Corporate tax in UAE free zones: All you need to know

In a landmark decision on June 1, the UAE introduced corporate tax businesses operating in the country. The move is a significant step in the UAE’s efforts to diversify the government’s sources of income, as it seeks to move away from a hydrocarbon-based economy.

Free zones are a key component of the UAE economy’s diversification efforts, and the zones have been serparately mentioned under specific provisions of the law. Khaleej Times talks to Dr Nabeel Ahmed, partner at DVS Management Consultancy and Siddharth Kohli, founder and CEO of Indigenesis Consulting, to get a clear idea of what the free zones need to do to comply with the UAE’s corporate tax rules. Excerpts from the interview:

What are the specific rules and regulations regarding the taxability of companies operating in free zones under the UAE’s corporate tax law?

Nabeel Ahmed: The legislation that would govern the taxability of corporations and business in all of UAE, is Federal Decree-Law No. 47 of 2022 on the taxation of corporations and businesses (‘CT Law’). Chapter 5 - Article 18 of the law specifically deals with qualifying free zone person (QFZP), wherein the taxability of QFZP would be at zero per cent tax rate, if all the conditions mentioned therein are met with. Cabinet decision No 55 of 2023 on determining qualifying income for the qualifying free zone person for the purposes of CT law and the ministerial decision no. 139 of 2023 regarding qualifying activities and excluded activities the purposes of the CT Law give a thorough understanding of the taxability of free zone companies.

Siddharth Kohli: Companies operating in free zones can benefit from zero per cent tax on income from carrying out ‘qualifying activities’. They would be termed Qualifying Free Zone Person (‘QFZP’) provided they maintain adequate substance in the free zone, have not specifically elected to be taxed, follow transfer pricing regulations and satisfy the de-minis requirement (explained below). All free zone companies are required to take corporate tax registration and file corporate tax returns.

Explain the concepts of qualifying income, qualifying activity, and excluded activities in relation to free zone entities?

Nabeel Ahmed: The Cabinet decision on what constitutes qualifying income was the most awaited decision after the CT law came into effect. Qualifying income as provided under ministerial decision no. 139 Of 2023 is defined as income from transactions with other free zone persons and non-free zone person, (be it domestic or foreign) and does not include excluded activities.

Qualifying activities are mentioned in cabinet decision no 55 of 2023, which gives a list of 13 activities conducted by QFZP as qualifying activities. The qualifying activities are : manufacturing and processing of goods or materials, holding of shares and other securities, ownership, management and operation of ships, reinsurance and fund management services, wealth and investment management services, headquarter services to related parties, treasury and financing services to related parties, financing and leasing of aircraft, distribution of goods or materials in or from a designated zone to a customer that resells such goods or material, logistics services and lastly any activities that are ancillary to the activities listed.

Excluded activities would include any transactions with natural persons, banking activities, insurance activities, finance and leasing activities ownership or exploitation of immovable property, other than commercial property located in a free zone where the transaction in respect of such commercial property is conducted with other free zone persons, ownership, or exploitation of intellectual property assets.

Siddharth Kohli: Simply put, a free zone company would not pay any tax on income derived from carrying out qualifying activities. QI been now defined to include:

(i) Income derived from transactions with other free zone persons, except income derived from “excluded activities”; (ii) Income derived from transactions with a non-free zone person, but only in respect of “qualifying activities”; and (iii) any other income provided that the QFZP satisfies the de minimis requirements (explained below). Qualifying activities include manufacturing, ownership & management of ships, fund management services etc.

The complete and specific list of qualifying activities and excluded activities can be referred from the ministerial decision no. 139 Of 2023 regarding qualifying activities and excluded activities and cabinet decision no. 55 Of 2023 on qualifying income.

What is the minimum requirement for transactions with mainland entities that could impact the tax-exempt status of free zone companies, and what are the potential consequences?

Nabeel Ahmed: The tax exempt status of the QFZP would be affected in case of income attributable to domestic permanent establishment (‘DPE’), or a foreign permanent establishment (‘FPE’). This therefore means that the income attributable to a mainland branch will remain taxable at 9 per cent. This, however, will not disqualify the QFZP from benefitting from a zero per cent CT rate on qualifying income or be factored into the de minimis test. A QFZP, can benefit from the zero per cent corporate tax rate when the taxable income is generated from the Free Zone area and is a qualifying income. The QFZP would be required maintain separate accounts one for the QFZP and another for the mainland documenting the transactions.

The De-Minimis threshold allows the ‘non-qualifying’ revenue which includes income from ‘excluded activities’ and from activities (other than ‘qualified activities’) with a non-free zone person to be taxed at zero per cent provided qualifying revenue derived by the QFZP in a tax period does not exceed 5 per cent of the total revenue of the QFZP in that tax period or Dh5 million, whichever is lower.

Siddharth Kohli: Upon the advent of corporate tax, inter-alia, the primary aspect of all activities that a free zone entity undertakes should be to comply with transfer pricing regulations, i.e. benchmark its transactions with related parties at an arm’s length price. Any substantial rejig in the operations would have to be looked at in light of the general anti abuse provisions provided under the corporate tax regime. However the minimum a free zone entity can do is to analyse their income sources, review legal structures, assess transaction structuring, and ensure compliance requirements and necessary documentation with the help of a tax consultant.