The UAE’s introduction of a 9% corporate tax from June 2023 on business profits above AED 375,000 ($102,110) will help diversify government revenue away from the oil sector, and broaden the government’s revenue base. The implementation of the tax marks another step in the modernization of the UAE's business environment and further aligns it with international standards.

In addition, we expect the additional tax revenues to support the economies of smaller emirates with low revenue bases, such as Sharjah and Ras Al Khaimah; especially if the corporate tax is distributed in the same way as value-added tax (VAT) revenue. Some 70% of VAT receipts collected in the individual emirates go to their respective governments, with the balance sent to the federal government. If the corporate tax is distributed in the same way, it would certainly support Sharjah and Ras Al Khaimah’s fiscal positions.

Introduction of corporate tax further aligns the UAE with international standards

In the context of the GCC, the UAE has been proactive in implementing fiscal reforms to diversify government revenue streams and align its business environment with global norms. Saudi Arabia and the UAE were the first GCC countries to introduce VAT in 2018. Tax reforms in the UAE are progressing along with changes to social policy and the business environment, such as no longer requiring the participation of local partners in every business and allowing foreigners to own up to 100% of local companies.

The corporate tax will further align the UAE with international efforts to combat tax avoidance, as the tax will be applied to all business and commercial activities except the hydrocarbon sector, which will remain subject to emirate level taxation. It also prepares the ground for compliance with the global minimum tax rate of 15%, which the UAE has agreed to as per the 2021 Organization for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) project.

All GCC countries except Bahrain already levy a corporate tax on foreign nonhydrocarbon companies: Qatar 10%; Saudi Arabia 20%; and Kuwait 15%. However, until the UAE's recent announcement, no GCC country apart from Oman had applied corporate tax to domestic nonhydrocarbon companies. Oman levies a rate of 15% on both foreign and domestic companies and is already in compliance with the BEPS agreement.

Effect on corporates’ cash flows will be manageable

Levying a corporate tax will inevitably affect corporates' cash flow positions and have earnings implications, but it is likely that companies will increase prices and manage their financial policies to absorb the impact. As such, for most corporates, a pronounced change in leverage is unlikely. That being said, the new tax will be a burden for small corporates or those in price-sensitive sectors, and they may need to cut costs, perhaps by reducing their headcount. 

Dubai and to a lesser extent Abu Dhabi account for the lion's share of corporate activity in the UAE. This is where most tax will be collected and where there will be the most pressure on corporates to manage costs.

Despite this, a significant number of corporates will remain based in the UAE and will not relocate outside the UAE due to the new tax. We instead foresee a levelling of the playing field for corporates operating globally in terms of the corporate tax rate they will be required to pay. In this respect, the UAE is to some extent stealing a march on its regional peers in terms of preparing the corporate sector for the new global operating environment, while applying the tax at a competitive rate within its own borders.

Banks will continue to enjoy strong profitability, and insurers will not be materially affected

We do not expect the introduction of corporate tax to have a significant impact on banks' creditworthiness either. Banks in the UAE enjoy strong profitability and have strong efficiency. In our view, they will use whatever tax-reduction mechanisms the government introduces to optimize their tax bills. At this stage, however, we cannot tell whether the introduction of corporate tax will prompt any cost-cutting initiatives.

The corporate tax will not have a material bearing on the creditworthiness of UAE-based insurers, in our view. Listed insurers in the UAE typically have adequate capitalization and the sector has shown strong profitability in recent years, with a return on equity of about 10%-12%. However, we do believe that insurers should adjust their information technology systems and operations to comply with the new tax requirements. This will lead to one-off expenses and put additional pressure on the earnings and capital of some smaller and weaker players.