Corporate Tax and Free Zone Taxation in the UAE

The UAE's Corporate Tax rules further enhance these advantages by enabling Free Zone companies and branches that meet certain conditions to benefit from a 0% Corporate Tax rate on specific Qualifying Activities and transactions. This blog explores the various aspects of Corporate Tax and Free Zone Taxation in the UAE, focusing on the conditions and benefits for businesses operating within these special economic areas. 

Free Zones in the UAE are designed to attract foreign investment by offering a range of incentives. Businesses in these zones enjoy benefits such as: 

• Relaxed foreign ownership restrictions, allowing 100% foreign ownership. 

• Streamlined administrative procedures that make it easier to set up and operate a business. 

• Modern and sophisticated infrastructure to support various business activities. 

• Developed business communities that provide networking opportunities and support. 

• Additional legal entity forms and a wider range of commercial activities are available for businesses. 

These benefits make Free Zones an attractive option for companies looking to establish a presence in the UAE. 

The UAE Corporate Tax rules provide significant tax benefits for Free Zone companies and branches that meet certain conditions. These rules aim to offer a 0% Corporate Tax rate on qualifying income from specific activities and transactions. Generally, the Corporate Tax rules for Free Zones are intended to provide a 0% Corporate Tax rate on qualifying income from: 

1. Qualifying Free Zone Person (QFZP) Transactions: Transactions between Free Zone Persons where the Free Zone Persons are the beneficial recipients. 

2. Activities Within Free Zones or Designated Zones (DZ): Certain activities performed within the prescribed geographical areas of a Free Zone or a Designated Zone(for distribution activities). 

To benefit from the 0% Corporate Tax rate, a Free Zone Person (QFZP) must meet several conditions: 

1. Definition of a Free Zone Person 

A Free Zone Person is defined as a juridical person incorporated, established, or otherwise registered in a Free Zone, including a branch of a non-resident person or a UAE juridical person registered in a Free Zone. Under any of these scenarios, the Corporate Tax rate of 0% applies only to the qualifying income of its Free Zone business. 

Consider the scenario below  of Free Zones and its’  

Under any of the above scenarios, Corporate Tax rate of 0% applies only on qualifying income of it’s Free Zone Business only.   

2. Adequate Substance in a Free Zone 

The Free Zone Person must maintain adequate substance within the Free Zone, including having sufficient assets, full-time employees, and incurring adequate operating expenditures to perform its core income-generating activities. A Free Zone Person may outsource its core income-generating activities to other entities located within the Free Zone, provided it maintains adequate supervision. 

3. Qualifying Income Sources 

The Free Zone Person must derive qualifying income from one or more of the following sources: 

• Transactions with Other Free Zone Persons: Provided the Free Zone Persons are the beneficial recipients of these transactions, and the transactions are not excluded activities. 

• Qualifying Activities: Activities not excluded from the qualifying activities criteria. 

• Ownership or Exploitation of Qualifying Intellectual Property: Income derived from intellectual property that meets qualifying conditions. 

• Other Income: If the QFZP meets the de-minimis requirements. 

Certain sources of income will not qualify and will be subject to a 9% tax rate unless exempted under other provisions of corporate tax laws. These include income from foreign permanent establishments, domestic permanent establishments, and immovable property (other than commercial property located in a Free Zone with transactions involving a Free Zone Person) and Income from ownership or exploitation of intellectual property (Other than Qualifying Income from Qualifying Intellectual Property) 

4. Election for Standard Corporate Tax 

The Free Zone Person must not have elected to be subject to the standard corporate tax rules and rates. 

5. Arm's Length Principle 

The Free Zone parent must earn and record operating profits or losses at arm’s length, determined in accordance with internationally accepted profit attribution methods such as the separate entity approach, considering the functions performed, assets used, and risks assumed through the Free Zone parent and through its foreign or domestic permanent establishments. 

6. Transfer Pricing Documentation 

The Free Zone Person must maintain documentation to demonstrate the arm’s length nature of relevant transactions, including a master file, local file, and disclosure form, if the relevant Transfer Pricing compliance thresholds are met. 

7. Audited Financial Statements 

The Free Zone Person must maintain audited financial statements, regardless of the revenue earned. 

8. De Minimis Requirement 

The de minimis requirements are met if the Free Zone Person’s non-qualifying revenue does not exceed the lower of: 

• AED 5,000,000 

• 5% of its total revenue 

The Free Zone Person’s non-qualifying revenue in a tax period is revenue derived from: 

• Excluded Activities: Activities that do not meet the qualifying criteria. 

• Activities with Non-Free Zone Persons: Transactions where the other party is not a Free Zone Person. 

• Non-Beneficial Transactions: Transactions with a Free Zone Person where the Free Zone Person is not the beneficial recipient of the relevant services or goods. 

If a Free Zone Person meets all the conditions mentioned above, it will be taxable as follows: 

• 0% Tax on Qualifying Income: Income derived from qualifying activities will be subject to a 0% tax rate. 

• 9% Tax on Non-Qualifying Income: Income that is not considered qualifying will be taxed at a 9% rate. 

A QFZP is not eligible for the 0% standard Corporate Tax rate applicable on taxable income - the AED 375,000 threshold. It is subject to 9% on non-qualifying income without the benefit of small business relief, qualifying group relief, business restructuring relief, transfer of tax losses, or the tax group regime. 

A Free Zone Person that does not earn any qualifying income in a tax period because it has not started to derive revenue will not be disqualified from being a QFZP, provided it does not derive any non-qualifying revenue and complies with all other requirements prescribed by the Corporate Tax Law. 

The selection to not be treated as a QFZP can be made at any time during the relevant tax period and after the end of such tax period in the related tax return. The election cannot be made after the due date for filing the relevant tax return has lapsed. Additionally, the election can be made effective from either: 

• The commencement of the tax period in which the election is made, or 

• The tax period commencing after the tax period in which the election was made. 

If a QFZP fails to meet the criteria for a tax period, it will cease to be a QFZP from the beginning of that tax period and for the four subsequent tax periods. 

The UAE’s Corporate Tax rules for Free Zones offer significant incentives for businesses to establish and operate within these special economic areas. By providing a 0% Corporate Tax rate on qualifying income, the UAE aims to attract and retain businesses, promote economic growth, and enhance its position as a leading global business destination. 

Understanding and complying with the conditions for being a Qualifying Free Zone Person is essential for businesses to maximize these tax benefits. With proper planning and adherence to the regulatory requirements, Free Zone companies can significantly reduce their tax burden and reinvest the savings into their growth and expansion initiatives.