Preparing Your Business for Increased Tax Scrutiny

Preparing Your UAE Business for Increased Tax Scrutiny: A Proactive Guide

The establishment of the Federal Tax Authority (FTA) and the rollout of VAT and Corporate Tax marked a new chapter in the UAE’s business environment. The initial years were a period of adjustment and learning for both businesses and the authority. That phase is now evolving. As the UAE’s tax system matures, the FTA is becoming increasingly sophisticated, data-driven, and focused. The era of lenient oversight is giving way to an era of increased tax scrutiny. It is no longer a question of *if* your business will be audited, but *when*.

This heightened scrutiny is not a punitive measure; it is the natural evolution of a modern tax jurisdiction. The FTA’s mandate is to ensure compliance and collect the revenues due to the state. To do this, they are leveraging advanced data analytics to identify discrepancies, red flags, and high-risk sectors. Businesses that continue with a reactive, “file-and-forget” mentality are exposing themselves to significant risks, including costly audits, disallowed expenses, substantial penalties, and reputational damage. The only sustainable strategy is to shift from a defensive posture to a proactive one: building a robust, transparent, and defensible tax position from the ground up. This guide provides a comprehensive framework for preparing your business for this new reality of intense tax scrutiny.

Phase 1: Fortifying the Foundation – Impeccable Record-Keeping

Before you can address complex tax issues, your foundational bookkeeping and documentation must be flawless. This is the bedrock of a defensible tax position. An auditor will start here, and if they find cracks in the foundation, they will dig much deeper.

1.1. The “Golden Rule” of Documentation

For every single transaction recorded in your books, you must be able to produce a complete “document package” on demand. This package typically includes:

• The Commercial Agreement: A signed contract, purchase order, or Master Service Agreement that justifies the business purpose of the transaction.
• The Invoice: A fully compliant tax invoice that matches the terms of the agreement.
• Proof of Delivery/Service: A delivery note, work completion certificate, or project report proving the goods/services were rendered.
• Proof of Payment: A bank transfer confirmation or cleared cheque copy showing the funds were transferred.

Missing any of these elements for a material transaction creates a weakness that an auditor can exploit to disallow an expense or challenge revenue recognition.

1.2. Moving Beyond Manual Processes

The complexity of modern tax requirements makes manual bookkeeping on spreadsheets unsustainable and high-risk. A cloud-based accounting system like Zoho Books is no longer a luxury; it’s a necessity for robust tax compliance.

• Data Integrity: It ensures a single source of truth, reducing the risk of version control errors common with spreadsheets.
• Audit Trail: Every entry is time-stamped, and changes are tracked, creating a clear and immutable audit trail that gives auditors confidence in your records.
• Document Attachment: You can digitally attach the entire document package (contract, invoice, etc.) to each transaction entry, allowing for instant retrieval during an audit.

1.3. Regular Reconciliation and Review

Strong records are not just about data entry; they are about verification.

• Bank Reconciliations: Must be performed at least monthly without fail.
• Control Account Reconciliations: Your accounts receivable and accounts payable sub-ledgers must be reconciled to the general ledger monthly.
• Periodic Reviews: A senior finance person should perform a high-level accounting review of the trial balance each month to spot anomalies or potential errors before they compound.

Phase 2: Addressing the High-Risk Areas

With a solid foundation, you can now focus on the complex areas where the FTA is likely to concentrate its efforts. These are the issues that have the largest potential impact on your tax liability.

2.1. Transfer Pricing (TP) Documentation

For any business with cross-border or even domestic transactions with related parties, transfer pricing is the number one audit risk. The FTA will want to ensure that profits are not being artificially shifted out of the UAE tax base.

• Master File and Local File: If you meet the revenue thresholds, preparing these documents is mandatory. They are the primary evidence of your TP policy.
• Commercial Rationale: Be prepared to defend the business logic behind your pricing. Why are services priced a certain way? How does it align with value creation?
• Benchmarking Studies: Your pricing must be supported by robust benchmarking studies that show it is in line with what unrelated parties would charge.

2.2. Scrutiny of Deductible Expenses

The FTA will closely examine large or unusual expenses to ensure they meet the “wholly and exclusively” for business purposes test.

• General & Administrative Expenses: Be prepared to justify large, unspecific costs. Break them down and document the business need for each component.
• Interest Expenses: Ensure your deductions comply with the 30% EBITDA interest limitation rule. Complex calculations may be required.
• Entertainment Costs: Only 50% of these costs are deductible. They must be meticulously segregated in your general ledger.
• Provisions and Accruals: The FTA will check if your provisions (e.g., for bad debt) are based on a sound, documented methodology and not just arbitrary estimates to reduce profit.

2.3. Economic Substance

For businesses in Free Zones aiming for the 0% tax rate, proving adequate economic substance is paramount. The FTA will look for tangible evidence of real operations.

• Core Income-Generating Activities (CIGAs): You must be able to demonstrate that your key business activities are happening within the Free Zone.
• Adequate Resources: This means having a suitable number of qualified employees, an appropriate physical office, and incurring sufficient operational expenditure in the UAE.

Phase 3: Implementing Robust Processes and Controls

Strong tax compliance is not about a single person; it’s about embedding good practices into the organization’s DNA through well-defined processes.

3.1. Develop a Tax Governance Framework

This is a formal document that outlines the company’s approach to tax risk and management.

• Define Roles: Clearly state who is responsible for preparing, reviewing, and signing tax returns.
• Establish Controls: Implement a “four-eyes principle” where one person prepares the tax calculation and another senior person independently reviews it.
• Escalation Policy: Create a clear procedure for escalating complex or uncertain tax issues to senior management or external advisors.

A CFO service can be instrumental in developing and implementing such a framework.

3.2. Conduct Pre-emptive Tax Health Checks

Don’t wait for the FTA’s letter. A proactive tax health check, conducted by an independent firm, simulates an FTA audit.

• Identify Weaknesses: It can uncover issues in your documentation, expense classification, or VAT treatment.
• Remediate Before Audit: It gives you the opportunity to fix problems, make voluntary disclosures if needed, and prepare defensive arguments before the official audit begins.
• Demonstrate Due Care: The act of conducting a health check shows the FTA that you take compliance seriously, which can be a mitigating factor in penalty discussions.