Accounting under Corporate Tax – Realization basis of accounting

We'll explore the key distinctions between realized and unrealized gains/losses, delve into concepts like fair value accounting and impairment, and clarify how they interact with the realization basis under specific circumstances.  

Additionally, we'll highlight the options available to taxable persons and businesses regarding the application of the realization basis and its impact on their corporate tax calculations

 To understand as per the accounting standards, 

• Realized gains/losses are gains/losses that have been converted into consideration (ex: Cash) received by the completion of a transaction. 

• Unrealized gains/losses are gains/losses that have not been converted into consideration and can arise for items subject to fair value accounting, such as financial instruments that are liquid and short-term. 

 IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The objective is to estimate the price at which a transaction to sell an asset or to transfer a liability would take place between market participants under the market conditions applicable on the measurement date. 

The core principle is that an asset must not be carried in the Financial Statements of the entity at a value higher than the highest amount that can be recovered through its use or sale. If an asset's value is higher than what it can realistically be sold for, it's considered "impaired." In this case, the company needs to lower the value of the asset to what it could be sold for and acknowledge the loss in value.

If a person uses the Accrual Basis of Accounting for their financial statements and they record any increases or decreases in the value of their assets or liabilities even if they haven't sold anything or paid off a debt yet. (Ex: change in the exchange rate affecting the value of a foreign currency contract to be settled in a future Tax Period, the creation or release of a provision for a doubtful debt.)  Taxable Persons who prepare their Financial Statements on an Accrual Basis of Accounting may elect to consider gains and losses on a realization basis.  In simpler terms, when figuring out how much money someone owes in taxes for a certain period, they only count profits or losses when they sell something or pay off a debt, rather than when the value of their asset’s changes on paper. 

The realization of an asset or a liability includes, but is not limited to, the following:  

• The sale, disposal, transfer (other than non-taxable transfers), settlement and complete worthlessness of an asset as per the Accounting Standards used by the Taxable Person. 

• The settlement, assignment, transfer (other than non-taxable transfers), and forgiveness of a liability as per the Accounting Standards used by the Taxable Person. 

 Certain transfers are not considered a realization of assets or liabilities.  

• A non-taxable transfer of assets or liabilities between members of a Qualifying Group 

• A transfer of assets or liabilities which qualifies for Business Restructuring Relief under 

  Who can use it?  

A Taxable Person, other than a Bank or Insurance Provider, may elect to consider gains and losses on a realization basis in relation to either:  

• All assets and liabilities that are subject to fair value or impairment accounting under Accounting Standards. 

• All assets and liabilities held on the capital account at the end of a Tax Period, whilst considering any unrealized gain or loss that arises in connection with assets and liabilities held on the revenue account at the end of that period. 

 Banks or Insurance Providers:   

• Only assets and debts that are still in possession at the end of a tax period are considered, while also acknowledging any potential profits or losses from assets and liabilities that are still active at that time. 

  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 for the realization basis must be made by the taxable person during the first tax period which practically will be at the time of submitting the first tax return. 

 Revocation: The election to use the realization basis is irrevocable. However, it may be revoked under exceptional circumstances and approval by the FTA.  

Effect for the entity: Considering gains and losses on a realization basis means that unrealised gains and losses recorded in the taxable person’s financial statements would be disregarded for Corporate Tax purposes.  This includes assets and liabilities subject to fair value or impairment accounting, assets and liabilities held on capital account, including unrealised foreign exchange gains and losses, except for assets and liabilities held on revenue account.  A Person elected for realization basis must make the following adjustments for relevant assets and liabilities when calculating the taxable income:   

• any decrease in value of an asset over time, like from wear and tear or other factors, won't be considered when figuring out how much someone owes in taxes unless they actually sell the asset. 

• any change in the value of a liability or a financial asset, including amortization, should be excluded from the accounting income when calculating the taxable income unless such liability is realized. 

• Upon the realization of an asset or a liability, any amount that had not been previously recognized for Corporate Tax purposes (for example, unrealized gains or losses) must be included in the taxable income. 

• However, any such gain/loss that arose before the most recent acquisition should not be included in the Taxable Income provided where Business Restructuring Relief or the relief for transfers within a Qualifying Group was not availed. 

 By comprehending the realization basis of accounting and its interplay with corporate tax regulations, businesses can make informed decisions about their financial reporting practices in UAE. This knowledge empowers them to optimize their tax strategies, ensuring compliance and potentially maximizing their financial advantage.  Remember, consulting with a qualified tax professional is always recommended for navigating the complexities of corporate tax in UAE and ensuring your specific situation is addressed accurately