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Dispelling misconception about tax on free zone businesses

Juridical persons that are incorporated within free zones are deemed qualifying free zone persons

I have come across numerous individuals, and many of them still believe that corporate tax does not apply to businesses registered in free zones. In response to this misconception, I have chosen to pen an article addressing this.

In free zones, resident businesses can operate as either non-juridical persons (such as sole establishments, unincorporated partnerships, etc.) or juridical persons (like LLCs, LLPs, PJSCs, etc.). If non-juridical persons based in the free zone earn up to Dh1 million in a Gregorian calendar year, they are exempt from corporate tax. Non-juridical persons in the free zone with revenues not exceeding Dh3 million in any current or previous tax period are required to register for corporate tax, but they can benefit from small business relief until the tax period ending on or before December 31, 2026. Non-juridical persons in the free zone with revenues exceeding Dh3 million must register for corporate tax and will be subject to zero percent corporate tax on taxable income up to Dh375,000, with a nine per cent tax rate applied to any income beyond that threshold. These same rules apply to non-juridical persons incorporated on the mainland.

Juridical persons that are incorporated within free zones are deemed qualifying free zone persons (QFZP), and every juridical person established in a free zone is required to register for corporate tax unless that is exempt from corporate tax. To maintain their QFZP status, these juridical persons must meet six conditions continuously, and failure to meet any of these conditions will result in the loss of QFZP status for the current tax period and the following four tax periods. Once the QFZP status is revoked, the free zone-based juridical person will be treated like a mainland registered business. It is important to note that small business relief is not applicable to QFZPs. Additionally, the taxable income of QFZPs is subject to either zero per cent or nine per cent tax, and they do not qualify for the exemption up to taxable income Dh375,000 that is available to non-QFZP and mainland registered businesses.

The revenue of the QFZP can be categorised as exempt, standard-rated, qualifying, or non-qualifying. Exempt revenue includes revenue generated from the foreign permanent establishment (PE) of the QFZP if the QFZP chooses not to include foreign PE revenue and related expenses under article 24 of the law. Additionally, dividends received from resident juridical persons and other revenue that qualify for participation exemptions under article 23 of the law shall be considered exempt revenue for the QFZP. Exempt revenue is not considered when applying the de minimis criteria.

There are four distinct types of revenues that are subject to a flat nine per cent corporate tax rate (standard rated revenue) and are not taken into consideration when applying the de minimis criteria. These revenues encompass income generated from both the local PE and foreign PE of the QFZP. This includes revenue derived from intellectual property other than qualifying income of the qualifying intellectual property. Additionally, it covers revenue generated from immovable property, excluding revenue from commercial property within the free zone when the transaction involves another free zone person, and the property is solely utilized for business purposes rather than accommodation and residential purposes.

The net revenue (total revenue minus exempt and standard-rated revenue as mentioned above) can be further categorised into qualifying revenue and non-qualifying revenue. Non-qualifying revenue consists of revenue obtained from sources like excluded activities, free zone persons who are not the ultimate beneficial recipient, and non-qualifying activities where the transaction is being made with a non-free zone person. The non-qualifying revenue of a QFZP should not surpass five per cent of the net revenue or Dh5 million, whichever amount is lower.

Qualifying revenue comprises revenue from various sources, except revenue from excluded activities. This includes revenue from transactions with other free zone persons where the Free Zone Person is the ultimate beneficiary, revenue from qualifying activities where transaction is being made with non-free zone persons, qualifying income from commercial property, qualifying income from qualifying intellectual property, and income that is below the de minimis threshold.

From the above its very clear that apart from non-juridical persons with revenue below Dh1 million in the Gregorian calendar year, all businesses including the free zone based juridical persons, are liable to register for corporate tax and submit the corporate tax return. For simplicity purposes, we have focused on the resident persons only.

The writer is a managing partner at Kress Cooper Management Consultants. The above article is not an official opinion of Khaleej Times but an opinion of the writer. For any queries/clarifications, please feel free to contact him at mahar@kresscooper.com.