UAE Businesses and Pillar Two: Maximising the Substance-Based Income Exclusion

Introduction

Despite the global movement towards a 15% minimum corporate tax under the OECD's Pillar Two framework, UAE businesses have a significant opportunity to maintain tax efficiency through the Substance-Based Income Exclusion (SBIE). This key feature allows multinational enterprises (MNEs) to legitimately reduce their effective tax rate below the 15% threshold by recognising genuine economic activities within a jurisdiction. For companies operating in the UAE, strategic planning around physical presence, payroll, and tangible assets can directly influence tax obligations, underscoring the enduring value of robust international tax advice.

This article explores the SBIE in detail, explains its mechanics, and outlines why it holds particular relevance for UAE-based businesses. We will also provide actionable steps for MNEs to use this exclusion, ensuring compliance while optimising their global tax position in this evolving landscape.

Understanding Pillar Two and the Global Minimum Tax

Pillar Two, an initiative spearheaded by the Organisation for Economic Co-operation and Development (OECD), aims to ensure large multinational enterprises pay a minimum corporate tax rate of 15% on their profits, regardless of where they operate. This framework, officially known as the Global Anti-Base Erosion (GloBE) Rules, is designed to counter profit shifting and base erosion, fostering a more equitable global tax environment. While the overarching goal is a 15% minimum tax, the SBIE is an intentional element of the design that offers specific relief for MNEs with demonstrable economic substance.

The GloBE Rules apply to MNEs with consolidated annual revenues exceeding 750 million euros (approximately AED 3.1 billion) in at least two of the four fiscal years immediately preceding the tested fiscal year. These rules introduce a complex system of top-up taxes, levied if an MNE's effective tax rate in any jurisdiction falls below the 15% minimum. Businesses operating within the UAE, especially those with international footprints, must carefully assess their structures and operations to ensure compliance and avoid unexpected tax liabilities.

For further insights into the UAE's approach to Pillar Two, consider reading our articles on UAE MNEs and the Global Minimum Tax: Understanding OECD's Latest Implementation Guidance and UAE's Pillar Two Global Minimum Tax: What MNEs Must Do for 2025 Compliance.

What is the Substance-Based Income Exclusion (SBIE)?

The Substance-Based Income Exclusion (SBIE) is a crucial component of Pillar Two, designed to prevent the GloBE Rules from penalising MNEs for genuine, value-creating economic activities. It allows MNEs to exclude a portion of their GloBE Income (the income subject to the 15% minimum tax) from the top-up tax calculation. This exclusion is directly linked to the demonstrable substance of their operations in a particular jurisdiction. In essence, if a company has real, tangible operations – such as employees on the payroll and physical assets – in a country, a percentage of the income generated by those activities can be excluded from the global minimum tax calculation. This 'carve-out' acknowledges that actual economic contributions, rather than just legal structures or tax incentives, should be recognised within the global tax framework.

The SBIE serves as a mechanism to encourage real investment and job creation. It offers a measured relief for MNEs that genuinely contribute to the economy of a jurisdiction by establishing a physical presence and employing personnel, thereby aligning taxation with economic activity.

How Does the SBIE Operate?

The SBIE operates by allowing an MNE to reduce its GloBE Income by an amount based on its eligible payroll costs and the carrying value of its eligible tangible assets in a given jurisdiction. These calculations are performed for each jurisdiction where the MNE has constituent entities.

The exclusion percentages are transitional, meaning they will change over time:

• Initial Years (2023-2027): The exclusion is set at 8% of eligible payroll costs and 10% of eligible tangible assets.
• Gradual Decrease: The percentages will progressively decrease over a ten-year transition period.
• Final Stage (From 2033 onwards): The exclusion will stabilise at 5% of eligible payroll costs and 5% of eligible tangible assets.

This phased reduction ensures a gradual adjustment for businesses and tax authorities. The principle remains constant: the more substantive your operations, evidenced by real employees and physical assets, the greater your potential exclusion from the GloBE minimum tax.

Why SBIE is Crucial for UAE Businesses

The UAE has consistently positioned itself as a premier destination for genuine economic activity, attracting businesses that establish a true physical presence, employ significant workforces, and contribute to the local economy. This long-standing focus on economic substance, particularly amplified by the introduction of the UAE's Economic Substance Regulations (ESR), positions UAE-based entities to benefit considerably from the SBIE.

Companies that have invested in a solid operational footprint within the UAE, complete with real offices, tangible assets, and a dedicated team, are precisely the types of businesses that the SBIE is designed to support. This reinforces the UAE's attractiveness for structuring international operations, even under the new global tax regime. For businesses already adhering to ESR requirements, much of the groundwork for demonstrating substance under SBIE may already be in place, creating a synergistic advantage.

For companies with existing offshore structures or those considering new ones, the SBIE unequivocally emphasizes that merely establishing a legal entity with minimal presence is no longer sufficient. The focus must be on demonstrating actual, verifiable substance. The UAE's robust infrastructure, business-friendly environment, and commitment to international standards make it an ideal jurisdiction to demonstrate this substance effectively. The availability of diverse free zones further supports this, provided entities within them meet their specific substance requirements and contribute to the local economy.

For more on UAE Free Zones and compliance, refer to The Evolving Landscape of UAE Free Zones: Compliance, Corporate Tax, and Global Standards.

Actionable Steps: Using the SBIE for Tax Efficiency

To maximise the benefits of the Substance-Based Income Exclusion, UAE businesses should undertake several strategic and proactive steps. These actions are vital not only for optimising tax positions but also for ensuring ongoing compliance with evolving international tax standards.

1. Review Your Operational Substance

Begin by thoroughly assessing your current operational setup in the UAE. This involves a granular review of:

• Physical Presence: Do you have genuine office space, either owned or leased, appropriate for your business activities? Is it actively used by your staff?
• Employees: Are your employees genuinely based in the UAE and on the local payroll? Do they perform core income-generating activities within the country? Quantify the number of full-time equivalent employees.
• Tangible Assets: Do you own or lease significant tangible assets, such as property, plant, machinery, or equipment, in the UAE? Are these assets actively used in your business operations?

2. Document Eligible Payroll Costs

Meticulous documentation of all eligible payroll expenses is critical. This includes:

• Salaries and Wages: Records of all remuneration paid to employees who perform substantive activities in the UAE.
• Employee Benefits: Documentation of other employee benefits, such as health insurance, pension contributions, and allowances, that are directly attributable to UAE-based staff.
• Substantiation: Ensure that these costs are accurately recorded in your financial statements and can be readily audited. Payroll records, employment contracts, and proof of payment are key.

3. Track Eligible Tangible Assets

Maintain precise records of the carrying value of all eligible tangible assets located within the UAE. This encompasses:

• Property, Land, Buildings: Valuation and ownership documents.
• Machinery and Equipment: Purchase records, depreciation schedules, and proof of physical location and use.
• Leased Assets: If assets are leased, ensure documentation clarifies the nature of the lease (e.g., operating vs. finance lease) as specific rules apply to their eligibility under SBIE.

4. Strategic Restructuring Consideration

For entities involved in complex international structuring, it is crucial to evaluate whether consolidating or enhancing substantive operations within the UAE could lead to a more favourable tax position under Pillar Two. This may involve:

• Relocating Functions: Shifting core income-generating activities, management, and control to the UAE.
• Expanding Workforce: Increasing the number of skilled employees performing substantive roles in the UAE.
• Investment in Assets: Committing to further investment in tangible assets in the UAE to support expanded operations. This goes beyond mere incorporation, focusing on establishing core functions and genuine operational activities.

5. Seek Expert Guidance

The nuances of Pillar Two, the SBIE, and their interaction with the UAE's domestic tax framework require a detailed understanding of complex international tax regulations. Engaging with experienced tax advisory experts, such as AURNE, is essential to:

• Interpret Regulations: Accurately apply OECD GloBE Rules and local UAE corporate tax laws.
• Assess Impact: Understand how Pillar Two and SBIE specifically affect your MNE group.
• Develop Strategy: Formulate an optimal tax strategy that ensures compliance while maximising SBIE benefits.
• Ensure Documentation: Prepare robust documentation to support all SBIE calculations and claims during potential audits.

Navigating Pillar Two and SBIE: Compliance and Future Outlook

The introduction of Pillar Two marks a fundamental shift in the international tax landscape, moving towards a global minimum tax rate. However, the Substance-Based Income Exclusion confirms that demonstrating genuine economic activity remains a powerful strategy for MNEs, particularly those with a strong presence in jurisdictions like the UAE. It is a clear signal that while global tax standards are evolving, the fundamental principle of aligning taxation with substance holds strong. Proactive planning and a clear understanding of these rules are therefore essential for maintaining tax efficiency and compliance in this new international tax environment.

The ongoing developments from the OECD, including further guidance and commentary, will continue to refine the application of these rules. MNEs must remain vigilant, adapting their strategies to align with the latest interpretations and implementation directives. The UAE's commitment to attracting businesses with real substance positions it favourably, but local entities must actively demonstrate this substance to realise the full benefits of the SBIE.

Broader Compliance Considerations

Beyond the SBIE, MNEs must also prepare for other significant Pillar Two requirements, such as the GloBE Information Return (GIR). This extensive reporting obligation demands detailed data collection and accurate disclosures, which requires substantial preparation and robust internal systems.

• Data Collection Challenges: MNEs will need to gather detailed financial and tax data from all constituent entities across all jurisdictions, often requiring enhancements to existing ERP and financial reporting systems.
• Intercompany Transactions: The impact of intercompany transactions and arrangements on effective tax rates and jurisdictional allocations needs careful scrutiny under GloBE rules.
• Reporting Deadlines: Adhering to strict reporting deadlines, such as the June 2026 deadline for the first GloBE Information Returns for 2024 fiscal years, is paramount.

For comprehensive details on reporting, see OECD GloBE Information Return: What UAE MNEs Need to Know for the June 2026 Deadline. Further insights into the evolving guidance can be found in OECD GloBE Rules Commentary 2026: Navigating Pillar Two for UAE Businesses and EU's Pillar Two Manual: A Guide for UAE Businesses with European Operations.

Practical Guidance: Best Practices for SBIE Optimisation

To effectively use the Substance-Based Income Exclusion, UAE businesses should integrate SBIE considerations into their broader tax and operational strategies.

Comprehensive Action Plan

1. Q4 2025: Initial Impact Assessment: Conduct a preliminary analysis of your MNE group's exposure to Pillar Two and potential SBIE benefits based on current operations. Identify data gaps.
2. Q1 2026: Data System Review & Enhancement: Assess current accounting and payroll systems for their ability to capture and report eligible payroll costs and tangible assets at a jurisdictional level. Implement necessary upgrades.
3. Q2 2026: Documentation Framework Development: Establish robust internal processes and documentation protocols for tracking and verifying all SBIE-eligible expenses and assets, ensuring compliance with OECD guidelines.
4. H2 2026: Strategic Operational Review: Evaluate potential adjustments to operational structures (e.g., employee relocation, asset acquisitions) to enhance economic substance in the UAE and maximise SBIE.

Essential Checklist for SBIE Readiness

• Verify Entity Classification: Ensure all UAE entities are correctly classified under Pillar Two rules (e.g., Investment Entities, Excluded Entities).
• Review Payroll Records: Confirm all payroll costs for substantive employees are accurately captured and attributable to UAE entities.
• Audit Tangible Asset Register: Validate the carrying value and physical location of all eligible tangible assets used in UAE operations.
• Analyse Intercompany Transactions: Understand how internal transactions might affect jurisdictional profit allocations and the effective tax rate.
• Develop GloBE Information Return (GIR) Strategy: Plan for the extensive data requirements and reporting obligations of the GIR.
• Engage Tax Advisors: Secure expert guidance for interpretation, calculation, and compliance.

Common Pitfalls to Avoid

• Ignoring Substance: Merely having a legal presence without genuine economic activity will not qualify for the SBIE.
• Inadequate Documentation: Failure to maintain detailed and auditable records for payroll costs and tangible assets can lead to disallowance of the exclusion.
• Incorrect Asset Valuation: Using inappropriate valuation methods or including ineligible assets can result in errors and non-compliance.
• Overlooking Transitional Rules: Failing to account for the gradual decrease in SBIE percentages over time can lead to inaccurate future tax planning.
• Delayed Action: Procrastinating on assessment and implementation will create significant challenges closer to compliance deadlines, given the complexity of the rules.

Conclusion

The Substance-Based Income Exclusion is a testament to the OECD's recognition of genuine economic activity as a legitimate basis for tax relief within the Pillar Two framework. For multinational enterprises operating in the UAE, this carve-out presents a significant opportunity to maintain competitive tax rates by aligning their tax planning with their real operational footprint. It underscores that investment in local talent, physical assets, and substantive business functions in the UAE can directly translate into tangible tax advantages under the new global tax regime.

Navigating the complexities of Pillar Two and effectively using the SBIE requires a proactive, strategic approach. Businesses must conduct thorough reviews of their current operations, meticulously document eligible costs and assets, and be prepared to adapt their structures to enhance economic substance. The evolving nature of international tax standards demands ongoing vigilance and a willingness to engage with expert advice to ensure both compliance and optimal tax positioning.

In this environment, professional guidance from experienced tax advisors is not merely beneficial; it is essential. AURNE stands ready to assist UAE businesses in deciphering the intricacies of Pillar Two, optimising their use of the Substance-Based Income Exclusion, and developing comprehensive compliance strategies that safeguard their interests in the dynamic global tax landscape.

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This article is for general information only and does not constitute professional, legal, tax, or financial advice. Speak to AURNE for guidance specific to your situation.