UAE Corporate Tax: Checklist for Qualified Free Zone Persons

“Special Economic Zones” have become a global phenomenon because of their role as drivers of economic growth and facilitators of foreign direct investment.

In the UAE, free zones operate under a special decree. They offer advantages such as efficient infrastructure, 100% ownership, profit and capital repatriation, and tax exemption. Best of all is zero percent corporate tax.

That said, corporate tax exemptions are conditional – so knowing the do’s and don’ts is crucial.

Concessions to “Qualified Free Zone Persons”

A “qualified free zone person” includes a branch in a free zone operated by a non-resident that meets the following criteria:

Qualifying income under the QFZP is taxed at 0%, while non-qualifying income (including income from excluded activities) within the minimum threshold is taxed at 9%.

Interestingly, any income from a domestic permanent establishment (PE) (a place of business or other form of existence of a QFZP outside a free zone) and in some cases income from immovable property is taxed separately at the rate of 9%.

These two income streams are not considered in the de minimis calculation. The basic exemption threshold of AED 375,000 does not apply to QFZP taxable income.

If the minimum threshold is violated, the QFZP will lose tax holiday eligibility for five tax periods, including the failed year. It will pay 9% corporate tax like normal taxpayers.

While the decision of the UAE Cabinet clarifies most aspects related to free zone tax exemption regulations, some issues still need to be resolved for greater certainty.

The QFZP does not cover freelancers and individuals working under a permit issued by the Free Zone Authority (FZA). It is unclear whether “natural person” refers only to individuals or also to self-employed persons. Support service providers in the free zone, such as hotels, shopping centers, and training or education companies, may be affected when interacting with individuals.

Coverage of free zone extension border areas without decrees shall not be included in qualified free zones. The respective free zone authorities can provide guidance on whether a particular area or company within a free zone is eligible for corporate tax incentives.

Initially, it was not clear whether the “located in or from a designated area” requirement for qualifying activities should apply to where the dealer is located or where the goods are located. Also, there has been some concern over whether the 0% rate applies to the bill-to-ship model (goods don’t actually move in and out of the free zone).

Recently, the ministry clarified in a public awareness meeting that QFZPs involved in distribution activities (transfer of ownership of goods) would be considered as “entering and exiting” designated areas, even if the goods were not physically moved.

Therefore, it should also be considered a qualifying activity and the income would qualify for a 0% tax rate.

However, qualifying distribution activities do not specify the source of the purchase of the goods. It is unclear whether goods sold in or from designated regions can be sourced from mainland suppliers.

Moreover, trade activities in designated areas only cover sales to wholesalers or retailers, not to final consumers.

Clarification is needed as to which services are considered eligible activities under headquarters services. Services such as consultancy, consultancy, advertising, construction, event management and IT may not be included in qualifying activities under head office services, as directed by head office related activities under the Economic Substance Regulation (ESR).

For entities whose employees work outside the free zone, and for entities whose agents and directors negotiate and enter into contracts outside the free zone, PE risk needs to be assessed.

Activities can be outsourced within the free zone, subject to appropriate oversight of economic substance requirements. The option to forego the 0% tax benefit should be chosen carefully.

If a QFZP selects a 0% tax rate, that QFZP cannot be part of a tax group. When considering transactions with other free zone persons, the recipient must be the beneficial owner of those goods/services. (i.e. the recipient should have the right to use and enjoy these goods/services, not just transfer them to another party.)

To alleviate taxpayer uncertainty, it is essential to obtain additional clarification from the Federal Tax Agency (FTA). In order to give full play to the tax advantages, it is necessary to evaluate the overall business activities of QFZP.

It is worth noting that in addition to corporate tax incentives, free zones also offer VAT, customs and excise benefits. Each relevant law has its own unique conditions.

Therefore, it is essential to carry out a comprehensive compliance check covering all tax laws, free zone regulations and ESR.

Some multinational companies operating in UAE free zones may also be subject to higher corporate taxes under the OECD Pillar 2 proposal. The legislation awaits further analysis.