The implementation of corporate tax in the UAE signifies a transition from a tax-free region to a jurisdiction that imposes taxes. With the commencement of UAE corporate tax on June 1st, 2023, it is essential for businesses to assess their readiness to adapt to this new tax system. Companies operating within UAE free zones are particularly concerned about the upcoming corporate tax, as they have been benefiting from various tax incentives.
To assist free zone companies in evaluating the potential impact of corporate tax on their operations, corporate tax consultants in Dubai can provide valuable support. However, it is crucial for free zone businesses to comprehend the significant challenges and advantages that lie ahead as the UAE business landscape enters a new era of taxation.
To address the primary corporate tax concerns of free zone companies, we have compiled a list of Frequently Asked Questions (FAQs). It is recommended that entities wait for the release of the UAE Corporate Tax Law by the government before making any tax-related decisions.
1.Is the income of a Free Zone company exempt from UAE Corporate Tax (CT)?
Only income generated from “Qualifying activities” by a Free Zone person (Qualifying Free Zone person) is exempt from UAE CT.
2.What qualifies as “Qualifying income”?
Income earned from the 13 activities listed under Article 2 of Ministerial Decision 139 of 2023 is considered “Qualifying Activities.”
3. Are there any other conditions for a free zone person to become a Qualifying Free Zone company?
Apart from meeting the conditions set out in Cabinet Decision No. 55 and Ministerial Decision No. 139, a Qualifying Free Zone company must:
- Maintain adequate substance.
- Comply with Arm’s length principle and transfer pricing documentation.
- Not elect to be subject to corporate tax voluntarily.
- Ensure non-qualifying revenue does not exceed the De Minimis limit.
- Prepare audited financial statements. Refer to Article 18(1) of the Decree law and Article 5(1) of Ministerial Decision 139 of 2023.
4. What happens if any of the required conditions are not met during a tax period?
The Qualifying Free Zone person will cease to be a Qualifying Free Zone person from the beginning of the relevant tax period and for the subsequent 4 tax periods.
5.What distinguishes a Designated Zone from a Free Zone in terms of taxation?
A Designated Zone, such as JAFZA or DAFZA, falls under the category of Free Zones. However, not all Free Zones are Designated Zones. Examples of Free Zones that are not Designated Zones include DMCC, IFZA, and DSO.
6. What happens if a Free Zone engages in activities other than Qualifying Activities?
Activities not listed as Qualifying Activities are categorized as excluded activities or non-qualifying activities. Income from such activities is subject to the “De minimis” requirements, which means the income should be lower than 5% of the total revenue or AED 5 million to maintain the status of a Qualifying Free Zone person. Refer to Article 4 for more details.
7.Are excluded activities and non-qualifying activities the same?
Excluded activities are listed under Article 3 of Ministerial Decision 139 and are part of non-qualifying income. Non-qualifying activities refer to activities where the other party involved in the transaction is a Non-qualifying Free Zone person. For example, distribution of goods is a qualifying activity, but if it is done with a Non-qualifying Free Zone person, it becomes a non-qualifying activity.
8.Does a Free Zone company engaged in trading business receive exemption from UAE CT?
To qualify for exemption, the trading activity must involve the distribution of goods or materials that are undertaken “IN” or “From” a Designated Zone, and the goods or materials entering the “State” must be imported through the Designated Zone. Consequently, only the following trading activities are considered qualified:
Goods sold to a Designated Zone (DZ) person
Goods imported by a mainland person
Goods exported from the Designated Zone (DZ)
9. Does a Free Zone company engaged in high sea sales have its revenue exempted from CT?
No, only trading activities conducted “IN” and “FROM” a Designated Zone are exempt from CT. Refer to Article 2(1)(k) and Article 2(3) of Ministerial Decision 139.
10.Is the income of a Service company exempt from CT?
According to Article 3(1)(a) of the Cabinet Decision, income derived “from a free zone person” falls under exempted activities. Services provided to a free zone person by a free zone person will be exempt, provided that income from services provided to a Non-free zone person falls under the De-minimis limit mentioned in Question 3.
11. Is income derived from services provided to a person outside the UAE exempt from CT?
No, as per Article 3(1)(a) of the Cabinet Decision, only income derived “from a free zone person” falls under exempted activities. Services provided to a foreign person will be subject to UAE CT.
12. What about income from real estate?
Income from commercial property derived by a free zone person, used exclusively for business purposes, from a free zone person is exempt from CT. Other types of income from real estate are taxable. Residential properties and hotels within the free zone are not exempted.
13. Is income from a branch of a free zone company in the mainland exempt?
No, income from a branch in the mainland is not exempt. A place of presence of a qualified free zone person outside the free zone is treated as a Domestic Permanent Establishment, subject to the provisions of Article 14 of the Decree law. Income attributable to a Domestic Permanent Establishment shall not be included in qualifying income, subject to the De Minimis limit explained in Question 3.
14. What if the free zone person is a branch of a mainland or foreign company?
The free zone entity is treated as a juridical person for UAE CT purposes. Therefore, it will be eligible for exemption on “Qualifying income” earned by the branch, subject to the De Minimis limit under Article 4 of the Cabinet Decision.
15. What is the meaning of maintaining “Adequate substance”?
A Qualifying Free Zone Person must carry out its core income-generating activities in a Free Zone and have sufficient assets, qualified employees, and operating expenditures based on the level of activities. Activities can be outsourced to a related party or third party in a Free Zone, provided there is adequate supervision of the outsourced activity. Refer to Article 7 of Cabinet Decision 55 of 2023.