Navigating the realities of distributors and traders in free zones

The establishment of Free Zones in the UAE was a strategic move aimed at strengthening UAE’s global market presence and enticing foreign investments. However, there persists a common misconception surrounding Free Zones, particularly regarding the free zone being free from taxes. Contrary to popular belief, not all Free Zones are entirely exempt from taxation, specifically Corporate Tax (CT). The CT legislation has explicitly outlined that Free Zones are subject to taxation unless they meet specific criteria stipulated in the law.

Moreover, the zero per cent tax rate, often associated with Free Zones, is available only when an entity derives income from a transaction with another free zone person provided the service recipient is the beneficial recipient of the service.

Another stream of income which can avail the benefit of zero per cent regime, is income derived in respect of list of activities which qualify for beneficial regime, subject to few other conditions i.e. the qualifying activities, except when revenue are derived from certain activities specifically excluded from the beneficial regime i.e. excluded activities.

Indulging into discussion about distributors, the key condition for availing the beneficial tax rate of zero per cent, for a distributor is to hold title to the products. Thereby, distinguishing a distributor from a sales agent who doesn’t hold title to the products and therefore, are not eligible to avail the beneficial tax rate of zero per cent.

The recent guide issued by Federal Tax Authority (‘FTA’) dedicated to free zones has addressed numerous ambiguous territories to provide definitive clarity. One of such instances is including definition of the term ‘goods’. While goods are defined as tangible and physical items, it has been clarified that distribution of intangible products and services such as licenses, software and financial products/ services will not be covered under distribution activity. However, the guide has further clarified that if the software is embedded onto a hardware, income for which is not separately identifiable, they can still qualify for Distribution activity.

Another area of clarification involves the taxation of 'High Sea Sales' within designated zones. The guide has clarified that the requirement of foreign goods to be imported through the designated zone only applies to the distribution of foreign goods to customers in the UAE which means that the activity of ‘High Sea Sales’ conducted by a designated free zone person would be a qualifying activity and any income derived from such activity would be considered as a qualifying income i.e. zero per cent tax rate. Let’s say, Company A is performing activity of distribution of goods, from a designated zone, purchases goods from Country-X and sells it directly to a retailer in Country-Y after adding a markup, then even if the goods do not enter a designated zone in UAE, it will still be considered as a qualifying activity.

The writer is Partner — MICS.