UAE: Is income of free zone businesses subject to zero per cent tax?

Except exempt entities, all juridical persons of the free zones should fulfill all related conditions to be classified as QFZP

By Mahar Afzal

Published: Tue 6 Jun 2023, 3:54 PM

Last updated: Tue 6 Jun 2023, 10:57 PM

The UAE Corporate Tax law (UAE CT law) states that zero per cent corporate tax (CT) is applicable on the qualifying income (QI) of the qualifying Free Zone Person (QFZP), and the non-qualifying income (NQI) of the QFZP is subject to tax at nine per cent.

To apply the CT properly on businesses registered in the free zones, it is important to understand the terms free zone, free zone persons, QFZP and qualifying income.

A free zone is a designated and defined geographic area within the UAE that is specified in a decision issued by the Cabinet. The free zone person is a juridical person incorporated, established, or otherwise registered in a free zone, including a branch of a non-resident person registered in a free zone.

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The term “qualifying free zone person” means a free zone person which (i) maintains adequate substance in the UAE, (ii) derives qualifying income as defined in the Cabinet Decision 55 of 2023 and Ministerial Decision 139 of 2023, (ii) complies with prevailing transfer pricing rules and regulations, (iv) has not elected to be subject to CT, (v) meet de minimis requirement for NQI and (vi) prepare and main audited financial statements as required by Ministerial Decision No. 114 of 2023.

The term “adequate substance” means the free zone juridical person must have Core Income Generating Activities (CIGA) in the free zone, and have adequate assets, employees and expenditures in the UAE as defined in the Economic Substance Regulations (ESR) law.

The definition of the term qualifying income was pending which has been defined in the Cabinet Decision 55 of 2023 and Ministerial Decision 139 of 2023 (collectively referred as “Decisions”). We can categorise that a QFZP can have transactions with the same and other free zone persons and non-free zone persons including the permanent establishment (PE) of the QFZP in the mainland of the UAE and out of the UAE.

The decisions define that any income derived from transactions with the free zone persons is qualifying income, except the income derived from the excluded activities, and any income derived from transactions with non-free zones persons is NQI except the income derived from qualifying activities which are not in the excluded activities list.

There are special rules for the immoveable property in the decisions. If the property is in the free zone and it is commercial property (being used exclusively for business purposes and not used as a place of residence or accommodation), then any income derived from transactions with the free zone person related to this property is qualifying income.

The decisions further define that if the NQI is five per cent or Dh5million, whichever is lower of the total revenue of the QFZP, it will be considered qualifying income as well. While calculating this percentage of five per cent, the numerator is NQI from (i) excluding activities from transactions with free zone and non-free zone persons and (ii) non-qualifying activities where transactions are with non-free zone persons. In the denominator, the total revenue includes qualifying and non-qualifying revenue of QFZP. The revenue from PE (domestic and foreign) of the QFZP and revenue from immoveable property shall not be included in the non-qualifying revenue and total revenue. However, the revenue from the free zone commercial property will be included in the total revenue where the property is being used exclusively for business purposes and transactions is with the other free zone person.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants.

The “qualifying activities” conducted by QFZP includes the manufacturing and/or processing of goods or materials, holding of shares and other securities, ownership, management, and operation of ships. Services like reinsurance, fund management, wealth and investment management and logistic services are part of the qualifying activities. If headquarter services, and treasury and financing services are being provided to related parties, it will also fall under the qualifying activities. Financing and leasing of aircraft, including engines and rotable components, and distribution of goods or materials in or from a designated zone to a customer that resells such goods or materials, or parts thereof or processes or alters such goods or materials or parts thereof for the purposes of sale or resale. Any ancillary activity related to these activities except the ancillary activity of distribution of goods or materials in or from a designated zone, shall be considered qualifying activities. Out of these activities, some activities are subject to certain conditions.

The “excluded activities” with few exceptions and conditions includes the activities with natural persons, banking activities, insurance activities, financing 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) and intellectual property assets, and any activity that is ancillary to any of these activities.

If the QFZP fails to meet any of the six conditions as mentioned above, then the QFZP shall cease to be recognised as such an entity from the beginning of the relevant tax period and for the subsequent four tax periods.

In a nutshell, except exempt entities, all juridical persons of the free zones should fulfill all related conditions to be classified as QFZP. They should identify their qualifying income and strategies to have the optimum impact of corporate tax.

Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official opinion of the Khaleej Times but a personal opinion of the writer. For any queries/clarifications, please write to the writer at mahar@kresscooper.com.

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