It can be a challenge to keep up with ever evolving accounting standards. For the majority, these hail from International Financial Reporting Standards. For those who conduct annual external audits, it’s really a mild seasonal headache.
The UAE's Federal Tax Authority has now released its position on corporate tax’s impact on such standards. All finance functions should be carefully studying this lengthy document.
As the legislative approach being taken is one of building blocks, Ministerial Decisions No. 82, No. 114 and No. 120 of 2023, in particular, should be reread in tandem.
One cautionary note: this document is subject to change without notice.
Here, I want to focus on small and medium enterprises, the difference between accrual and cash accounting, and the benefits, if any, to your future corporate tax bill.
In simple terms, accrual accounting means provisioning for revenue or cost as being invoiced when it hasn’t actually been done.
For example, in late December, you invoice a customer for a product. However, your supplier has not invoiced you. They are on holiday. To ensure you do not have numerically lumpy accounts, you provide for the cost as if the supplier invoice was received in December.
The supplier invoice arrives and is dated January. You match that bill against the provision you made in December. So you now have a sale and a matching purchase in December, leaving you with the profit you made on the sale.
In your January accounts, the supplier invoice and the provision will match off to zero. From a corporate tax perspective, your taxable profit in December is the difference between the two amounts. Otherwise, it would have been the full value of the sale.
Hence, you pay less tax. This is not tax avoidance. This is the time honoured approach whereby your financial statements match revenues to their costs.
The other legislated approach is cash accounting, which might be best described as the movements of your business bank account.
In the above example, we were concerned with the invoices that were sent, received or provided for. None of that applies here.
Knowing the pricing from an earlier quotation, imagine a customer pays for a product in December. Your accounting function is on holiday and no invoice is raised until they return in January.
Your supplier raises its invoice in December but you do not settle this liability until your accountants return. As we are only interested in cash movements, there is a sale in December that is uninvoiced but there is no corresponding purchase.
Assuming your fiscal year ends in December, the whole value of monies received becomes taxable at 9 per cent.
Yes, you will still get to deduct the cost of the product relating to that sale, assuming you pay for it at some point in the following year, but it will be as part of your subsequent corporate tax return.
UAE corporate tax: What you need to know
A few thoughts might now be passing through your mind. Ignoring whether accrual or cash accounting is the best approach, maybe delaying the raising of an invoice to a customer or pressing for upfront payment at the end of your reporting year might be a good tax strategy?
This is called sandbagging and is the type of practice conducted by a salesperson who has maxed out his commissions in the current year. It is not something a sensible trading entity should do.
For one, VAT law has a say on the matter through the time of supply rules. You have 14 days to raise a customer invoice from either the delivery of service or receipt of monies.
Worse, you are effectively asking your customer(s) to engage in your tax planning activities. If they are so willing, you need to carefully consider whether you should be doing business with them.
Finally, as an SME, the amount of time spent trying to calculate the optimum tax payment position would certainly have been better spent closing sales and delivering to your customers’ expectations.
In theory, you must adopt a whole year approach, picking either accrual or cash accounting. There are conditions and there are exceptional circumstances that can forcibly change your chosen approach.
To use cash accounting your revenue should not exceed Dh3 million ($0.82 million) in the period. Yes, you can make an exceptional application to the Federal Tax Authority even if this is exceeded.
However, the financial planning you conducted at the start of the year should have been robust enough to identify the likelihood that the threshold would be breached.
Imagine with a month to go in a tax year having to completely change your accounting of income and costs? Depending on an exceptional application to the relevant authority for special dispensation late in the year is reckless.
Plan carefully. Monitor regularly. Report on time.
David Daly is a partner at the Gulf Tax Accounting Group in the UAE
