In January 2022, The UAE announced a new Federal Corporate Tax applicable to business profits for financial years starting on 1 June 2023. This was a significant shift in the UAE’s tax landscape, especially affecting businesses operating within the nation’s Free Zone Regime.
The UAE Free Zone corporate tax regime gives a system of economic zones that offer favorable conditions for doing business in and outside the UAE. It gives many benefits, including 100% foreign ownership, simplified administrative procedures, and tax incentives.
There were some key elements that were left undefined in the Federal Degree-Law No. 47 of 2022. The Criteria for a Free Zone Person to Qualify as a Qualifying Free Zone Person (QFZP), and a status enabling access to the FZ’s embedded 0% corporate tax rate.
Of the five conditions, two were critical to achieving QFZP status, the requirement to derive “Qualifying income” and the requirement to maintain adequate substance. However, the definition of both these terms under the UAE corporate tax law was ambiguous requiring clarification by the UAE Ministry of Finance (MoF).
To address these critical aspects, the UAE Ministry of Finance issued two landmark decisions no 1 June 2023. Cabinet Decision no. 55 of 2023 on determining qualifying and ministerial decision no. 139 of 2023 about qualifying Activities and excluded activities. These decisions give essential guidance for businesses operating in one of the more than 40 multidisciplinary UAE Free Zones. We discuss those elements in detail further below.
Determining Qualifying Income For Free Zone (FZ) Persons
Cabinet Decision no 55 of 2023 is the definition of ‘qualifying income.’ This term defines two key areas, transactions with Free Zone persons and transactions with non-Freezone persons. To fully understand the nuances of this cabinet decision, it is important to comprehend a few key terms.
The term ‘Beneficial Recipient’ denotes the individual or entity that is the actual recipient of the income. On the other hand, the term ‘Good’ in the context of this cabinet decision refers, amongst others, to any commodity or tangible product that is involved in transactions within any of the UAE Freezones.
Qualifying Income by a QFZP includes the following:
- Income derived from transactions with other Free Zone Persons, except for income derived from Excluded Activities.
- Income derived from transactions with Non-Free Zone persons, only in respect of qualifying activities and not excluded activities.
- Any other income provided that the QFZP satisfies the so-called ‘De Minimis Requirements.’
From the above flowchart, the starting point is understanding the source of income earned by a QFZP, which can arise from the following categories:
- Income from Non-FreeZone Person
- Income from FreeZone Person
- Income from Real Estate
- Income from Permanent Establishment
- Now, we will discuss each category to guide you on whether the source of income will ultimately be subject to 9% or 0%.
Non-Freezone Person
Transactions with Non-FreeZone persons refer to income generated from dealings with entities incorporated or not registered within UAE Free Zone. The particular consideration and conditions for such transactions need to be evaluated thoroughly.
There is a need to make a distinction between Excluded Activities, Qualifying Activities, and Non-Qualifying Activities, the latter term is not defined.
If the source of income increased from the Qualifying Activity of a Free Zone Person, the income will be considered as Qualifying income and is subject to 0%.
If the source of income arises from an Excluded Activity of a Free Zone person, the income will be considered Taxable income and is subject to 9%.
If the source of income increases from a Non-Qualifying Activity of a Free Zone Person, the income will be considered as ‘Taxable Income’ and is subject to 9%, which is also subject to the ‘De Minimis Requirement’ rule.
Qualifying Activity
As per Ministerial Decision No. 139 of 2023, Qualifying Activities include a good range of businesses activities and services given to entities located outside of a UAE free zone, including:
- Manufacturing materials or goods
- Processing of materials or goods
- Holding of shares or other securities
- Reinsurance services
- Management, ownership, and operation of ships
- Fund management services subject to UAE regulatory oversight
- Headquarters services to related parties
- Leasing and financing of aircraft, including engines and rotatable components
- Financing and treasury services to related parties
- Distribution in or from a Designed Zone that meets relevant conditions
- Logistics services
- Any activities ancillary to the above activities
Excluded Activities
Excluded activities are those that are not considered Qualifying Activities and therefore, cannot benefit from a 0% tax rate, including:
- Insurance activities subject to UAE regulatory oversight.
- Banking activities subject to UAE regulatory oversight.
- Leasing and Finance activities subject to UAE regulatory oversight.
- Exploitation and ownership of intellectual property assets.
- Exploitation and ownership of immovable property.
- Any transactions with a natural person, except certain transactions in relation to Qualifying Activities.
De Minimis Requirements are fulfilled where Non-Qualifying Revenue derived by a QFZP are:
- Max 5% of total revenue earned in a tax period by the QFZP
- Max AED 5 million of revenue earned in a period by the QFZP
Conclusion
The UAE Cabinet and Ministry of Finance recently issued a number of decisions that provide much-needed clarity on the corporate tax (CT) regime for businesses operating in free zones (FZs). These decisions define qualifying income, qualifying activities, and excluded activities, and set out the requirements for maintaining adequate substance in a free zone.
The new free zone corporate tax regime is designed to be simple and competitive. It is expected to attract new businesses to the UAE and boost economic growth. We have discussed the decision ambiguities for the UAE residents to know in detail. ebs is one of the best accounting and bookkeeping firms in the UAE. We have helped many businesses to grow and stay compliant with their tax regulations.
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