Introduction
In a move that has significant implications for businesses operating within UAE’s free zones, the implementation of the Corporate Tax Law through Federal Decree-Law No. 47 of 2022 issued on 1st June 2023 has ushered in a new era of taxation. This landmark legislation follows the global commitments that UAE has made to ensure tax transparency and enhanced regulatory oversight. Adhering to global standards enhances UAE’s reputation as a responsible global financial hub.
Taxation Rates and Applicability
Under Article 3 of the Corporate Tax Law, Qualifying Free Zone Persons (QFZPs) enjoy favourable tax rates: 0% on Qualifying Income and 9% on Taxable Income that does not meet the criteria for Qualifying Income. A Qualifying Free Zone Person is defined as one that adheres to specific conditions outlined in Article 18 of the Law. These conditions include the following:
a) Maintaining adequate substance in the State.
b) Derives Qualifying Income as specified in a decision issued by the Cabinet at the suggestion of the Minister.
c) Has not elected to be subject to Corporate Tax under Article 19 of this Decree-Law.
d) Complies with Articles 34 and 55 of this Decree-Law.
e) Meets any other conditions as may be prescribed by the Minister.
Ministerial Decision No. 139 of 2023 has prescribed the following additional conditions to be met by a QFZP:
a) Its non-qualifying revenue does not exceed the
De-minimis requirements set out in Article (4) of the Decision.
b) It prepares audited financial statements.
Maintaining adequate substance in the State
The emphasis on substance serves as a cornerstone for promoting transparency, fairness and adherence to international standards in taxation. Businesses are encouraged to establish substantial operations, tangible assets and a genuine economic presence within the state. By adhering to the FTA’s directives and maintaining adequate substance, companies contribute to a sustainable economy while minimizing the risk of inappropriate tax practices.
Based on the guidance provided in Cabinet Decision No. 55 of 2023, a QFZP shall undertake its core income-generating activities in a Free Zone and have adequate assets, an adequate number of qualified employees, and incur an adequate amount of operating expenditures, in relation to the activities carried out.
Qualifying Income
The Cabinet has issued Decision No. 55 of 2023 on determining Qualifying Income for the QFZP and the Ministry of Finance (MOF) has issued Decision No. 139 of 2023 regarding Qualifying Activities and Excluded Activities for the purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses.
The following constitute Qualifying Income of a QFZP:
• Income derived from transactions with another Free Zone Person (FZP), other than the excluded activities, where such Free Zone Person is the ultimate beneficiary of the goods or services.
• Income derived from Non-Free Zone Persons (NFZP), in respect of Qualifying Activities, that are not excluded activities.
• Non-qualifying revenue within the De-minimis limits i.e., if non-qualifying revenue is within 5% of total Revenue or AED 5 million, whichever is lower.
Additionally, the following income shall not be Qualifying Income:
• Income attributable to a Domestic Permanent Establishment or a Foreign Permanent Establishment.
• Income attributable to ownership or exploitation of Immovable Property, as follows:
o Transactions with NFZP, in case of commercial property
o Transactions with any Person, in terms of non – commercial property
Qualifying Activities as specified in Ministerial Decision No. 139 of 2023.
(a) Manufacturing of goods or materials.
(b) Processing of goods or materials.
(c) Holding of shares and other securities.
(d) Ownership, management, and operation of ships.
(e) Reinsurance services that are subject to the regulatory oversight of the competent authority in the State.
(f) Fund management services that are subject to the regulatory oversight of the competent authority in the State.
(g) Wealth and investment management services that are subject to the regulatory oversight of the competent authority in the State.
(h) Headquarter services to Related Parties.
(i) Treasury and financing services to Related Parties.
(j) Financing and leasing of Aircraft, including engines and rotable components.
(k) Distribution of goods or materials in or from a Designated Zone to a customer that resells such goods or materials, or parts thereof or processes or alters such goods, materials, or parts thereof for the purposes of sale or resale.
(l) Logistics services.
(m) Any activities that are ancillary to the activities listed in paragraphs (a) to (l) of this Clause.
Excluded Activities as specified in Ministerial Decision No. 139 of 2023
(a) Any transactions with natural persons, except transactions in relation to the Qualifying Activities specified under paragraphs (d), (f), (g) and (j) of Clause (1) of Article (2) of this Decision.
(b) Banking activities
(c) Insurance activities
(d) Finance and leasing activities
(e) 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 other Free Zone Persons.
(f) Ownership or exploitation of intellectual property assets.
(g) Any activities that are ancillary to the activities listed in paragraphs (a) to (f) of this Clause.
De Minimis Requirements as specified in Cabinet Decision No.55 of 2023
The De minimis requirements shall be considered satisfied where the non-qualifying Revenue derived by the QFZP in a Tax Period does not exceed 5% (five percent) of the total Revenue of the Qualifying Free Zone Person in that Tax Period or AED 5,000,000 (five million dirhams), whichever is lower.
Articles 34 and 55 of the Decree-Law
As per Article 34, in determining taxable income, transactions and arrangements between related parties must meet the Arm’s Length standard. Arms’ Length standard is a principle used in business and tax contexts, where transactions between related parties should be conducted as if they were unrelated and independent entities, ensuring fairness and market value without any special influence or bias. The Arms’ Length Price must be determined by applying one or a combination of the following transfer pricing methods: (a) The comparable uncontrolled price method (b) The resale price method (c) The cost-plus method (d) The transactional net margin method (e) The transactional profit split method.
As per Article 55, a taxable person is required to file together with their tax return a Disclosure Form containing information regarding the taxable person’s transactions and arrangements with its Related Parties and Connected Persons in the form prescribed by the authority. One must note that the definition of Related Parties and Connected Persons as per the Decree Law covers a wide range of relationships and is wider than the definition of Related Parties under IAS 24 – Related Party Disclosures. While Ministerial Decision No.97 of 2023 provides relief in maintaining Master File and Local File to certain Tax Payers (Tax Payers who are not constituents of a Multinational Enterprises Group and has Revenue less than AED 200 million), all Tax Payers are expected to maintain documentation required to prove that relevant transactions meet the Arm’s Length standard.
Digital Public Consultation
Further to the issuance of the Decree Law and implementing decisions relating to the application of Corporate Tax in the Free Zones, the MoF has indicated in the published FAQs that more details and guidance regarding the scope and meaning of each qualifying activity will be provided as required, by FTA in due course. In this regard, the MoF has issued the consultation paper seeking views on certain elements of the proposed framework for the classification of the qualifying activities and excluded activities set out under Ministerial Decision 139 of 2023. With a goal of obtaining valuable perspectives of all the stakeholders and accommodating the diverse business practices that are prevalent in the economy, the consultation was active from 19 July 2023 to 9 August 2023. On the basis of inputs and feedback received through this initiative, it is expected that additional guidance and clarity would be rendered with respect to the Free Zone tax regime.
Conclusion
In conclusion, the UAE’s Free Zone tax regime stands as a testament to the country’s commitment to fostering economic growth and attracting foreign investment. The incentivized tax rates offered to eligible Free Zone entities serve as a powerful incentive for businesses seeking to establish a presence in these strategic zones. However, moving forward, Free Zone companies must approach this opportunity with a clear understanding of the prescribed conditions outlined in the Decree Law.
A comprehensive evaluation of eligibility criteria before embarking on operations within a Free Zone is paramount. It is incumbent upon each Free Zone entity to ensure they meet these conditions to avoid any unforeseen implications. The repercussions of non-compliance, leading to the loss of QFZP Privilege for up to four subsequent Tax Periods, underscore the importance of adhering to the regulatory framework.
Furthermore, the guidance provided in the frequently asked questions (FAQs), specifically advising Free Zone companies to engage with their respective Free Zone authorities for confirmation of eligibility for the 0% corporate tax rate, offers a practical and proactive approach to compliance. Such collaboration between businesses and regulatory bodies will not only streamline the process but also enhance transparency and clarity.
As Free Zone entities set their sights on the future, it is imperative to recognize the symbiotic relationship between regulatory adherence and sustained success. By meticulously evaluating eligibility, maintaining open communication with Free Zone authorities, and embracing the advantages of the UAE’s Free Zone tax regime, businesses can position themselves for continued growth and prosperity within this dynamic economic landscape.