Understanding the Realization Basis and Its Impact on Corporate Tax in the UAE

The key difference is whether your profit or loss has been locked in through an actual sale, or is still just "on paper" waiting to be realized. 

• Realized Gains and Losses: These occur when you actually sell an investment for a profit or loss, making the gain or loss "real" and often subject to taxation. 

• Unrealized Gains and Losses: These are changes in the value of an investment that you still hold and have not sold yet, so the gains or losses are "on paper" and not subject to tax until realized. 

 Fair Value Accounting 

It is the practice of measuring assets or liabilities at their current market price, the amount you would expect to receive if you sold the asset or paid if you transferred the liability in a normal, fair transaction between independent buyers and sellers on the measurement date. 

Impairment 

This happens when an asset’s recorded value on the books is higher than what the asset can realistically be recovered for. Accounting rules require recognizing this loss in value promptly, but under the realization basis for tax purposes, you might only see the impact when the asset is eventually sold or disposed of. In short, fair value shows the real-time market worth of an asset or liability, while impairment is about recognizing when an asset’s value drops below its recorded amount. Under the realization basis, the tax effects of impairment may be deferred until there's an actual sale or disposal of the asset. 

If someone uses the Accrual Basis of Accounting for their financial statements, they record increases or decreases in the value of their assets or liabilities even if nothing has been sold or no debt has been paid yet. (For example: a change in exchange rate affecting the value of a foreign currency contract to be settled in a future tax period, or creating/releasing a provision for doubtful debts.) Taxable persons who prepare their financial statements on an accrual basis can choose to record gains and losses only on a realization basis. In simple terms, when working out how much tax they owe for a certain period, they only include profits or losses when they actually sell something or settle a debt, not when the value changes only on paper.  

Realization of an asset includes: 

• Sale, disposal, or transfer (except non-taxable transfers). 

• Settlement of the asset. 

• Complete worthlessness of the asset (as per applicable Accounting Standards). 

Realization of a liability includes: 

• Settlement of the liability. 

• Assignment or transfer (except non-taxable transfers). 

• Forgiveness of the liability (as per applicable Accounting Standards). 

Not considered realization: 

• Non-taxable transfers of assets or liabilities within a Qualifying Group. 

• Transfers qualifying for Business Restructuring Relief. 

   Who can use it? 

• Taxable Persons (except Banks or Insurance Providers) can choose to apply it for: 

• All assets and liabilities subject to fair value or impairment accounting under accounting standards. 

• All capital account assets and liabilities held at the end of a Tax Period, while still accounting for unrealized gains or losses on revenue account assets and liabilities at that date. 

• Banks and Insurance Providers can apply it only for: 

• Assets and debts still held at the end of the Tax Period, including any unrealized gains or losses on those still-active items. 

 This means that banks and financial institutions cannot elect to consider gains and losses on a realization basis in relation to assets and liabilities that are subject to fair value or impairment accounting under Accounting Standards.   

Timeline: The election to use the realization basis must be made by the taxable person in their first tax period, practically when they submit their first tax return. 

Revocation: The election to use the realization basis is irrevocable, except in exceptional circumstances where revocation may be allowed with approval from the Federal Tax Authority (FTA). 

Effect for the entity: 

• When using the realization basis, unrealized gains and losses recorded in financial statements are disregarded for tax purposes. This applies to assets and liabilities subject to fair value, impairment accounting, and capital account holdings, including unrealized foreign exchange gains/losses, except for items held on the revenue account. 

• Decreases in asset value over time (like wear and tear) are not deductible for tax unless the asset is sold. 

• Changes in the value of liabilities or financial assets (including amortization) are excluded unless the liability is realized. 

• When an asset or liability is realized (e.g., sold or settled), any previously unrecognized gains or losses must be included in taxable income. 

• Gains or losses that arose before the most recent acquisition are not included in taxable income, provided no Business Restructuring Relief or Qualifying Group transfer relief was claimed. 

Understanding the realization basis and how it impacts your corporate tax obligations in the UAE can significantly influence your financial planning and compliance. By choosing the realization basis, businesses can align their tax liability with actual transactions, potentially deferring tax on unrealized gains and losses until they are truly realized. This approach empowers companies to optimize their tax outcomes while ensuring adherence to UAE tax laws. With deep expertise in UAE corporate tax, Kitaab helps businesses navigate complex regulations, align with compliance requirements, and make confident financial decisions.   Talk to us now.