What Is ‘Qualifying Income’ In The UAE Free Zone?

Now is the time to engage in Free Zone business tax compliance upgrades as UAE corporate tax kicks in. 

The new corporate tax regime in the UAE has now begun (June 1) with some clarifications still being issued by the UAE Ministry of Finance. An oft asked question as businesses look to minimise the taxable part of their income is related to ‘qualifying income’ and what free zone (FZ) based businesses in the UAE can expect under the new corporate tax rules.  

In fact, the UAE Ministry of Finance issued guidelines on May 31, which as was widely anticipated, indicates that these businesses will have 0 per cent corporate tax applied on ‘all activities’ related to transactions with other FZ entities, regardless of whether this involves renting commercial property, professional services, distribution and other activities.

Clarifications

When the UAE announced its corporate tax plans, FZ based businesses came under the 0 per cent tax regime. But for those based externally from FZ operations, the tax includes the same activities.

For UAE FZ based investors, this means that they can freely transact with other FZ based enterprises within the UAE. For the thousands of companies registered and based in free zones, the latest announcements are of vital importance.

In one such clarification, the Ministry says that ‘to keep the free zone corporate tax regime simple and easy to comply with, there is no requirement to determine or verify whether the other free zone person is a ‘qualifying’ entity.

What Is ‘Qualifying Income’?

According to the Ministry, this now includes:

• Income derived from transactions with other FZ Persons, except for income from ‘excluded activities”;
• Income derived from transactions with any person – domestic and foreign – in the case of “qualifying activities’, except for income from excluded activities.

However, there is also the ‘de-minimis’ clause to consider. Under this, and instances where a qualifying FZ entity earns a small or incidental amount of non-qualifying income – without triggering corporate tax liabilities, such income (known as the ‘de-minimis’ threshold) must not exceed either Dh5 million (US$1.36 million) or 5 per cent of total revenues. Exceeding either of these thresholds triggers corporate tax (9%).

What Are ‘Qualifying Activities’ For FZ Businesses?

The FZ corporate tax coverage applies only to income derived from activities ‘performed exclusively in or from within such an entity. This is defined within the ‘qualifying income’ category, which includes income derived from transactions with other FZ persons as well as domestic and foreign sourced income from conducting any of the ‘qualifying activities’. These include:

Manufacturing of goods or materials;

Processing of goods or materials;

Holding of shares and other securities;

Ownership, management, and operation of ships;

Reinsurance services;

Fund management services that are subject to the regulatory oversight of the competent authority in the UAE;

Wealth and investment management services that are subject to the regulatory oversight of the competent authority in the UAE.

Headquarter services to related parties;

Treasury and financing services to related parties;

Financing and leasing of aircraft,

Logistics services;

Distribution in or from a designated zone that meets the relevant conditions; and any activities that are ancillary to the above-mentioned activities.

What Are ‘Excluded Activities’?

Income from certain specific ‘excluded activities’ will not be treated as ‘qualifying income’ regardless of whether the income is derived from a free zone entity or as part of undertaking a ‘qualifying activity’. This includes:

Income derived from transactions with individuals;

Income derived from certain regulated financial services activities;

Income derived from intangible assets;

Income derived from immovable property, other than transactions with FZ enterprises in relation to commercial immovable property located in a free zone.

Earning income from ‘excluded activities’ or earning any other income that is not ‘qualifying income’ will disqualify the FZ person from the regime.

Bookkeeping & Accounting Compliance

For businesses based in UAE FZ, it is important to note that the internal accounting needs to be exact and booked correctly. (Professional advise may be sought). For example, revenue attributable to a domestic or foreign permanent establishment of the FZ business, and revenues attributable to immovable property in a FZ that does not benefit from the FZ corporate tax regime will not count towards the de-minimis threshold. Instead, the associated taxable income will be subject to the regular UAE corporate tax at 9%.

Where the de-minimis requirements are not met or the FZ entity does not continue to meet any of the other qualifying conditions, the business will no longer be able to benefit from the 0% free zone corporate tax regime for a minimum period of five years. During this period, the business will be treated as an ‘ordinary taxable person’ and subject to tax at 9% on taxable income above Dh375,000 (US$102,000).

For this reason, we strongly advise FZ based businesses to either employ internal and qualified bookkeeping staff to maintain the company accounts in a compliant manner, or outsource this to a reputable firm. If not in compliance, the unpaid tax penalties and fines can be considerable. This is a management issue and local directors and shareholders should pay attention. Compliance is required.

Non-compliance can be expensive and it is now time to upgrade your business internal structure in this area, including the use of appropriate accounting software and training staff. Please contact Dezan Shira & Associates at dubai@dezshira.com for assistance.

Related Reading

• Updates on the UAE’s New 9% Corporate Income Tax Charges and Applicability
• An Introduction to Doing Business in Dubai 2023

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