UAE Corporate Tax Rules for Free Zone Persons

Companies established in the UAE Free Zones can enjoy a 0 percent corporate tax rate if they meet specific qualifying criteria for establishment and income. In this article, we outline the qualifying criteria.

By Arendse Huld

In December 2022, the UAE introduced new corporate tax (CT) rules under the Corporate Tax Law (CTL), marking a significant shift in its fiscal landscape. However, under the new rules, companies established in the UAE’s Free Zones can continue to benefit from a 0 percent CT rate, if they meet certain qualifying criteria for establishment and income.

This article provides a brief guide to the specific criteria and regulations that Free Zone Persons must meet to qualify for CT relaxations based on the Corporate Tax Guide from the UAE’s Federal Tax Authority.

Corporate tax rates for free zone persons in the UAE

CT rates for Qualifying Free Zone Person (QFZP) are as follows:

• 0 percent on Qualifying Income.
• b) 9 percent on Taxable Income that is not Qualifying Income.

As stated in the guide, the CT rules for Free Zones are intended to provide a 0 percent CT rate on Qualifying Income from:

• Transactions between QFZPs and Free Zone Persons (where the Free Zone Person is the Beneficial Recipient of these transactions); and
• Certain activities carried out within a Free Zone (or a Designated Zone for distribution activities).

Note that a QFZP is not eligible to benefit from the standard 0 percent CT rate that is applicable on income up to AED 375,000 (US$102,096) for companies based in the UAE mainland. Taxable income of QFZPs up to this threshold will still be subject to 9 percent CT.

What is a Free Zone Person and a QFZP?

A Free Zone Person is any company that has been incorporated, established, or otherwise registered in a Free Zone. This includes:

• A branch of a non-resident company registered in a Free Zone.
• A UAE company registered in a Free Zone.
• Relevant Free Zone authorities and other government-controlled entities established in a Free Zone.

Note that a Free Zone Person can have its head office in a Free Zone and have a branch outside the Free Zone, or have a head office on the UAE mainland (outside a Free Zone) or in another country and have a branch within a Free Zone.

If the company has its head office in the UAE mainland it would be generally be considered a Domestic Permanent Establishment. If it has its head office in a foreign country it would be considered a Foreign Permanent Establishment.

Meanwhile, to be considered a QFZP, a company (that is a Free Zone Person) must meet all of the following conditions:

1. Maintain adequate substance in the State.
2. Derive Qualifying Income.
3. Not have elected to be subject to CT as is permissible under the CTL.
4. Comply with the Arm’s Length Principle for Transfer Pricing and maintain Transfer Pricing documentation, as required under the CTL.
5. Meet any other conditions as may be prescribed by the Minister of Finance.

A QFZP that fails to meet any of the above conditions during a Tax Period will cease to be a QFZP from the beginning of that Tax Period.

What is a Beneficial Recipient?

A Free Zone Person is considered the Beneficial Recipient of services or goods if they have the right to use and enjoy these services or goods without any contractual or legal obligation to supply them to another person. To qualify as the Beneficial Recipient, the services or goods must be for the Free Zone Person’s use and not for their Foreign or Domestic Permanent Establishment.

Conversely, if the Free Zone Person is acting as a conduit or intermediary, such as an agent or nominee for a third party, then the Beneficial Recipient is the third party, not the conduit or intermediary.

What is adequate substance?

To maintain adequate substance in the State, a QFZP must:

1. Conduct core activities in specified zones: Carry out their core income-generating activities in either a Free Zone or a Designated Zone, as required.
2. Have adequate assets: Possess sufficient assets in the respective zone based on the level of activities performed.
3. Have qualified employees: Have an adequate number of qualified full-time employees working in the relevant zone.
4. Have adequate operating expenditures: Incur a sufficient amount of operating expenditures related to each activity.

Core income-generating activities are the significant functions that drive the business value for each activity conducted by a QFZP. These activities are not exclusively or mostly support activities and may vary according to the specific activity.

What is Qualifying Income?

Qualifying income refers to the following categories of income (as stipulated in Cabinet Decision No. 100 of 2023):

1. Income derived from transactions with a Free Zone Person, except for income derived from Excluded Activities.
2. Income derived from transactions related to Qualifying Activities with a Non-Free Zone Person.
3. Income derived from the ownership or exploitation of Qualifying Intellectual Property.
4. Any other income provided that the QFZP satisfies the de minimis requirements.

What are Qualifying Activities?

Qualifying Activities are any of the following activities conducted by a QFZP (as stipulated in Ministerial Decision No. 265 of 2023 UAE):

1. Manufacturing of goods or materials.
2. Processing of goods or materials.
3. Trading of Qualifying Commodities (metals, minerals, energy, and agriculture commodities that are traded on a recognized commodities exchange market in raw form).
4. Holding of shares and other securities for investment purposes.
5. Ownership, management, and operation of ships.
6. Reinsurance services.
7. Fund management services.
8. Wealth and investment management services.
9. Headquarter services to related parties.
10. Treasury and financing services to Related Parties.
11. Financing and leasing of aircraft.
12. Distribution of goods or materials in or from a Designated Zone.
13. Logistics services.
14. Any activities that are ancillary to the Qualifying Activities specified in items (a) to (m).

However, income derived in the following circumstances, even if it is derived from Qualifying Activities, is not Qualifying Income and will be considered Taxable Income:

• Income that is attributable to a Domestic Permanent Establishment or a Foreign Permanent Establishment.
• Income that is derived from the ownership or exploitation of immovable property (including transactions with a Non-Free Zone Person in respect of commercial property and transactions with any Person in respect of immovable property that is not commercial property).
• Income derived from the ownership or exploitation of intellectual property that is not Qualifying Intellectual Property and income in excess of Qualifying Income calculated.

What are the Excluded Activities?

The following activities are excluded and not considered qualifying income (as stipulated in Ministerial Decision No. 265 of 2023 UAE):

1. Any transactions with natural persons, except transactions in relation to items (e), (g), (h), and (k) of the Qualifying Activities.
2. Banking activities.
3. Insurance activities, except with regard to items (f) and (i) of the Qualifying Activities.
4. Finance and leasing activities, except with regard to items (e), (j), and (k) of the Qualifying Activities.
5. Ownership or exploitation of immovable property, other than Commercial Property located in a Free Zone where the transaction in respect of such Commercial Property is conducted with a Free Zone Person.
6. Any activities that are ancillary to the Excluded Activities specified above.

What is Qualifying Intellectual Property?

Qualifying Intellectual Property includes:

• Patents
• Copyrighted software
• Any right functionally equivalent to a patent that is legally protected and subject to a similar approval and registration process, such as:
  • Utility models
  • Intellectual property assets that grant protection to plants and genetic material
  • Orphan drug designations
  • Extensions of patent protection

Qualifying Intellectual Property does not include marketing-related intellectual property assets, such as trademarks.

What are the de minimis requirements?

According to Cabinet Decision No. 100 of 2023, the de minimis requirements for Qualifying Income are met if the non-qualifying revenue of a QFZP in a tax period does not exceed a specified percentage of their total revenue or a specified amount, whichever is lower, as determined by the Minister of Finance.

To meet the de minimis requirements, the Free Zone Person’s non-qualifying revenue must not exceed either one of the following thresholds, whichever is lower:

• AED 5 million (US$1.36 million); or
• 5 percent of its total revenue.

Non-qualifying revenue includes income from excluded activities, activities that are not qualifying when the other party is a non-free zone person, and transactions with a free zone person who is not the beneficial recipient of the services or goods. Total revenue includes all income earned by the QFZP in a tax period. However, revenue from specific transactions related to immovable property in a free zone, revenue attributable to domestic or foreign permanent establishments, and revenue from intellectual property ownership or exploitation (with certain exceptions) are excluded from the calculation of non-qualifying and total revenue.

For these purposes, a QFZP and its domestic or foreign permanent establishment are treated as separate, independent, and related parties.

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