In the ever-evolving landscape of global commerce, the UAE has emerged as a prominent hub for business and investment, propelled in large part by its robust network of free zones.
These designated economic zones offer a wealth of incentives and advantages for companies seeking to establish a presence in the region, ranging from streamlined business setup processes to strategic geographical positioning, access to world-class infrastructure, and more recently, the prospect of benefiting from a 0% tax rate.
Since the introduction of the corporate tax regime in the UAE, the pertinent question for many free zone entities is whether they could be considered a Qualifying Free Zone Person (QFZP) and be entitled to benefit from a 0% corporate tax rate on their “Qualifying Income.”
Following the provisions of the QFZP designation under the Corporate Tax Law, further clarifications were provided by the Ministry of Finance in November 2023, under Cabinet Decision No. 100 of 2023 and Ministerial Decision No. 265 of 2023 (together, the Free Zone Decisions).
The Free Zone Decisions clearly set out the scope of Qualifying Activities and the rules on deriving the Qualifying Income. Not all free zone entities are automatically eligible for QFZP treatment, and therefore, must carefully consider whether they satisfy these key conditions:
Adequate substance
A free zone person maintains adequate substance in the UAE if it undertakes its core income-generating activities in a free zone and, having regard to the level of activities carried out, has adequate assets, an adequate number of qualified employees and incurs an adequate amount of operating expenditure.
Despite the absence of specific guidelines from UAE authorities regarding the determination of adequate substance for QFZP status, an indicative measure lies in compliance with the economic substance requirements outlined in the UAE Economic Substance Regulations. Free zone entities should consider whether the significant functions that drive their business are located within the free zone, and assess their overall substance in light of this crucial condition.
Qualifying Income
The Free Zone Decisions outline the manner and means by which free zone entities can derive qualifying income, which encompasses several categories of income, subject to certain conditions. These include income from transactions with other free zone persons, other than excluded activities, as well as income from transactions with non-free zone entities pertaining to Qualifying Activities that are not excluded.
By scrutinising their revenue streams and activities against the outlined criteria, free zone entities can ascertain whether their income falls within the scope of Qualifying Income, thereby maximising their eligibility for the advantageous 0% tax rate.
De minimis requirements
Free zone entities can be varied in the nature and scope of their activities, and to account for any such discrepancies, the Free Zone Decisions additionally clarified the de minimis threshold. In order to satisfy the de minimis threshold, a free zone person’s non-qualifying revenue should not exceed Dh 5 million or 5% of the total revenues for the relevant financial year, whichever is lower.
However, meeting this threshold may pose challenges for companies with diverse revenue streams or complex operational structures, requiring careful monitoring and management of income sources to ensure compliance with the stipulated criteria.
In addition to the above, free zone entities must also ensure that they prepare audited financial statements, comply with the arms-length provisions and transfer pricing requirements under the Corporate Tax Law, and have not elected to be subject to corporate tax.
For entities believing they meet QFZP conditions, proactive measures are essential. Conducting a comprehensive review of current and future income sources, activities, and structure is advised, followed by seeking guidance from tax advisors or legal experts to navigate regulatory complexities. This is especially crucial given that disqualification from QFZP status may result in applicability of the 9% tax rate for at least five tax periods.
By taking proactive steps, free zone entities can confidently assert their eligibility for preferential tax treatment, positioning themselves for sustained success in the UAE’s dynamic business landscape.
