Federal Decree Law No. (47) of 2022, as amended by Federal Decree Law No. (60) of 2023 (“Corporate Tax Law”), entered into effect on 1 June 2023, significantly altering the tax landscape for businesses in the United Arab Emirates (UAE). Consequently, all businesses in the UAE, including those based in UAE free zones, need to register for corporate tax with the Federal Tax Authority.
The eagerly awaited Free Zone Persons Corporate Tax Guide, issued by the Federal Tax Authority in May 2024 (“Guidelines”), consolidates and clarifies several corporate tax regulations relevant to free zone companies providing a comprehensive reference to the corporate tax rules applicable to free zone persons.
Under the Corporate Tax Law, two main tax rates apply:
(i) a rate of 0% levied on the Qualifying Income (as further defined below) of a qualifying free zone person (“QFZP”) as well to the taxable income of non-qualifying free zone persons and mainland companies with income less than AED 375,000; and
(ii) a rate of 9% levied on the non-qualifying income of QFZP as well to the taxable income of non-qualifying free zone persons and mainland companies exceeding AED 375,000.
This article explores the conditions under which a free zone company or branch (Free Zone Person) can achieve the status of a QFZP and benefit from the 0% corporate tax rate.
Requirements to be considered a QFZP
To be considered a QFZP, the Free Zone Person must meet several requirements as set out in the Corporate Tax Law and relevant implementing decisions, including the Guidelines. Such requirements are further elaborated below.
i. Definition of a Free Zone Person
A Free Zone Person is a juridical person (who may not be an individual) incorporated, established or registered in one of the free zones in the UAE, including a branch of a foreign company, or a branch of a UAE (mainland) company. Free zones are established under a special decree passed by the Ruler of the Emirate in which the free zone is created or pursuant to federal law in the case of financial free zones.
ii. Adequate Substance
The Free Zone Person must maintain adequate substance in the free zone. This entails having sufficient assets and full-time employees in the free zone and incurring adequate capital expenditure to perform its core income-generating activities. It is worth noting that the Guidelines provide that a Free Zone Person may outsource its core income-generating activities to other persons based in the free zone, provided it maintains adequate supervision of such outsourced activities.
When assessing whether a Free Zone Person meets the adequate substance requirement, the nature and activities of the Free Zone Person, along with other relevant factors, will be considered. For instance, the adequate substance expected from businesses engaged in manufacturing will differ from those applicable to a holding company.
iii. Qualifying Income
The Free Zone Person must derive income from one or more of the following sources: (“Qualifying Income”):
b) qualifying intellectual property[3] (subject to meeting the R&D expenditure and income nexus requirements);
c) transactions with other Free Zone Persons who are the beneficial recipients of the underlying goods or services, even if such transactions do not relate to Qualified Activities, provided that they are not Excluded Activities or relate to an immovable property located outside the free zone or non-commercial property located in a free zone; and
d) other income that does not fall within the scope of any of the foregoing provided that the Free Zone Person must satisfy the de minimis requirement (as further explained below).
iv. The Free Zone Person Must Not Elect the Standard Corporate Tax Rules and Rates
The Free Zone Person should not elect to be subject to the standard corporate tax rules, which impose a 0% rate on taxable income up to AED 375,000 and a 9% rate on taxable income exceeding AED 375,000.
v. Arm’s Length Principle and Transfer Pricing
The Free Zone Person must abide by the arm’s length principle in its transactions with its related parties. This means the Free Zone Person must use internationally accepted profit attribution methods such as the separate entity approach in respect of these transactions. Additionally, the Free Zone Person must comply with transfer pricing requirements in its related party transactions and maintain the required documentation regarding these transactions.
vi. Audited Financial Statements
The Free Zone Person must maintain audited financial statements regardless of the amount of revenue achieved according to accepted accounting standards in the UAE including IFRS.
vii. De Minimis Requirement
The Free Zone Person will have met the de minimis requirement if its non-qualifying income does not exceed the lower of 5% of its total revenues in the tax period, or AED 5,000,000. If the Free Zone Person does not meet the de minimis requirement, it loses its status as QFZP.
[1] Qualifying activities are as follows: manufacturing of goods or materials; processing of goods or materials; trading of qualifying commodities; holding of shares and other securities for investment purposes; ownership, management and operation of ships; reinsurance services; fund management services; wealth and investment management services; headquarter services to related parties; treasury and financing services to related parties; financing and leasing of aircrafts; distribution of goods or materials in or from a designated zone; logistics services; and any activities that are ancillary to such qualifying activities (Article 2 (1) of Ministerial Decision No. (265) of 2023) (collectively “Qualifying Activities”).
[2] Excluded Activities are as follows: any transactions with natural persons (except in relation to ownership, management and operation of ships, fund management services, wealth and investment management services, and financing and leasing of aircrafts); banking activities; insurance activities (except reinsurance activities and headquarter services to related parties); and finance and leasing activities (except ownership, management and operation of ships, treasury and financing services to related parties, and financing and leasing of aircrafts); ownership or exploitation of immovable property (except if it’s a commercial property in a freezone and the transaction is with a freezone person); and any activities that are ancillary to such excluded activities (Article 2 (2) of Ministerial Decision No. (265) of 2023) (collectively “Excluded Activities”).
[3] The Corporate Tax Guide defines qualifying intellectual property as “Patents, Copyrighted Software and any right functionally equivalent to a Patent that is both legally protected and subject to a similar approval and registration process to a Patent, such as utility models, intellectual property assets that grant protection to plants and genetic material, orphan drug designations, and extensions of Patent protection, but not including any marketing related intellectual property assets, such as trademarks.”
Elhassan Abdelrazek
Partner
NHB LEGAL