For a company to stay afloat, it takes more than investment and workforce. A prosperous business is based on a well-organized administration, the proper utilization of resources, and timely compliance with the country’s laws and regulations. One of the most important regulations to follow has to do with taxes and their administration. For this reason, in the following lines, we will talk about the deferred tax liabilities.
In this article, you will find information about the deferred tax, assets, and liabilities, how each of them works and how we can help you with the deferred tax liabilities of your company.
- The tax system in the UAE
- What is a deferred tax?
- What is a deferred tax asset?
- How do deferred tax assets work?
- What are deferred tax liabilities?
- How do deferred tax liabilities work?
- Is deferred tax liability a bad thing or a good thing?
- How can we help you with the deferred tax liabilities of your company?
1. The tax system in the UAE
The tax system in the United Arab Emirates, or rather the lack of taxes paid, is one of the main attractions of the region for many ex-pats. For instance, the employees do not pay income tax and there is no system for corporate and inheritance taxes, among others.
Some of the taxes that the UAE presents are the following:
1.1 Individual tax
Employees of the United Arab Emirates (who are GCC Nationals) are subject to a social security regime of 17.5%. Those who are UAE Nationals pay 5% (with an automatic deduction off their paycheck) and the employer pays the further 12.5%. The social security obligations also apply to employees of branches and companies registered in a free trade zone.
1.2 Corporate tax
The corporate taxes apply to oil companies and foreign banks in the UAE. However, if you establish your company in one of the 45 free zones in the country, you can be exempt from paying tax for a period that can be extended. There are no capital gain taxes unless the company is taxable under another income tax. Note that you can check out an extensive variety of information regarding corporate tax in our insights section.
1.3 Income tax
The United Arab Emirates does not levy a tax on income. In other words, an income tax return is not necessary since the individual tax is not applicable in the country. The same also applies to self-employed individuals and freelancers who live in the country.
1.4 Tourist facility tax
The resorts, hotels, and restaurants (among others) must charge the following taxes:
- Service charge (10%)
- City tax (6-10%)
- Municipal fee (10%)
- 10% on the room rate
- Tourism fee (6%)
1.5 Property transfer tax
A transfer charge applies to all property transfers in the UAE. This varies according to the Emirate, for example, in Dubai, this tax is 4%. Although the seller and buyer share the burden of this, the buyer, generally, pays the transfer fee.
1.6 Value Added Tax (VAT)
The Value Added Tax rate of the UAE is 5%. However, this tax does not apply to certain products. For example:
- International transportation
- Investment-grade precious metals
- Some education and healthcare services
- Exports of goods and services outside the GCC
- Newly constructed residential properties
In 2020, due to the COVID-19 pandemic, the government exempted some personal protective equipment, such as single-user gloves, chemical disinfectants, textile and medical masks, and antiseptics.
This is just a list of certain basic taxes. However, we will enter the world of managing a company and managing its taxes.
2. What is a deferred tax?
A deferred tax is an important part of a company’s balance sheet. Managing this factor helps reduce the taxable income. The deferred tax generally has a positive or negative effect on the balance sheet. This entry can be in the form of assets or liabilities.
In the event that the entrepreneur has paid advance taxes and has received a tax credit that can be used in the future, it will fall under assets. Alternatively, when a company is liable to pay additional taxes in the future, it will be considered a liability.
3. What is a deferred tax asset?
A deferred tax asset (DTA) is an entry in the balance sheet that shows a difference between the internal accounting of the company and the taxes owed. For example, if your company paid its taxes in full and then received a tax reduction for that period. You can use that unused deduction in future tax files as deferred tax assets.
3.1 What type of asset is a deferred tax asset?
This tax is an intangible asset because it is not a physical object like buildings or equipment. It only exists on the balance sheet.
3.2 Is the deferred tax asset a financial asset?
Yes, this tax is a financial asset because it shows a tax overpayment that can be redeemed in the future.
3.3 When does a deferred tax asset have to be used?
These tax assets have no expiration time, they can use it when and how best suits the business.
3.4 Where can you find the deferred tax assets on the balance sheet?
In the balance sheet, you can find this tax as “Non-current taxes”
3.5 Situations where deferred tax assets may arise
Some of the reasons why deferred tax assets may appear are the following:
- The tax bases or rules for assets and liabilities are different
- The tax of the revenue is ready before you recognized it
- The taxing authority takes into account the expenses before they recognized it
Please know that while you can use the deferred tax assets for future tax files, you cannot use them to tax files in the past.
4. How do deferred tax assets work?
To better understand the concept of tax assets, we will present an example: Imagine that you use a rideshare service, but the car broke down and you had to walk home. In compensation, the company sent an AED 50 credit to your account in the app. If you had planned to spend AED 50 on ridesharing the next month, you can now budget that your spending will be 0, because the credit you have will cancel it out.
This is what the deferred tax assets represent. You haven’t used it yet, but you know it has value in the future and you can adjust your spending accordingly.
4.1 What causes deferred tax assets?
A deferred tax appears when there is a difference between the income on the tax return and the income in the accounting records of the company (income per book)
4.2 Example of deferred tax assets
- Not operating loss: The company incurred a financial loss for that period.
- Tax overpayment: You paid more of what you should in the previous period
- Business expenses: When you recognize the expenses in one accounting method but not the other
- Revenue: Instances where you collect the revenue during one accounting period but recognized in another.
- Bad debt: Before an unpaid debt is written off as uncollectible, it is reported as revenue. When the unpaid receivable is finally recognized, the bad debt becomes a deferred tax asset.
5. What are deferred tax liabilities?
A deferred tax liability (DTL) is a tax payment that the company has marked on its balance sheet, but does not have to be paid until a future tax filing. A payroll tax holiday is a type of DTL that allows companies to put off paying their payroll taxes until a later date.
The tax holiday represents an advantage for the company today, however, in the long term it becomes a liability.
Some tax incentives may create a deferred tax liability journal entry, granting the business some temporary tax relief. However, you can collect this tax later.
In addition to this, depreciation expenses, like the annual devaluation of a fleet of company vehicles, can generate deferred tax liabilities.
5.1 Is the deferred tax liability a debt?
A DTL journal entry shows a tax payment that, due to timing differences in accounting processes, the payment can be postponed until a later date.
5.2 How can you find the deferred tax liabilities on the balance sheet?
You can find these taxes on the balance sheet as “non-current liabilities”
5.3 Reasons for deferred tax liability to arise
Some of the reasons why a deferred tax liability can arise are the following:
- Companies, generally, try to push their profits to show maximum income to their shareholders.
- Dual accounting of figures. For example, most companies keep multiple copies of financial statements for their personal use as well as those that are furnished to the tax authorities and the public. This is somewhat because the standard tax code and accounting rules differ heavily in key areas like expense, revenue, and depreciation of the asset.
- Generally, companies try to push current profits also into the future to reduce the tax burden. This means more money for investment purposes rather than paying it off as tax to the government.
6. How do deferred tax liabilities work?
The deferred tax liability on a company balance sheet represents a future tax payment that the business is obligated to pay. This tax is calculated by multiplying the company’s anticipated tax rate by the difference between the taxable income and the earnings.
DTL is the amount of taxes that a company has not paid yet but it will in the future. This does not mean that the company has fulfilled all of its responsibilities. In fact, it recognizes a payment that is not yet due.
For example, a company that earned net income for the year knows that it will have to pay corporate income taxes. Because this tax applies to the current year, it must show the expenses for the same period. However, the company will not pay the tax until the next calendar year. In order to rectify the accrual/cash timing difference, the tax is saved as deferred tax liability.
6.1 What causes a deferred tax liability?
Any temporary difference between the amount of money owed in taxes and the amount of money to be paid in the current accounting cycle creates a deferred tax liability.
6.2 Deferred tax liability examples
- Tax underpayment: The company did not pay the full amount of the tax in the previous cycle, and will have to make it up for it in the next cycle.
- Installment sale: When you pay a product for installments, the company lists the full value of the sale on their balance sheet, but they only pay the taxes for each annual installment. The business recognizes that they have a DTL for future payments on that sale.
- Depreciation of assets: Most businesses use an advanced asset depreciation model that results in the difference between the company’s balance sheet value and its value for tax purposes. This is the most common example of this tax.
7. Is deferred tax liability a bad thing or a good thing?
A DTL is either good or neutral, depending on the situation. This tax means that you owe money, but you do not have to pay it right away. The downside is that your business needs to have money set aside to pay this debt in the future.
8. How can we help you with the deferred tax liabilities of your company?
One of the most important aspects of a company is the administration of its finances and handling of taxes. Connect Zone is the best business setup agency to carry out all the administrative processes you need. Our professionals will accompany you at every step and will offer you valuable advice so that you make the best decisions.
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