UAE Corporate Tax in a Free Zone – Does it Meet Business Expectations?
Patryk Karczewski, local partner at AMERELLER, examines the new corporate tax landscape in the UAE, detailing the intricate conditions businesses must meet to benefit from a 0% corporate tax rate in UAE Free Zones.
Introduction
The United Arab Emirates is known for its visionary public policies, safety, and focus on fostering the most attractive business environment. Until May 2023, it was also recognised as a corporate tax haven, even though for decades the UAE had imposed selective corporate tax on foreign banks and the oil and gas sector, governed by the local governments of the Emirates.
However, in June 2023 a corporate tax – at a very competitive rate of 9% – was introduced. Consequently, many businesses operating in the UAE need to learn how to navigate this more complex tax landscape and remain compliant and competitive.
One popular strategy has been to explore the UAE free zones’ corporate tax regime. According to Federal Decree-Law No 47 of 2022 on the Taxation of Corporations and Businesses, a “Qualifying Free Zone Person” can apply a 0% corporate tax rate to “Qualifying Income”. Qualifying Income is further clarified in two separate legal acts: Cabinet Decision No 55 of 2023 (“CD No 55 of 2023”); and Ministerial Decision No 139 of 2023 (“MD No 139 of 2023”). Based on an analysis of these legal acts, taking advantage of the 0% corporate tax rate may be more challenging than businesses initially anticipated.
Requirements for 0% Corporate Tax Rate
The UAE legislature allows certain categories of companies established or otherwise registered in UAE Free Zones (the Cabinet Decision listing Free Zones within the meaning of the UAE CT Law is not yet publicly available as of the publication of this article) to be recognised as Qualifying Free Zone Persons (QFZPs) when certain conditions are met, as outlined below:
- the taxpayer maintains adequate substance in the State*;
- the taxpayer derives the Qualifying Income as stipulated by the CD No 55 of 2023 and the MD No 139 of 2023**;
- the taxpayer has not elected to be subject to corporate tax at a standard rate of 9%;
- the taxpayer trades with Related Parties adhering to an arm’s length principle and maintains the transfer pricing documentation; and
- the taxpayer prepares audited financial statements.
- the taxpayer observes de minimis requirements***.
Failure to meet any of the above conditions will result in the forfeiture of QFZP status for the tax period during which the violation occurred and the following four periods. Only entities with QFZP status can apply the 0% corporate tax rate and only for Qualifying Income.
"A QFZP must factor in the investment required to maintain compliance with regulations."
Practical Aspects of Maintaining QFZP Status
While the prospect of partially benefiting from a 0% income tax rate may seem attractive, a QFZP must factor in the investment required to maintain compliance with regulations during the implementation phase.
Firstly, a QFZP needs to ensure that they have robust records containing the following information:
- revenue categorised by source and trading party:
- revenue from Qualifying Activities;
- revenue from Excluded Activities;
- revenue from transactions with other QZFP;
- revenue from mainland and foreign companies;
- revenue from the QFZP’s domestic permanent establishment or foreign permanent establishment;
- revenue from the immovable property located in the Free Zone (indicating if this is commercial or residential property and whether the customer is a QFZP or not).
- Expenditures, allocated to the categories specified above.
Secondly, a QFZP should ensure its contracts with Free Zone companies clearly state that the contracting party is a Beneficial Recipient**** to minimise the risk of income from such contract being treated as non-qualifying revenue and counted towards the de minimis limit.
Furthermore, a QFZP should ensure that the number of qualified personnel and assets maintained in the Free Zone is adequate considering the level of operations. Also, a QFZP has needs to incur a sufficient amount of operating expenditures in the Free Zone.
In addition, due to the potentially preferential corporate tax regime, there are certain reliefs or simplifications that are not accessible for entities with QFZP status:
- a QFZP cannot be a member of a Qualifying Group (that allows no gain/no loss treatment when it comes to the transfer of the assets between members);
- a QFZP cannot benefit from the Business Restructuring Relief (that allows no gain/no loss treatment when transferring the business or an independent part of the business);
- a QFZP cannot offset its tax losses with other taxpayers, even where the direct or indirect ownership in that other person exceeds 75%; and
- a QFZP cannot be a member of a Tax Group (enabling submission of one tax return).
As a result, one needs to carefully weigh up the pros and cons before applying for QFZP status.
Conclusions
The introduction of the special regime for free zone persons stems from long-standing agreements promising a tax-free regime for businesses located in a free zone. However, the practicalities of the current corporate tax regime may make it too costly for some businesses to meet the requirements for QFZP status. As a result, these businesses may be effectively pushed to become regular taxpayers, paying 9% corporate tax on their UAE-wide income.
However, if done correctly, obtaining QFZP status can result in significant savings for free zone businesses, which may significantly exceed the initial setup and compliance costs in the long run.
Consequently, businesses considering applying for QFZP status are encouraged to engage with professional advisers who can assist in navigating the application process and ensuring the status is secured. This way, companies can ensure that they are able to realise the full benefits of QFZP status and avoid the higher tax rates that apply to regular taxpayers.
*Even though the legislature used the word “State”, it is widely understood that it is intended to mean the Free Zone. Such interpretation is supported by Article 7 of the CD No 55 of 2023, which discusses the substance requirement regarding the Free Zone.
**The list of activities that fall within the definition of Qualifying Income can be found in Articles 2 and 3 of the MD No 139 of 2023, which should be read in conjunction with Article 3 of the CD No 55 of 2023.
***De minimis requirements are described in Article 4 of the MD No. 139 of 2023 and allow the QFZP to source revenue from Excluded Activities or non-Qualifying Activities (where the other party is not a Free Zone Person) up to 5% of the total revenue of AED 5M, whichever is lower.
****Per Article 3(3) of the CD No 55 of 2023, “the term ‘Beneficial Recipient’ shall mean a Person who has the right to use and enjoy the service or the Good and does not have a contractual or legal obligation to pass on such service or Good to another person and the term ‘Good’ shall mean tangible or intangible property that has economic value in dealing including moveable and immovable property.”
AMERELLER
