New regulations regarding corporate tax in the United Arab Emirates (UAE) stipulate that qualifying income (QI) generated by qualifying Free Zone Persons (QFZPs) is subject to zero percent corporate tax, while non-qualifying income (NQI) is taxed at a rate of nine percent. The implementation of these tax laws is set to take effect soon, requiring businesses registered in free zones to carefully navigate the conditions and definitions outlined in the legislation.
To better understand the implications of corporate tax on free zone businesses, it is important to comprehend key terms such as “free zone,” “free zone persons,” “QFZPs,” and “qualifying income.” Free zones are designated geographic areas within the UAE, as specified by Cabinet decisions. Free zone persons include legal entities incorporated, established, or registered in a free zone, including branches of non-resident entities operating within free zones.
A “qualifying free zone person” refers to a free zone entity that meets several criteria: maintaining sufficient substance within the UAE, deriving qualifying income as defined in Cabinet Decision 55 of 2023 and Ministerial Decision 139 of 2023, complying with transfer pricing rules, not electing to be subject to corporate tax, meeting de minimis requirements for NQI, and preparing audited financial statements in accordance with Ministerial Decision No. 114 of 2023.
The term “adequate substance” entails the presence of Core Income Generating Activities (CIGA) within the free zone, along with adequate assets, employees, and expenditures in the UAE, as defined by the Economic Substance Regulations (ESR) law.
The definition of “qualifying income” was pending and has now been defined in Cabinet Decision 55 of 2023 and Ministerial Decision 139 of 2023. It can be categorized that a QFZP can engage in transactions with other free zone persons, non-free zone persons, and even the permanent establishment (PE) of the QFZP within the UAE mainland or abroad.
According to the decisions, income derived from transactions with free zone persons is generally considered qualifying income, except for income derived from excluded activities. Conversely, income derived from transactions with non-free zone persons is classified as NQI, with the exception of income derived from qualifying activities that are not part of the excluded activities list.
Specific rules apply to immovable property within free zones. If the property is commercial and used exclusively for business purposes (not as a place of residence or accommodation), any income derived from transactions related to this property with free zone persons is deemed qualifying income.
The decisions also state that if the NQI amounts to five percent or AED 5 million (whichever is lower) of the QFZP’s total revenue, it will be considered qualifying income as well. When calculating this percentage, the numerator comprises NQI from excluded activities with both free zone and non-free zone persons. The denominator includes total revenue, encompassing both qualifying and non-qualifying revenue. Revenue from the QFZP’s PEs (domestic and foreign) and revenue from immovable property are excluded from the non-qualifying revenue and total revenue calculations. However, revenue from free zone commercial property is included in the total revenue if it is exclusively used for business purposes and transactions are conducted with other free zone persons.
Qualifying activities for QFZPs encompass manufacturing and/or processing of goods or materials, holding of shares and securities, ship ownership and operation, and services such as reinsurance, fund management, wealth and investment management, and logistics. Additional qualifying activities include headquarter services, treasury and financing services provided to related parties, financing and leasing of
aircraft, and distribution of goods or materials within or from designated zones. Ancillary activities related to these qualifying activities (excluding the ancillary distribution of goods or materials) are also considered qualifying activities, subject to certain conditions.
Excluded activities, with a few exceptions and conditions, include transactions involving natural persons, banking activities, insurance activities, financing and leasing activities, ownership or exploitation of immovable property (excluding commercial property in free zones when transacting with other free zone persons), and intellectual property assets. Any activity ancillary to these excluded activities is also excluded.
Failure to fulfill any of the six conditions mentioned above results in the QFZP losing its recognition as such for the relevant tax period and the subsequent four tax periods.
In summary, all juridical persons operating within UAE free zones, except for exempt entities, must meet the necessary conditions to be classified as QFZPs. These businesses must identify their qualifying income and develop strategies to optimize their corporate tax impact.
