While some individuals choose to relocate during global fluctuations, the overwhelming majority of UAE residents and business owners remain steadfast. As a service provider, my everyday conversations with customers and suppliers confirm that, for the most part, it is business as usual.
However, in the corporate landscape, uncertain times can lead to unexpected shifts. This brings up a critical question regarding UAE Corporate Tax: What happens when a minor shareholder-who is also an employee-suddenly exits the company?
Defining the Minor Shareholder
First, we must define what constitutes a minor shareholder. Under Federal Tax Authority (FTA) guidelines, any individual holding 25% or more of a company’s shares is subject to specific regulatory scrutiny. Their personal details must be accurately recorded on the FTA portal and immediately updated upon any changes.
Failing to maintain these records in a timely manner attracts severe penalties. These company secretarial duties are legally binding, and all corporate entities must manage them continuously.
The “Connected Party” Dilemma
When a shareholder is also an employee, they are legally classified as a “connected party.” This means the business must prove that the shareholder’s compensation-whether salary, health insurance, or declared dividends-strictly matches their skills and the actual work they perform for the company.
Annual tax returns must include sufficient evidence of this alignment. But while most companies easily account for monthly salaries, a major financial blind spot often remains: the provision for End of Service Benefits (EOSB).
Accounting for End of Service Benefits (EOSB)
Rooted in the 1980 Labour Law and having evolved significantly over the years, the EOSB is a mandatory provision. There is simply no excuse for businesses to overlook it.
All companies should be accruing this cost regularly-preferably within their monthly management accounts-followed by a formal review at the end of each fiscal year. Because the payable amount scales with the length of an employee’s service, keeping accurate personnel records is imperative.
In tumultuous times that require operational retrenchment or redundancies, these costs should already be factored into the profit and loss (P&L) accounts. Dealing with an economic downturn is challenging enough without the compounded headache of sudden, unprovisioned cash flow crises.
Are Departure Costs Tax Deductible?
Since the end-of-service benefit is only paid out upon departure, should this accrued amount form part of a shareholder-employee’s corporate tax declaration?
Under International Financial Reporting Standards (IFRS), the rules are clear: accrued costs must be accounted for and deducted from profits. However, the waters muddy when applying this to connected party declarations.
Consider this scenario: An employee-shareholder is leaving involuntarily, and legal counsel has been retained. Can those legal fees be offset against taxable profits?
For an expense to be deductible, it must be wholly and necessarily incurred in the conduct of the business. One could reasonably argue that the legal and regulatory costs of amending the shareholder register-or even onboarding a new shareholder-are essential business expenses. However, a clear threshold is needed to avoid unnecessary bureaucracy while preventing companies from unfairly striking out standard entity formation costs.
Calculating the Final Gratuity Payout
Could the final payment differ depending on the nature of the employee’s separation? While the 2022 Labour Law updates removed the baseline financial distinction between resignation and redundancy, individual employment contracts can still mandate enhanced payouts for redundancies.
Given that a company might face two potential gratuity amounts (the legal baseline vs. the contractual enhancement), which one should be accrued?
- Prudence suggests provisioning for the higher amount to ensure absolute financial safety.
- Materiality, especially within a large workforce, might suggest accruing the lower baseline.
Both accounting concepts clash here, but either approach can be considered reasonable depending on your business model. Ultimately, this is exactly the kind of healthy, strategic conversation your finance team and corporate leadership should be having today.