Taxation of Unincorporated Partnership in UAE Corporate Tax

Introduction
Internationally, partnerships are diverse legal arrangements where two or more parties collaborate for mutual interests, often involving business activities. They come in various forms, such as general partnerships with joint liability and limited partnerships with limited liability. The taxation of partnerships varies across countries due to differences in legal systems, with some recognizing partnerships as legal entities and others not. Additionally, there is a distinction between fiscally transparent entities (FTEs), like partnerships, where income is taxed at the owner and investor level, and separate entities, where the entity itself is taxed. FTEs pass income through to owners and investors, making them responsible for taxation, while separate entities are taxed as standalone entities.

Taxing partnerships as separate entities?
The legal status of partnerships varies worldwide and can impact their tax treatment. In some countries, partnerships are considered legal entities but are not taxed as such. For instance, Belgium, Spain, and many Latin American nations tax certain partnership types as legal entities, except in specific cases where a tax transparency rule applies.
In common law countries, partnerships are generally not seen as legal entities and are not taxed like corporations. However, in some cases where partnerships resemble corporations, they might be taxed as corporations, despite not having legal entity status. Indonesia, for example, taxes partnerships as separate entities even though they lack legal personality.
Transition countries have also seen changes in their business laws, affecting how partnerships are taxed. For example, in Kazakhstan and Romania, all legal entities, including partnerships, pay income tax separately. In Latvia, enterprise income tax applies to most registered enterprises, but partnerships are taxed based on their income flow-through to owners. In Estonia, legal entities pay entity-level taxes, including most partnerships, with some exceptions for smaller partnerships.
Taxing partnerships as separate entities simplifies tax collection and reporting, but it often leads to a flat tax rate instead of individual partner-specific rates. This approach avoids favoring one business form over another but may not consider individual partner circumstances.

OECD Action Plan on Taxation of Partnership.
The OECD Action Plan addresses the issue of double non-taxation in the context of international partnerships and tax treaties. It explores whether a partnership qualifies as a resident under tax treaties. The OECD's Model Tax Convention provides that the Convention applies to residents of contracting states. However, determining whether a partnership qualifies as a resident can be complex.
The OECD released a report in 1999 titled 'The Application of the OECD Model Convention to Partnerships,' which analyses various scenarios involving partnerships in cross-border taxation, both in bilateral and triangular situations. The report offers solutions to these issues and suggests that for a partnership to benefit from tax treaties, it must be considered a 'person' under Article 3 of the Convention and a 'resident of a contracting state' under Article 4. However, the lack of explicit inclusion of partnerships in the definition of 'person' has led to uncertainty.
Regarding the second criterion, the report examines whether a partnership is 'liable to tax' in its resident country. Different countries tax partnerships differently, with some taxing at the entity level and others at the partner level, leading to the possibility of double taxation or double non-taxation. The report concludes that if a jurisdiction treats a partnership as fiscally transparent, it cannot claim benefits under the Convention.
The report also discusses the tax treatment of partnerships in member countries. In some countries, income is computed at the partnership level and then allocated to partners, while in others, the tax payable by partners is aggregated at the partnership level. The key factor in determining whether a partnership is liable to tax is whether the tax payable on partnership income considers the personal characteristics of the partners.
However, there are criticisms of the OECD's approach. Some argue that the Convention should not require de facto taxation and that a transparent partnership should still be eligible for treaty benefits. Others point to the issue of partnerships with intermediate status, where a country partially recognizes transparency. The report does not address this scenario adequately.
Critics also raise concerns about the application of Article 3(2) of the Convention, which allows each contracting state to decide whether a partnership is transparent based on its domestic law. This could lead to inconsistencies.
The OECD Action Plan and its associated report aim to clarify the tax treatment of partnerships in international taxation and tax treaties. However, there are ongoing debates and criticisms regarding the interpretation and application of the principles outlined in the report.

Treatment in UAE Corporate Tax
Unincorporated partnership is a business structure where two or more individuals or entities come together to carry on a business. In such a partnership, each partner is personally liable for the debts and obligations of the partnership.
An unincorporated partnership is not considered a taxable entity in its own right. Instead, each partner is treated as an individual taxable person for the purposes of the tax laws. This means that each partner is required to register for taxes, file tax returns, and pay taxes on their share of the partnership income. However, if an application is made to the FTA to treat unincorporated partnership as a taxable person and is approved, the Unincorporated Partnership will be treated as a taxable person in its own right, and will be responsible for paying Corporate Tax on its income. The partnership will need to obtain a Tax Registration Number (TRN) and file tax returns with the FTA.
Assuming the income of the Unincorporated Partnership is AED 1,000,000, and there are two partners with 45% and 55% share respectively, the tax treatment will differ depending on whether an application is made to the FTA or not.

Latest Developments
As per Ministerial Decision No. 127 of 2023, When you request that an Unincorporated Partnership be considered a Taxable Person on its own in the Corporate Tax Law and your request is granted, the following rules will apply:
Your request is permanent, and you can only change it in exceptional situations with the Authority's approval.
If any of the following events happen, the Unincorporated Partnership must inform the Authority within 20 business days:
a. If a new partner joins the Unincorporated Partnership.
b. If a partner leaves the Unincorporated Partnership.

Scenario 1: No application made to FTA
If no application is made to the FTA, the partnership will not be considered a taxable person in its own right, and the two partners will be treated as individual taxable persons for the purposes of Corporate Tax. Each partner will be responsible for paying tax on their respective share of the partnership's income.
In this scenario, Partner 1 would be responsible for paying Corporate Tax on AED 450,000 (45% of AED 1,000,000), and Partner 2 would be responsible for paying Corporate Tax on AED 550,000 (55% of AED 1,000,000).

Scenario 2: Application made to FTA and approved
If an application is made to the FTA and is approved, the Unincorporated Partnership will be treated as a taxable person in its own right, and will be responsible for paying Corporate Tax on its income. The partnership will need to obtain a Tax Registration Number (TRN) and file tax returns with the FTA.
In this scenario, the partnership would be responsible for paying Corporate Tax on AED 1,000,000. The partners would not be individually liable for paying Corporate Tax on their share of the partnership's income.
It's important to note that if an application is made to the FTA and is not approved, the partners will continue to be treated as individual taxable persons for the purposes of Corporate Tax.

First Option - Computation of Partners Taxable Income
The Taxable Income of a partner in an Unincorporated Partnership refers to the amount of income earned by the partner that is subject to corporate tax. This tax is calculated based on the partner's share of the partnership's profits.
The two factors that are taken into account when calculating a partner's taxable income in an Unincorporated Partnership are:
a) Expenditure incurred directly by the partner in conducting the Business of the Unincorporated Partnership: This refers to any expenses that are directly related to the partner's activities in the Unincorporated Partnership. For example, if the partner spends money on office supplies, travel expenses, or any other costs that are necessary for conducting the partnership's business, these expenses can be deducted from the partner's share of the partnership's profits when calculating their taxable income.
b) Interest expenditure incurred by the partner in relation to contributions made to the capital account of the Unincorporated Partnership: This refers to any interest payments that the partner may have incurred on loans or other forms of financing that were used to contribute to the capital account of the partnership.
For example, if the partner borrowed money to invest in the partnership, any interest payments on that loan can be deducted from their share of the partnership's profits when calculating their taxable income.
In summary, when calculating the taxable income of a partner in an Unincorporated Partnership, any expenses that are directly related to the partner's activities in the partnership, as well as any interest payments on loans used to contribute to the partnership's capital account, can be deducted from their share of the partnership's profits.

Second Option - Computation of Unincorporated Partnership Taxable Income
The Decree Law provide an option for Unincorporated Partnership to apply to the Authority to be treated as a Taxable Person. If the application is approved, the Unincorporated Partnership will be treated as a Taxable Person, and the first option as discussed in the previous paragraphs will not be allowed.
However, it is important to note that each partner in the Unincorporated Partnership will remain jointly and severally liable for the Corporate Tax Payable by the Unincorporated Partnership for those Tax Periods when they are partners in the Unincorporated Partnership. This means that each partner will be responsible for the payment of the Corporate Tax Payable by the Unincorporated Partnership, and in case of non-payment, any partner can be held liable
In addition, one partner in the Unincorporated Partnership will be appointed as the partner responsible for any obligations and proceedings in relation to this Decree-Law on behalf of the Unincorporated Partnership.
If the application is approved, the Unincorporated Partnership shall be treated as a Taxable Person effective from the commencement of the Tax Period in which the application is made, or from the commencement of a future Tax Period, or any other date determined by the Authority. This means that the Unincorporated Partnership will be liable to pay Corporate Tax and comply with all the requirements under the Decree-Law as a Taxable Person from the effective date determined by the Authority.

Deduction for Interest paid to partners on their capital contribution allowed?
In an unincorporated partnership, the partners contribute capital to the partnership, which is then used to conduct the partnership's business. The partnership may pay interest to the partners on their capital account, as a way of compensating them for the use of their funds.

However, according to the statement, this interest paid by the partnership to the partner on their capital account is not considered a deductible expense for the purpose of calculating the taxable income of the partner in the partnership. This means that the partner cannot deduct this interest expense from their taxable income.
The reason for this is that the interest paid on the capital account is considered an allocation of income to the partner, rather than a true expense incurred by the partnership. Since the partner is receiving income from the partnership in the form of interest, they cannot also deduct that same amount as an expense for tax purposes.

Allocation of Foreign Tax Credit to each Partner
Any foreign tax incurred by an Unincorporated Partnership will be allocated as a Foreign Tax Credit to each partner in proportion to their distributive share in the partnership. The partners can then use this credit to offset the Corporate Tax payable on their share of the partnership income.
For example, let's say an Unincorporated Partnership with two partners, A and B, has a total income of 1,000,000 AED and has paid foreign tax of 100,000 AED. Partner A has a 45% distributive share, and partner B has a 55% distributive share in the partnership income.
To allocate the foreign tax credit, the foreign tax paid by the partnership, 100,000 AED, will be allocated to the partners in proportion to their distributive share. So, partner A will be allocated 45,000 AED (45% of 100,000 AED) as a Foreign Tax Credit, and partner B will be allocated 55,000 AED (55% of 100,000 AED) as a Foreign Tax Credit.
When calculating their Corporate Tax payable on their share of partnership income, partners A and B can then offset the Foreign Tax Credit allocated to them against their Corporate Tax liability. This helps to prevent double taxation of the same income by the UAE and the foreign jurisdiction.

Can Foreign Partnership shall be treated as an Unincorporated Partnership?
A Foreign Partnership shall be treated as an Unincorporated Partnership for the purposes of this Decree-Law where all of the following conditions are met:

a) The Foreign Partnership is not subject to tax under the laws of the foreign jurisdiction.
b) Each partner in the Foreign Partnership is individually subject to tax with regards to their distributive share of any income of the Foreign Partnership as and when the income is received by or accrued to the Foreign Partnership.
As per ministerial decision no 127, each partner in the Foreign Partnership shall be considered to be subject to tax if they would be subject to tax on their distributive share of any income in the Foreign Partnership in the jurisdiction in which the partner is a tax resident.
c) Any other conditions as may be prescribed by the Minister.
The prescribed conditions are
a. The Foreign Partnership submits an annual declaration to the Authority to confirm meeting the conditions specified above being; i) The Foreign Partnership is not subject to tax under the laws of the foreign jurisdiction and ii) Each partner in the Foreign Partnership is individually subject to tax with regards to their distributive share of any income of the Foreign Partnership as and when the income is received by or accrued to the Foreign Partnership
b. Adequate arrangements exist for cooperation between the State and the jurisdiction under whose applicable laws the Foreign Partnership was established, for the purpose of sharing tax information of the partners in the Foreign Partnership.

In summary foreign partnerships that do not pay taxes in their home countries are still liable to pay Corporate Tax under this Decree-Law, and that the partners of these foreign partnerships are taxed on their share of income as and when the income is received or accrued to foreign partnership.


Disclaimer: The information provided in this article is for general educational purposes and is not intended to serve as professional advice, whether financial, legal, tax-related, or any other field. Laws and regulations can change, and individual circumstances can vary widely. Relying solely on the information in this article for making important decisions is not recommended, and we disclaim any liability for actions taken without seeking appropriate professional consultation.