Obtaining 0% Tax Liability In UAE Processing and Distribution

The UAE’s corporate tax public consultation for free zones (PCD) has provided several insights and the possible direction of the tax regime these hubs would come under. However, the interpretation of the new tax rules among the government and professional finance and tax community still has gaps in the common understanding. Two impacted areas are in processing and distribution. We discuss the implications.

Clarifying Processing and Distribution

Income from the distribution of goods is eligible for the preferential 0 per cent tax rate (subject to conditions) only if the distribution is in or from a designated zone. However, income from processing of goods is eligible for 0 per cent tax rate if the business is based in a UAE free zone.

This includes the preparation, treatment, transformation or conversion of goods into another form for further commercial use or sale. International jurisprudence has common principles that the UAE is likely to follow in order to decide what activities amount to the processing of goods.

There are challenging examples. Will the roasting of coffee beans and sales amount to processing, or distribution? Does the packing of readymade jackets and trousers into an individual suit change the form of the goods? Does a scrap dealer dismantling old goods into components, or simply crushing them into multiple pieces, undertake processing or distribution?

Does packing of goods change its form and thereby result in a processing? Are companies that program debit/credit cards (with chips) before selling them, processing those goods?

The expression ‘preparation’ has therefore created a variety of interpretations as to how this procedure alone could change the goods into another form. For free zone businesses contemplating to classify their distribution activities as processing, the wider tax ramifications should be evaluated first before finalising their tax position.

Clarifying Processing and Manufacturing

Income from qualifying activities – eligible for preferential 0 per cent tax rate includes income from manufacturing of goods and from processing of goods. The PCD proposes to categorise such activities into:

Manufacturing of own goods, and;

Manufacturing for and on behalf of another person.

In the first case, the income of the manufacturer has to be split into manufacturing and sales profits. We have previously discussed how manufacturers in free zones – other than those in designated zones – could find themselves in tax confusion.  To revisit this, the manufacturing

profit will be at 0 per cent tax rate for all free zone based manufacturers. However, sales profits – equated to ‘distribution activity’ – will qualify for 0 per cent tax rate only if the manufacturer is in a designated zone. Practical challenges in such splitting of profits adds to the complexity. The processing of goods can also be carried out:

Of own goods and;

For and on behalf of another person.

However, UAE Free zone businesses need to wait for further rulings if the concept of ‘sales profit’ could be extended to income from processing of own goods and the potential tax impact on their operations.

HQ Services to Related Parties

Income from your corporate Headquarters services to related parties is also eligible for 0 per cent tax rate.

The public consultation proposes that headquarters services include the administering, overseeing and managing of business activities of related parties, including provision of senior and general management, captive insurance services, administrative services, business planning and development, risk management, coordination of group activities, procurement and in general incurring expenditures (such as trademarks and patent usage) on behalf of related parties and providing other support services to related parties.

Varied interpretations have resulted in companies planning to shift their senior management and head offices into free zones even if it is outside the designated zone. By attributing a portion of the overall corporate profits to such headquarters services, businesses are looking at saving sizeable tax outflows.

However, a careful reading of the public consultation may divulge a different interpretation. It could mean for example that providing ‘HQ services’ requires that all the activities listed should be provided as a single package, and that one or more activities provided individually would not qualify for 0 per cent tax rate. Additionally, shifting the place of management without any commercial or fiscal justifications could also expose companies to anti-abuse provisions.

These questions are still awaiting clarification and guidance by the UAE tax authorities. (For regular updates subscribe to Middle East Briefing here. It is free, with users receiving our regular weekly bulletin of these and related issues.

Meanwhile, if the Economic Substance Regulations (ESR) could be used as a guidance, additional requirements would apply. Through the provision of headquarters services, a free zone company should take on the responsibility for the overall success of the group or is responsible for an important aspect of the overall group’s performance.

Future Guidance

Businesses should also wait for the additional guidance/legislation on the free zone taxation resulting from the pubic consultation process. Ask the right questions to keep your business on the correct trajectory, or contact dubai@dezshira.com for assistance and clarifications. Our firm has 30 plus years of experience in assisting foreign investors into the Asia region.

Related Reading

• Understanding The UAE Free Trade Zone Vs. UAE Mainland Establishment Investment Structure Options
• Foreign Investors In the UAE: Non-Compliance Tax Rules – Compliance and Non-Compliance Penalties

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