On June 1, the UAE took a landmark decision to introduce corporate tax operations operating in the country. The move is an important step in the UAE’s efforts to diversify its sources of government revenue as it seeks to move away from a hydrocarbon-based economy.
Free zones are a key component of the UAE’s economic diversification efforts, and specific provisions of the law refer to them separately. Khaleej Times interviewed Dr. Nabeel Ahmed, Partner at DVS Management Consulting and Siddharth Kohli, Founder and CEO of Indigenesis Consulting, to gain a clear understanding of what the free zones need to do to comply with the UAE’s corporate tax rules. Excerpt from the interview:
The legislation governing taxation of companies and businesses throughout the UAE is Federal Decree No. 47 of 2022 on Taxation of Companies and Businesses (“CT Law”). Chapter 5 – Article 18 of the Law deals specifically with Qualified Free Zone Persons (QFZPs) where, if all the conditions mentioned therein are fulfilled, the taxable rate of the QFZP will be zero. Cabinet Decision No. 55 of 2023 on Determination of Qualifying Income for Qualified Free Zone Persons under the CT Act, and Ministerial Decision No. 55. CT Law No. 139 of 2023 on Qualifying Activities and Excluded Activities seeks to provide a comprehensive picture of the taxability of Free Zone companies.
Companies operating in a free zone can benefit from zero taxation on income from carrying out “qualifying activities”. They will be referred to as Qualified Free Zone Persons (“QFZPs”) if they maintain sufficient substance in the free zone, do not specifically elect to pay taxes, comply with transfer pricing regulations and meet the minimum requirements (described below). All free zone companies are required to register for corporate taxation and file corporate tax returns.
Cabinet’s decision on qualifying income is the most anticipated decision after the CT Act comes into force. Eligible income under Ministerial Decision No. 1 139 Of 2023 is defined as income from transactions with other free zone persons and non-free zone persons, whether domestic or foreign, excluding excluded activities.
Eligible activities are referred to in Cabinet Decision No. 55 of 2023, which lists 13 eligible activities carried out by the QFZP. Qualifying activities include: manufacturing and processing of goods or materials, holding of shares and other securities, ownership, management and operation of ships, reinsurance and fund management services, wealth and investment management services, head office services for related parties, treasury and financing Services provision of aircraft financing and leasing to related parties, distribution of goods or materials in or from designated territories to customers who resell such goods or materials, logistics services and finally any activity related to the listed activities.
Excluded activities include any transactions with natural persons, banking activities, insurance activities, financing and leasing activities, ownership or exploitation of immovable property, except commercial property located in a free zone where such commercial property is traded with other free property of. Territory Personnel, Ownership or Exploitation of Intellectual Property Assets.
In short, a free zone company does not pay any tax on income derived from carrying out qualifying activities. QI has now been defined to include:
(i) income from transactions with other free zone persons, other than income from “excluded activities”; (ii) income from transactions with non-free zone persons, but only from “qualifying activities”; (iii) ) QFZP Any other income (described below) that meets the minimum requirements. Eligible activities include shipbuilding, ownership and management, fund administration services, etc.
A full and specific list of eligible activities and excluded activities can be found in Ministerial Decision No. 12. No. 139 of 2023 on Qualified Activities and Excluded Activities and Cabinet Decision No. 139 of 2023 No. 55 on Qualified Income.
The tax-exempt status of a QFZP will be affected if the income is attributable to a domestic permanent establishment (“DPE”) or a foreign permanent establishment (“FPE”). Therefore, this means that the income attributable to the mainland branch will still be taxed at 9%. However, this will not disqualify the QFZP from benefiting from the zero CT rate on qualifying income, nor will it be subject to the de minimis test. A QFZP is entitled to zero corporate tax rate when the taxable income is derived from a free zone and qualifying income. QFZPs will be required to maintain separate accounts, one for the QFZP and another for the mainland, to record transactions.
The de minimis allows for zero-rated taxation of “non-qualifying” income, including income from “excluded activities” and activities with non-free zone persons (other than “qualifying activities”), provided that the qualifying income generated by the QFZP is within Taxes for a tax period do not exceed 5% of the QFZP’s gross income for that tax period or AED 5 million, whichever is lower.
Failure to comply with the conditions mentioned in the CT and Cabinet decisions will trigger a corporate income tax of 9% for at least five years.
When UAE Free Zone companies conduct transactions with the mainland, they must ensure that the transactions fall within the list of “eligible activities” defined by the Cabinet and not the list of excluded activities. Failure to meet these requirements will result in the loss of free zone status for that year and the following four years. Income from domestic permanent establishments or foreign permanent establishments of eligible free zone persons and income from property located in the respective free zone are not subject to the minimum requirement as such income is subject to the standard UAE corporate tax regime.
One of the conditions that a free zone person must meet in order to qualify for the QFZP is compliance with the arm’s length principle and transfer pricing (TP) documentation. I wouldn’t say areas of uncertainty, but areas of concern for businesses center on assessing their current structure and transfer pricing policies to ensure they don’t lose out on benefits. After the introduction of the CT Law, many businesses had to conduct impact assessments on existing corporate structures in free zones due to limitations in taking advantage of group tax relief and taxation of transactions with mainland entities.
The taxability of service income derived by free zone companies from exports may be unclear and requires clarification from the authorities. Such as AED 375,000 income threshold, AED 5 million minimum calculation limit, AED 12 million interest cap threshold and AED 3 million eligibility for small business relief if established or liquidated within the stipulated time Thresholds such as thresholds may need to be prorated. Year. To address these complexities, seeking clarification from the relevant authorities is critical to accurately interpreting and implementing tax regulations.
In order to maintain a zero tax rate, QFZPs are required to prepare and maintain audited financial statements. Internal restructuring to ensure tax compliance can be achieved through the establishment of new departments or expansion of existing account departments, with appropriate breakdown/allocation of expenses incurred in earning qualifying and other income. The QFZP is also required to review transactions/arrangements with related parties or associated persons, as compliance with the arm’s length principle and transfer pricing (TP) documentation is a mandatory requirement of the CT Act. Complying with the above steps will ensure that the QFZP can adequately ensure tax transparency and reduce the compliance burden.
Free zone companies in the UAE should update and integrate their accounting systems to facilitate accurate reporting and identification of qualifying and non-qualifying income. This requires tuning systems, allocating resources, conducting thorough testing and providing comprehensive training to employees. These measures ensure a seamless transition and successful implementation of necessary changes. A number of companies are actively developing software solutions that not only ensure compliance, but also improve the transparency and accuracy of UAE free zone reporting.
The CT Law will come into force on June 1, 2023, so accurate accounting and auditing mechanisms are an integral requirement for free zone businesses. The CT announced in early 2022 should be viewed as an opportunity to examine the legal, financial, governance and risk aspects of the business, as these have a causal impact on management decisions and financial results. All structural, contracting, business and employment areas should be reviewed and updated to take into account the new tax laws. Additionally, deal flow and financial matters, governance and policies should be revisited to ensure tax readiness.
Among other things, following the advent of corporate tax, the first aspect of all activities carried out by free zone entities should be compliance with transfer pricing regulations, i.e. the determination of the basis of transactions with related parties at arm’s length prices. Any substantive adjustments in operations must be reviewed against the general anti-abuse provisions of the corporate tax regime. However, the least a free zone entity can do is analyze its sources of income, review legal structures, assess transaction structures and, with the help of tax advisors, ensure compliance requirements and necessary documentation.
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