Khaleej Times, Wednesday, Jun 07, 2023 | Thul-Qidah 18, 1444
UAE: Is income of free zone businesses subject to zero per cent tax?
Emirates:
The UAE Corporate Tax law (UAE CT law) states that zero per cent corporate tax
(CT) is applicable on the qualifying income (QI) of the qualifying Free Zone
Person (QFZP), and the non-qualifying income (NQI) of the QFZP is subject to tax
at nine per cent.
To apply the CT properly on businesses registered in the free zones, it is
important to understand the terms free zone, free zone persons, QFZP and
qualifying income.
A free zone is a designated and defined geographic area within the UAE that is
specified in a decision issued by the Cabinet. The free zone person is a
juridical person incorporated, established, or otherwise registered in a free
zone, including a branch of a non-resident person registered in a free zone.
The term “qualifying free zone person” means a free zone person which (i)
maintains adequate substance in the UAE, (ii) derives qualifying income as
defined in the Cabinet Decision 55 of 2023 and Ministerial Decision 139 of 2023,
(ii) complies with prevailing transfer pricing rules and regulations, (iv) has
not elected to be subject to CT, (v) meet de minimis requirement for NQI and
(vi) prepare and main audited financial statements as required by Ministerial
Decision No. 114 of 2023.
The term “adequate substance” means the free zone juridical person must have
Core Income Generating Activities (CIGA) in the free zone, and have adequate
assets, employees and expenditures in the UAE as defined in the Economic
Substance Regulations (ESR) law.
The definition of the term qualifying income was pending which has been defined
in the Cabinet Decision 55 of 2023 and Ministerial Decision 139 of 2023
(collectively referred as “Decisions”). We can categorise that a QFZP can have
transactions with the same and other free zone persons and non-free zone persons
including the permanent establishment (PE) of the QFZP in the mainland of the
UAE and out of the UAE.
The decisions define that any income derived from transactions with the free
zone persons is qualifying income, except the income derived from the excluded
activities, and any income derived from transactions with non-free zones persons
is NQI except the income derived from qualifying activities which are not in the
excluded activities list.
There are special rules for the immoveable property in the decisions. If the
property is in the free zone and it is commercial property (being used
exclusively for business purposes and not used as a place of residence or
accommodation), then any income derived from transactions with the free zone
person related to this property is qualifying income.
The decisions further define that if the NQI is five per cent or Dh5million,
whichever is lower of the total revenue of the QFZP, it will be considered
qualifying income as well. While calculating this percentage of five per cent,
the numerator is NQI from (i) excluding activities from transactions with free
zone and non-free zone persons and (ii) non-qualifying activities where
transactions are with non-free zone persons. In the denominator, the total
revenue includes qualifying and non-qualifying revenue of QFZP. The revenue from
PE (domestic and foreign) of the QFZP and revenue from immoveable property shall
not be included in the non-qualifying revenue and total revenue. However, the
revenue from the free zone commercial property will be included in the total
revenue where the property is being used exclusively for business purposes and
transactions is with the other free zone person.
The “qualifying activities” conducted by QFZP includes the manufacturing
and/or processing of goods or materials, holding of shares and other
securities, ownership, management, and operation of ships. Services like
reinsurance, fund management, wealth and investment management and logistic
services are part of the qualifying activities. If headquarter services, and
treasury and financing services are being provided to related parties, it
will also fall under the qualifying activities. Financing and leasing of
aircraft, including engines and rotable components, and distribution of
goods or materials in or from a designated zone to a customer that resells
such goods or materials, or parts thereof or processes or alters such goods
or materials or parts thereof for the purposes of sale or resale. Any
ancillary activity related to these activities except the ancillary activity
of distribution of goods or materials in or from a designated zone, shall be
considered qualifying activities. Out of these activities, some activities
are subject to certain conditions.
The “excluded activities” with few exceptions and conditions includes the
activities with natural persons, banking activities, insurance activities,
financing and leasing activities, ownership, or exploitation of immovable
property (other than commercial property located in a free zone, where the
transaction in respect of such commercial property is conducted with other
free zone persons) and intellectual property assets, and any activity that
is ancillary to any of these activities.
If the QFZP fails to meet any of the six conditions as mentioned above, then
the QFZP shall cease to be recognised as such an entity from the beginning
of the relevant tax period and for the subsequent four tax periods.
In a nutshell, except exempt entities, all juridical persons of the free
zones should fulfill all related conditions to be classified as QFZP. They
should identify their qualifying income and strategies to have the optimum
impact of corporate tax.