Since the introduction and implementation of corporate tax in the UAE in June 2023, it has become crucial for businesses and entrepreneurs to carefully assess their business activities due to potential tax compliance challenges. A key issue in corporate tax compliance is understanding the taxation of unincorporated partnerships.

Consider a scenario where two individuals or a combination of individuals and companies form a partnership for a single project or venture. Questions arise: Who is liable for taxes? How will all parties report their taxes? This article aims to clarify the differences between types of partnerships and their tax obligations, enabling companies and individuals to comply effectively and avoid penalties.

What is a partnership?

A partnership typically involves an agreement, relationship, or contract between two or more Persons to conduct business or a project together and share both the profits and losses. In the UAE corporate tax context, partnerships can be categorized into incorporated and unincorporated types. The primary distinction lies in that an incorporated partnership possesses a separate legal identity from its partners, while an unincorporated partnership does not.

Incorporated partnerships

Incorporated partnerships have limited liabilities and are recognized as distinct entities separate from their owners. Examples of these legal forms include joint liability companies and limited liability companies (LLCs). In terms of corporate tax, incorporated partnerships are taxed as a normal company or juridical persons.

Unincorporated partnership

An unincorporated partnership, on the other hand, is formed through a contract (written or verbal) between two or more individuals or entities to engage in business or undertake a project together, sharing both profits and losses. examples will be trusts, joint ventures, consortiums, and associations of persons.

How to Identify an Unincorporated Partnership?

To determine whether an arrangement qualifies as an unincorporated partnership, consider the following key indicators:

• A contract (either written or verbal) agreed upon by all involved parties.
• A mutual intention among the parties to share both the profits and losses of the business.
• Joint conduct of business activities by the partners.
• The absence of a separate legal identity for the partnership, distinct from its partners.

Taxation of Unincorporated Partnership

Unincorporated Partnerships can be taxed in two main ways: fiscally transparent, where each partner is individually taxed, and fiscally opaque, where the partnership itself is registered for tax and subject to corporate tax obligations.

A. Fiscally Transparent Unincorporated Partnership

• This is the default status under the Corporate Tax Law.
• The partnership is not recognized as a separate taxable entity and thus is not directly subject to Corporate Tax.
• Each partner is taxed on their share of the business’s profits, as if they are conducting the business themselves.
• Partners must individually assess and manage their Corporate Tax responsibilities.
• An authorized partner must be designated to handle tax obligations and procedures on behalf of all partners.
• The authorized partner is required to register the partnership for Corporate Tax and obtain an inactive Tax Registration Number (TRN), although the partnership itself is not subject to Corporate Tax.
• The authorized partner must also submit an annual declaration detailing the partnership’s taxable income.
• The Federal Tax Authority (FTA) may request that the authorized partner provide the partnership’s Financial Statements along with each partner’s share of the distributive income.

B. Fiscally Opaque Unincorporated Partnership

• Partners can apply to the Federal Tax Authority (FTA) to have the partnership treated as a taxable entity.
• With the FTA’s approval, the partnership is then subject to Corporate Tax as if it were a Resident Person, and must file Corporate Income Tax returns as a taxable entity.
• This type of unincorporated partnership is required to register with an active TRN and file Corporate Income Tax returns as a taxable entity.
• Despite the partnership’s tax status, all partners remain jointly and severally responsible for fulfilling the partnership’s tax obligations.

Determining Taxable Income

Each Taxable Person—whether individual partners in a fiscally transparent partnership or the partnership itself when fiscally opaque—must calculate their taxable income independently. This calculation should be based on adequate, standalone financial statements prepared in accordance with IFRS (International Financial Reporting Standards) or IFRS for SMEs. Additionally, these financial statements must meet the auditing requirements stipulated by UAE corporate tax law.

Interacting with Free Zone Entities

Since an unincorporated partnership is not considered a juridical person, it cannot be classified as a Free Zone Person and is not eligible for the 0% corporate tax regime. However, a Free Zone company can participate as a partner in an unincorporated partnership.

A Free Zone entity that qualifies for the 0% corporate tax rate and is a partner in an unincorporated partnership must carefully assess the tax implications on its distributive share. It is essential for such entities to ensure they meet all conditions to maintain their qualification status.

Transfer Pricing Rules and Unincorporated Partnerships

Transfer pricing rules are applicable to transactions involving unincorporated partnerships. Transactions both with and between partners (including their related parties) in these partnerships must adhere to the arm’s length standard, ensuring that all dealings are conducted as if the parties were independent and operating at market conditions.

General Anti-abuse Rule

The General Anti-abuse Rule empowers the FTA to modify or nullify transactions that are primarily aimed at obtaining a tax benefit contrary to the intent of the Corporate Tax Law, particularly if they lack genuine commercial substance.

Therefore, if a partnership undertakes a transaction primarily to gain a Corporate Tax advantage, the FTA can negate this benefit by disallowing exemptions or deductions, reallocating income, recharacterizing payments, or ignoring the relevant tax rules

Conclusion

Business people need to first determine whether an unincorporated partnership exists, as many undertake projects together without a formal written contract or a business license. Partnerships operating in the UAE must then thoroughly review their structures to assess their tax liabilities and compliance obligations under the UAE Corporate Tax Law. Additionally, a cost-benefit analysis should be conducted to evaluate the administrative costs associated with managing the partnership’s accounts and taxes separately.