UAE: Impact of corporate tax on free zone entities

Generally all free zone entities will be taxed at nine per cent over and above profits of Dh375,000. However, if the free zone person is a qualifying free zone person earning qualifying income and is satisfying the conditions of De Minimis then the free zone person can claim the benefit of zero per cent corporate tax.

Conditions to be a qualifying free zone person: The free zone entity maintaining adequate substance; deriving qualifying income; not electing for normal rate of corporate tax; satisfying the de minimis requirements; maintaining audited financial statements and; complying with the transfer pricing rules will be considered as a qualifying free zone person.

Understanding the definition of adequate substance is of utmost importance. Cabinet decision No. 55/2023, Article 7 pens down adequate substance as having, core income generating activities ; adequate assets; adequate number of qualified employees and adequate operating expenditure in that free zone.

However, qualifying free zone person will lose the following benefits; the free zone entity cannot avail certain benefits which are extended to normal entities i.e. business restructuring relief; being a member of qualifying group; transfer of tax losses; and taking benefits of small business relief.

Qualifying free zone person earning qualifying income will be eligible for zero per cent corporate tax. ‘Qualifying income’ includes three categories of income according to Cabinet Decision No 55 of 2023, namely: a) income derived from transactions with a non-free zone person, but only in respect of qualifying activities that are not excluded activities; b) income derived from transactions with other free zone persons, provided these are not excluded activities (income will be considered as derived from transactions with a free zone person where that freezing person is the beneficial recipient of the relevant goods or services); and c) any other income, provided the qualifying free zone person satisfies the de minimis requirement.

Qualifying activities include: Manufacturing / processing of goods or materials; logistics services; holding of shares or securities; fund management, wealth management, investment management services subject to regulatory oversight; headquartered, treasury and financing services; ownership, management and operation of ships; distribution of goods/materials in or from a designated free zone for further sale / resale; financing or leasing of aircraft, and reinsurance services subject to regulatory oversight.

Excluded activities include: Banking activities; finance leasing activities except provided to related parties; insurance activities except reinsurance activities; certain transactions with natural persons; ownership or exploitation of intellectual property rights and; ownership or exploitation of immovable property other than commercial property located in free zones.

The hottest debate in the free zone business community was regarding distribution of goods or material being shipped directly from foreign country A to foreign country B from a designated free zone entity and the taxability of such transactions. However, as per the recent UAE Ministry of Finance Corporate Tax Consultation Paper, qualifying activities point 3.11 Article 2(1)(k), distribution of goods or materials illustration, it seems that the ministry has clarified that the transaction pertaining to goods being shipped directly from foreign country A to foreign country B from a designated free zone entity will be covered under the scope of qualifying activities and therefore, any income earned from such activity will also be considered as qualifying income and will be subject to zero per cent corporate tax rate.

It would be important to note that not all qualifying free zone person will get the benefit from distribution of goods / materials. Therefore, trading of goods / materials from non designated Free zones will be subject to 9 per cent corporate tax. However, only designated free zone persons will get the benefit of 0 per cent tax rate from distribution of goods / materials as clarified by the UAE Ministry of Finance Corporate Tax Consultation Paper.

Entities registered in free zones providing export of services (i.e. technology services, marketing services, consultancy services, etc) to non free zone entities will be subject to 9 per cent corporate tax.

Normally, free zone entities holding properties in UAE mainland will be subject to 9 per cent tax rate. The only exception is in regards to income from commercial properties held by qualifying free zone entities located in free zones, which will qualify for zero per cent tax rates.

Further, all qualifying free zone entities will have to apply for corporate tax registration and have to compulsorily get their books of accounts audited irrespective of applicable tax rates either zero per cent or nine per cent.

The writer is Partner - MI Capital Services.

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