Equity Method Simplified for UAE-CT Return Filing

Regarding filing the UAE Corporate Tax (CT), an understanding of the Equity Method of accounting for investments can help companies with trust in their tax reporting and reporting. Many companies in the UAE have substantial interests in other companies, often referred to as associates or affiliate companies, so it is important to know how these investments are accounted for and reported for tax purposes. 

This article describes in basic terms what the Equity Method means, and provides a simple example, and sets the stage for discussion of its implications for UAE CT purposes. 

What Is the Equity Method? 

The Equity Method is an accounting method used when one entity (the investor) has significant influence over another entity (the investee) but due to several management or legal arrangements, the investor does not control the investee. 

Generally, significant influence is presumed when the investor entity owns between 20% and 50% of the voting power of the investee. In this case, within the body of International Financial Reporting Standards (IFRS), the investee is referred to as an associate or affiliate.

Instead of recognizing dividends received as income, the investor recognizes their share of the investee’s profits and losses directly in the investor’s financial statements. This closely reflects the economic reality of the investor’s income position, since their income is related to the performance of the associate, not simply the dividends received.

Practical Example

Let’s look at a simple case to understand how the Equity Method works in practice.

Scenario:

• A-Co buys 40% of B-Co for AED 1,000,000.
  
• At year-end, B-Co reports:
  
  • Net Income: AED 200,000
    
  • Dividends Declared: AED 100,000
    

Step 1: Initial Recognition

At acquisition, A-Co records the investment at cost under “Investments in Associates” (a long-term asset).

Debit  Investment in Associates       AED 1,000,000

Credit  Cash                          AED 1,000,000

Step 2: Recognition of Dividend

A-Co’s share of B-Co’s dividend is 40% of AED 100,000 = AED 40,000.
This reduces the carrying value of A-Co’s investment because the cash represents a distribution of previously recognized profits.

Debit  Cash                           AED 40,000

Credit Investment in Associates       AED 40,000

Step 3: Recognition of Share of Profit

A-Co’s share of B-Co’s net income is 40% of AED 200,000 = AED 80,000.
This increases A-Co’s investment value and is recorded as investment income.

Debit  Investment in Associates       AED 80,000

Credit Investment Income              AED 80,000

Resulting Balance

By year-end, the investment account has an ending balance of AED 1,040,000, representing:

• Initial Cost: AED 1,000,000
  
  • Share of Profit: AED 80,000
    
• − Dividend Received: AED 40,000
  = AED 1,040,000
  

This increase of AED 40,000 corresponds to A-Co’s share of B-Co’s retained earnings (AED 100,000 × 40%).

The Importance of the Equity Method for UAE-CT Returns

Under the UAE Corporate Tax regime as set forth in the Federal Decree-Law No. 47 of 2022, how you account for investments affects your taxable income. The accounting treatment of investments in associates will be especially important for companies filing their CT returns, as the adjustments associated with the Equity Method may not create taxable income or deductible expense amounts.

So, here’s how it generally works:

• Taxable Income vs. Book Accounting: The equity method of accounting will impact accounting profit, but for tax purposes, adjustments will need to be made to comply with the UAE CT regime. As an example, any unrealized gains or losses recorded via the equity accounting method may be excluded in computing taxable income.

• Dividend income from associates: Under Article 22 of the UAE CT Law, dividend income and capital gain income arising from qualifying shareholdings may be exempt from taxation, subject to satisfying certain ownership and holding requirements.

• Consolidated vs. Separate Entity Returns: For purposes of a UAE CT Return, each taxable person is required to file their return separately. Therefore, even if the investor is using the equity method in their books for accounting purposes, it will need to separately compute its taxable income, without simply consolidating the results of the associate.

• Recordkeeping and Disclosure: When you account for investments using the equity method, it is very important to keep comprehensive records of equity method adjustments, i.e., your share of the profits (or losses,) dividends received, and any revaluation of investment, for accurate tax calculations, and compliance with FTA requirements. 
  
  For companies with complex investment structures, securing the services of a specialist, certified corporate tax consultant in Dubai is essential to correctly apply participation exemption rules and manage unrealized gains, ensuring your calculated Taxable Income is fully compliant with FTA requirements.

Important Points for UAE Businesses

• You can apply the Equity Method if you have significant influence (typically 20–50% ownership) over another business. 

• Your investment account reflects your share of profits and dividends, not just cash distributions. 

• With respect to UAE Corporate Tax, while accounting for equity method investments will affect financial reporting, you may have to adjust for tax (to compute taxable income). 

• You should always consider whether dividends or capital gains from associates qualify for participation exemption under UAE CT law. 

• Maintaining clear documentary support for these findings will ease the burden on filing of your CT return, and potentially mitigate risks associated with compliance during an FTA review. 

Concluding Thought

The Equity Method supports a more honest reflection of your economic relationship with an associate. However, when filing your UAE corporate tax return, you need to understand the distinction between accounting treatment and tax treatment. 

Engaging an accounting firm Dubai that is knowledgeable about IFRS, and CT law will support you in meeting your reporting obligations and continuing to maintain compliance while optimizing your position with corporate tax.