimbursements - must not only comply with the arm's-length principle, but also be incurred exclusively for business purposes to be deductible.

If a payment exceeds market value, the excess is denied as a deduction for the payer. In addition, non-compliant payments could be treated as business activity for the connected person, potentially subjecting them to corporate tax if their income exceeds the thresholds, although individuals are generally exempt unless they conduct licensed activities.

Key differences: thresholds, documentation, and oversight

For related parties

Reporting thresholds
Aggregated transactions exceeding AED 40 million must be reported in the transfer pricing disclosure form, with details by category (e.g., goods, services) for those exceeding AED 4 million.

Documentation
A transfer pricing study, including a functional analysis and OECD-compliant comparables, is required for large entities (revenue ≥ AED 200 million or part of a multinational group with consolidated revenue ≥ AED 3.15 billion).
The master file and local file must be prepared and submitted upon request by the FTA.

For connected persons

Reporting thresholds
A lower aggregate threshold of AED 500,000, with category-based reporting for amounts exceeding AED 500,000.

Documentation
Justifying market value through remuneration studies and benefit tests is mandatory, regardless of overall transfer pricing documentation thresholds. Contemporaneous evidence is crucial to avoid disallowances.

The FTA applies stricter scrutiny to payments to connected persons due to the increased risk of abuse, such as inflated executive remuneration. While the rules for related parties focus on comprehensive transfer pricing studies, connected persons compliance emphasizes transaction-level evidence.

Common pitfalls and UAE-specific nuances

Many businesses fall into the trap of applying international transfer pricing frameworks without adapting them to the specificities of the United Arab Emirates.

For example: a bonus of AED 2 million for a director could be treated as ordinary remuneration, but under the connected persons rules, it requires comparison with market rates - failure could result in total disallowance of the deduction.

Key considerations in the UAE context

• The fourth-degree relationship rule may link entities in unexpected ways.

• The interaction between CIT and VAT adds complexity: misclassified transactions may affect input VAT credits.

• International guidance does not always cover the "two-track" approach specific to the UAE:

  • Related parties → extensive documentation for significant transactions

  • Connected persons → detailed evidence even for modest amounts

Compliance strategies for businesses

To mitigate risks:

• Thorough mapping: Identify all related parties and connected persons early in the fiscal year.

• Robust comparisons: Use comparable data for valuations, in line with OECD methods.

• Documentation: Keep contracts, analyses, and market studies.

• Advance decisions: Request a ruling or APA to clarify complex cases.

• Internal training: Raise awareness among finance, HR, and management teams.

Attention: fines of up to AED 20,000 for non-compliance!