The UAE has long been known as a tax-free Country, attracting investors and entrepreneurs from around the world. However, to ensure sustainable economic growth and contribute to the country's development, the UAE has shifted from a tax-free government to a Corporate Tax system.
The Federal Decree-Law No. 47/2022 on the Taxation of Corporations and Businesses, effective on June 1, 2023, marks a significant change in the UAE's economic landscape.
This article aims to provide a comprehensive guide to proper corporate taxation in UAE Free Zone areas, specifically focusing on Corporate Tax and its impact on Free Zone Persons.
The Significance of Free Zones:
In recent years, free zone areas have gained prominence as strategic business locations due to the numerous incentives they offer to companies. These zones provide businesses with a range of benefits, including 100% foreign ownership, exemption from import and export duties, and a variety of tax advantages.
However, it is essential for companies operating in free zone areas to have a comprehensive understanding of the corporate tax regulations in place to ensure compliance and maximize the advantages available.
Defining Free Zone Persons:
The comprehensive Corporate Tax in UAE Free Zones is to differentiate between two fundamental categories of persons: Natural Persons and Juridical Persons. This distinction is essential to understanding the tax obligations and benefits applicable to entities operating within UAE Free Zones
- Natural Persons: Natural Persons include individuals who operate businesses independently, such as freelancers, sole establishments, and civil companies. even if these individuals conduct their businesses from a Free Zone, they are not recognized as Free Zone Persons under the UAE Corporate tax laws.
- Juridical Persons: Juridical Persons consist of corporate entities, including Limited Liability Companies. These entities can attain the status of Free Zone Persons if they are incorporated within a Free Zone.
Corporate Tax Rates for Free Zone Companies:
Corporate Tax rates for Free Zone Persons vary depending on their classification.
- Qualifying Free Zone Person (QFZP): A QFZP may be eligible for specific tax benefits, including a 0% tax rate on qualifying income.
- Non-Qualifying Free Zone Person (NQFZP): NQFZPs do not meet the specific conditions required to attain QFZP status, and consequently, they may not access the same tax benefits.
Qualifying Free Zone Person (QFZP) Criteria:
A QFZP must fulfil a set of specific conditions:
- Meet Adequate Substance in the UAE, involving main income-generating activities, sufficient assets, qualified employees, and mandatory operating expenses.
- Derive "Qualifying Income" as specified in Cabinet Decision No. 55 of 2023.
- Avoid opting for the 9% tax rate applicability.
- Comply with Arm's Length & Transfer Pricing Rules.
- Satisfy other specified conditions outlined in Cabinet Decision No. 139 of 2023.
Three Types of Business Activities for Free Zone Taxability:
Under UAE corporate tax regulations, business activities for Free Zone taxability can be categorized into three distinct groups:
- Qualifying Activities: These are specific activities explicitly mentioned in Cabinet Decision No. 139 of 2023. Businesses engaged in these activities may be entitled to tax benefits or exemptions.
- Excluded Activities: A list of activities outlined in the Cabinet Decision that may not qualify for the same tax benefits or exemptions as Qualifying Activities.
- Other Activities: Activities not explicitly mentioned in either the Qualifying or Excluded Activities lists have tax implications determined based on their nature and the relevant tax regulations.
Qualifying Income Categories:
Qualifying Income is categorized based on the nature of transactions and the parties involved:
- Transactions with Other Free Zone Persons: Qualifying Income includes income from all transactions except those derived from Excluded Activities.
- Transactions with Non-Free Zone Persons: Qualifying Income includes income from Qualifying Activities only. Excluded Activities do not qualify.
- Income From All Other Transactions: Qualifying Income may include other income, provided it meets de minimis requirements.
- Tax on Accountable Income to Establishments: Income attributable to Domestic Permanent Establishments or Foreign Permanent Establishments of Free Zone Persons is taxed at a rate of 9%.
Tax on Accountable Income to Immovable Property in Free Zones:
Income from immovable property in Free Zones is subject to variable tax rates based on property type and the parties involved:
- Income from commercial property, when dealing with Non-Free Zone Persons, is taxed at 9%, while dealing with Free Zone Persons is considered Qualifying Income and taxed at 0%.
- Income from non-commercial property is taxed at 9%, regardless of the parties involved.
The De Minimis Rule:
The De Minimis Rule sets the conditions that Qualifying Free Zone Persons (QFZPs) must meet regarding their Non-Qualifying Revenue. To attain Qualifying Free Zone Persons (QFZP) status, a company's Non-Qualifying Revenue should be less than the lower of 5% of their Total Revenue or AED 5 million, whichever is lower.
- Non-Qualifying Revenue includes income from Excluded Activities and activities not classified as Qualifying when dealing with Non-Free Zone Persons.
- Total Revenue encompasses all income generated by a Qualifying Free Zone Person during a specific tax period.
Exclusions from Non-Qualifying & Total Revenue:
Certain types of revenue are excluded from both Non-Qualifying and Total Revenue calculations, including:
- Revenue attributable to immovable property located in a Free Zone from specific transactions.
- Revenue attributable to a Domestic Permanent Establishment or a Foreign Permanent Establishment of the Qualifying Free Zone Person.
Understanding Corporate Taxation in UAE Free Zones is paramount for businesses and individuals aiming to maximize tax benefits while following regulations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.