UAE Company Formation: A Guide To The 9% Corporate Tax And 0% Free Zone Rate

I. Introduction

In the world of international trade, when the "United Arab Emirates" is mentioned, what primarily comes to mind are modern skyscrapers, dynamic trade volume, and the promise of "zero tax."

This "tax haven" reputation has successfully attracted entrepreneurs globally, with Dubai, in particular, emerging as a premier destination for UAE company formation. However, in light of today's shifting economic dynamics, it is crucial to re-evaluate whether this perfect theoretical scenario remains fully intact.

With the introduction of a new 9% UAE Corporate Tax in 2023 has fundamentally altered this landscape. A critical question now arises: Is the "tax-free" era over for UAE? For those who plan incorrectly, the answer could be yes. The 0% corporate tax rate still exists, but it is no longer automatic. It is now contingent on a complex set of new rules.

II. UAE Company Formation & Corporate Tax: Mainland and Free Zone Companies

The widespread perception that "there is no corporate tax in the UAE" has undergone a significant change with the new Corporate Tax Law that came into effect in 2023. The current tax structure has taken on a more complex nature compared to the past. In this new structure, critical details such as the tax implications of choosing between Mainland and Free Zone companies, the status of Value Added Tax (VAT), and the scope of Corporate tax liability have become prominent.

In this context, the primary company types available in the United Arab Emirates (UAE) will be examined. While foreign investors historically encountered structures like the Free Zone company, the Mainland company, and the International Business Company (IBC), the IBC structure has largely lost its operational prevalence. Therefore, the primary decision for potential investors now centers on the strategic choice between a Free Zone and a Mainland company.

2.1 Key Differences Between Mainland and Free Zone Companies: A Strategic Comparison for UAE Company Formation

When establishing a presence in the UAE, the structural choice between Mainland and Free Zone companies carries distinct and fundamental differences. These differences may prove crucial when planning a UAE company formation.

Mainland companies are standard structures registered directly with the Department of Economic Development (DED), providing full access to the UAE's "local" market. The biggest advantage of this structure is the flexibility to conduct business directly with any customer (individual or corporate) within the UAE, participate in government tenders, and establish a physical presence anywhere in the UAE (such as a shop in a mall or an office on the street). From a tax perspective, Mainland companies are subject to a 9% Corporate Tax, but only on the portion of their annual net profit that exceeds 375.000 AED. Profits below this threshold remain fully exempt.

In contrast, Free Zone companies are established within one of over 40 designated special economic zones (such as IFZA, JAFZA, or DIFC) designed to promote international trade. The fundamental distinction is market access: Free Zone companies are generally restricted from transacting directly with the UAE mainland market (e.g., selling directly to a local consumer). Their activities are typically confined to their specific free zone or international markets. To access the mainland, they must usually engage a local distributor or agent.

2.2 The 'Qualifying Free Zone Person' (QFZP) Status

Achieving "Qualifying Free Zone Person" (QFZP) status is the primary mechanism through which a Free Zone company can access a 0% Corporate Tax rate. However, this status is not automatic and is contingent upon meeting several strict conditions.

Accordingly, the Company must conduct its main income-generating activities within the Free Zone, possess adequate assets, qualified personnel, and operating expenditures appropriate for the scope of these activities, and the income derived must be "qualifying income." The company operating in the Free Zone must prepare financial statements in accordance with International Financial Reporting Standards (IFRS). In addition to these conditions, furthermore, if the company earns any income from "non-qualifying" activities, this income must not exceed 5% of its total revenue.

2.3. Corporate Tax Rates: The 0% vs. 9% Framework

Under the Corporate Tax Law, Corporate Tax is applied at a rate of nine percent (9%) on the taxable income of the taxable company. However, the first 375.000 AED portion of the income is tax-exempt.

If the relevant taxpayer is a Qualifying Free Zone Person (QFZP), their qualifying income will be exempt from corporate tax. Non-qualifying income will remain subject to tax at a rate of nine percent (9%), subject to the applicability of other exemptions or deductions.

III. Accessing the 0% Corporate Tax Rate: Qualifying vs. Excluded Activities

Free Zone companies, despite all the restrictions mentioned above, offer significant advantages in terms of corporate tax. Indeed, provided certain conditions are met, the income of Free Zone companies can be held exempt from corporate tax.

As stated above, it is possible for a company established in a Free Zone to benefit from the 0% Corporate Tax advantage if it earns "Qualifying Income." The conditions required for a company's income to be considered qualifying income are listed in UAE Cabinet Decision No. 55/2023.

According to Cabinet Decision No. 55/2023, "qualifying income" covers the below explained income categories:

• Income derived from transactions with companies outside the free zone within the scope of qualifying activities (however, this income must not be from income excluded from the tax exemption scope)
• Income from transactions with other Free Zone companies (provided it is not 'excluded income')

3.1 Defining "Qualifying Activities"

Cabinet Decision No. 139/2023 specifies the activities eligible for the 0% rate. These include:

1. Manufacturing of goods or materials
2. Processing of goods or materials
3. Holding of shares and other securities
4. Ownership, management, and operation of ships
5. Reinsurance services (supervised by a competent authority)
6. Fund management services (subject to supervision)
7. Wealth and investment management services (subject to supervision)
8. Headquarter services to related parties
9. Treasury and financing services to related parties
10. Financing and leasing of aircraft (including engines and parts)
11. Distribution of goods or materials in or from a designated zone
12. Logistics services
13. Ancillary activities related to the above.

Crucially, income from transactions with mainland or overseas entities is only eligible for the 0% rate if it stems from one of these specific activities. In contrast, income from transactions with other Free Zone companies can often benefit from the 0% rate even if the activity is not on this list (provided it is not "Excluded").

The Decision also stipulates that if a Free Zone company establishes a "Permanent Establishment" (PE) on the UAE mainland, the income attributable to that PE is taxed at 9%.

3.2 "Excluded Activities" Ineligible for 0% Corporate Tax

The law explicitly carves out certain "Excluded Activities." These are ineligible for the 0% corporate tax exemption and will incur a 9% Corporate Tax liability, even if conducted by a Free Zone entity:

1. Income from transactions with natural persons (exceptions apply for specific qualifying activities like wealth management).
2. Banking activities
3. Insurance activities (excluding reinsurance)
4. Finance and leasing activities
5. Income from real estate transactions (other than commercial property within the Free Zone)
6. Income from the ownership or exploitation of intellectual property rights
7. Any ancillary activities to those listed above.

This framework underscores the importance of precise planning. To benefit from the 0% corporate tax regime, the company's intended activities must be clearly defined and perfectly aligned with the qualifying criteria before formation.

IV. Navigating Value Added Tax (VAT)

Separate from Corporate Tax, any entity operating in the UAE must also navigate Value Added Tax (VAT). Introduced on January 1, 2018, at a standard rate of 5%, VAT operates on a different set of principles. Therefore, any UAE company formation investment decision should also consider potential VAT applications.

The obligation for a business to become a VAT payer (taxable person) is tied to specific turnover thresholds. If the total value of a business's taxable supplies and imports exceeds the mandatory registration threshold of 375.000 AED, it must register for VAT. Additionally, a voluntary registration option is available. If the business's taxable supplies and imports remain below the mandatory threshold but exceed the voluntary registration threshold of 187,500 AED, it may register voluntarily. This voluntary registration opportunity is designed specifically to allow newly established (start-up) businesses, which may not yet have turnover but whose expenses exceed this threshold, to join the system.

The basic logic of VAT is based on offsetting. If the VAT a business collects from its customers (output tax) is greater than the VAT it pays to its suppliers (input tax), it is obligated to pay the difference to the government. In the opposite case, meaning the paid VAT (input tax) is greater than the collected VAT (output tax), the business has the right to reclaim (refund) this excess amount from the government.

The application of VAT in the real estate sector shows significant differences depending on the nature of the property. The sale or lease of commercial properties is subject to the standard 5% VAT rate. On the other hand, residential properties are generally exempt from VAT. However, to enable entrepreneurs operating in the real estate sector to recover the VAT on residential construction costs, the first sale of newly constructed residential properties (within three years of their completion) is subject to "zero-rated" (0%) VAT.

Furthermore, it is seen that VAT exemptions are applied to some sales and transactions in the UAE. The law has applied this advantageous tax regime to specific economically and socially important areas. The most prominent item in this scope is the export of goods and services outside the GCC (Gulf Cooperation Council) region. As another element supporting exports, international transportation and related supply services are also zero-rated. Transportation and investment vehicles are also in this category; the supply of certain sea, air, and land transportation vehicles, such as aircraft and ships, and the supply of investment-grade precious metals like gold and silver with 99% purity are subject to 0% VAT.

Areas where social benefit is prioritized form the basis of this list. As mentioned earlier, the first sale of newly constructed residential properties within three years of their completion is zero-rated. In addition, basic education and healthcare services (and the supply of goods and services directly related to these services) are also supported by applying 0% VAT.

V. Strategic Assessment: Making the Right Choice

The decision to establish a company in the UAE carries significant long-term implications, and the investors choice of structure will be the single most decisive factor in determining the tax liabilities.

For any UAE company formation decision, the target market is the primary determinant. If a business model targets end-consumers (B2C) or other companies on the UAE mainland, a Mainland company is often the necessary choice. This brings with it the 9% Corporate Tax on profits over 375.000 AED.

Conversely, if the model is focused on international clients (outside the UAE) or B2B transactions with otherFree Zoneentities, the Free Zone structure offers a clear path to tax optimization.

However, the 0% Corporate Tax rate for Free Zones is not an automatic entitlement. It is strictly contingent on business operations meeting the "Qualifying Activities" criteria and avoiding the "Excluded Activities" list. A miscalculation here could result in a 9% tax liability, even within a Free Zone.

Finally, VAT liability operates independently. The 375.000 AED registration threshold is based on total taxable turnover (not profit) and applies to both Mainland and Free Zone companies. Even if all of the revenue is zero-rated (e.g., 100% exports), one must still register if they cross the turnover threshold.

VI. Why the UAE Remains a Premier Business Hub

Despite the new Corporate Tax, the UAE's strategic advantages remain exceptionally strong. The new regime provides clarity and international compliance while retaining powerful incentives:

0% Withholding Tax: The UAE does not levy any withholding tax on dividend distributions paid to your parent company in Turkey or to you as an individual shareholder.

Double Taxation Avoidance Agreement (DTAA): The DTAA between Turkey and the UAE prevents income taxed in the UAE from being taxed a second time in Turkey, providing a robust legal framework.

No Personal Income Tax: This remains the cornerstone of the UAE's appeal. There is no personal income tax on salaries or dividends received by an individual.

Navigating this complex interplay of Free Zone regulations, Corporate Tax laws, and VAT requirements demands detailed risk analysis and strategic planning. The complexities of establishing a secure and tax-efficient structure make professional legal and tax advisory not just recommended, but essential for success.

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.