Is every free zone trader a qualified distributor to enjoy 0% tax?

The UAE corporate tax law applies to traders (persons who buy and sell the goods) unless they meet specific criteria for exemptions based on factors like legal structure and revenue. Non-free zone resident juridical taxable traders are liable to pay tax on their global income, with a zero per cent tax rate on income up to Dh375,000 and a nine per cent rate beyond that. For natural persons working as traders in the UAE, they are exempt from corporate tax if their revenue is up to Dh1 million in a Gregorian calendar year. If their revenue exceeds Dh1 million, they face the same tax rates as resident juridical taxable traders.

Traders classified as Qualifying Free Zone Persons (QFZPs) are subject to a zero per cent tax rate on their qualifying income and a nine per cent tax rate on non-qualifying income. Qualifying income includes income from transactions with other free zone persons where the receiving entity is the beneficial recipient of the goods, as well as sales of qualifying goods to non-free zone entities where the customers are not the permanent establishment (PE) of the QFZP. The income generated from excluded activities from any person will be considered non qualifying income.

The question arises when Qualifying Free Zone Traders (QFZTs) sell non-qualifying goods to non-free zone persons that are not their PEs, will they still be able to enjoy 0% tax? In this scenario, the income would not be classified as qualifying income unless the seller is a Qualifying Free Zone Distributor (QFZD); performing qualifying activities in the designated zone; and selling goods to non-free zone resellers that are not their PEs.

The UAE government offers specific incentives, such as a zero per cent tax rate, to QFZDs operating in designated zones. As mentioned above, this benefit applies when QFZDs are maintaining their QFZP status, performing qualifying activities in the designated zones and selling goods to free zone persons and non-free zone resellers. To retain their Qualifying Free Zone Person status in designated zones, QFZDs must consistently meet requirements like maintaining adequate substance in the designated zones, meeting de-minimus criteria, having audited financial statements, adhering to transfer pricing regulations, not opting to be taxed and generating non qualifying income less than 5% of the total income or Dh5 million, whichever is lower.

The distribution of goods or materials within or from a designated zone involves a range of activities, such as purchasing and selling tangible goods, materials, and component parts. These activities encompass functions like importing, storing, managing inventory, handling, transporting, and exporting these items to customers who may further resell, process, or modify them for sale. To qualify, these activities must take place within a designated zone, and if the goods enter the UAE, they must be brought in through the designated zone. Even if the goods do not enter the UAE, but a QFZD meets the relevant conditions, the activity will still be considered qualifying, and the income generated from such activity will be treated as qualifying income.

There are no restrictions on the method of distribution. The distribution of goods specifically pertains to tangible products and does not cover the distribution of intangible products and services like licenses, software, and financial products or services. Nevertheless, if any goods contain integrated software or firmware whose income cannot be distinctly identified, such cases would not be exempted from this rule.

To qualify as a qualifying activity, distribution services must be provided to a customer who either resells the goods or processes them for resale. If goods are distributed to an end user - the individual who uses or consumes the product - the activity will not meet the criteria for a qualifying activity. The end user is the final recipient of the goods after any intermediary distribution, production, or resale stages. Essentially, the end user is the individual who ultimately utilizes the product for its intended purpose, whether that purpose is personal, commercial, or industrial. Therefore, a QFZD must perform essential due diligence, like 'know your client' procedures (KYC) and obtaining confirmation through agreements or contracts, to verify that their customer is not the end user.