A Guidance towards Corporate Tax Compliance: Navigating Transitional Rules

Case Study: Asset Acquired before the First tax Period

Background:
A taxable entity acquired an asset prior to its first tax period for AED 1,000 (arm’s length amount), recorded on the historical cost basis. The market value of the asset at the start of the first tax period is AED 1,700. During the first tax period, the entity disposes of the asset for AED 2,200, realizing a taxable gain of AED 1,200.

Historical Cost Basis:
Under the historical cost basis, the asset is reported in the opening balance sheet at the original cost of AED 1,000, even though the market value is AED 1,700. Upon disposal for AED 2,200, the taxable gain is calculated as AED 1,200 (sale price AED 2,200 less cost AED 1,000). Out of this gain, AED 700 relates to periods prior to the first tax period.

Fair Market Value Basis:
Alternatively, if the entity applies the fair market value basis, the asset is reported in the opening balance sheet at AED 1,700, reflecting its market value. Upon disposal for AED 2,200, the taxable gain is calculated as AED 500 (sale price AED 2,200 less fair market value AED 1,700).

Conclusion:
Taxable persons are required to prepare their financial statements according to IFRS for the financial year immediately preceding the commencement of their initial tax period. Additionally, they must conduct a thorough analysis of the balances presented in the related balance sheet to adjust them to fair market value. The primary objective of adjusting these balances to their fair value is to ensure that gains are taxed in the appropriate period while losses are accounted for in the relevant period. Taxable persons are not obligated to pay taxes on gains acquired before the initiation of the tax period, nor should they be permitted to claim losses sustained prior to entering the first corporate tax period.

Disclaimer:
The content provided in this document offers general guidance and should not be construed as legal, financial, or tax advice. It is recommended to consult qualified professionals for personalized guidance. While efforts have been made to ensure accuracy, no guarantee is provided for completeness or applicability to individual situations. Users are responsible for interpreting and taking actions based on this information, at their own risk.