Distribution of Goods or Materials as a Qualifying Activity

Distribution activities are recognized as a qualifying activity under the corporate tax UAE regulations. The latest guidelines on Corporate Tax in UAE Free Zones elaborate on qualifying activities, including distribution. Many global organizations are attracted to UAE free zones, especially designated zones offering significant privileges, including zero percent corporate tax. With the implementation of corporate tax in the UAE, businesses are keen to leverage tax advantages, particularly the zero percent tax rate on qualifying activities such as the distribution of goods.

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Prominence of Trading and Distribution Companies

Trading and distribution companies are particularly prominent in the UAE’s free zones, including designated zones. According to the Ministerial Decision No. 265 of 2023, it is mandatory for businesses to understand the distribution of materials or goods from a designated area. This decision directly impacts their activities, especially in trading.

Interpretation and Challenges

Observations of several free zone companies reveal that many believe the distribution activities eligible for the preferential tax rate are limited to transactions with resellers. Consequently, companies involved in B2B sales, such as selling capital equipment to infrastructure firms or spare parts to vehicle leasing companies, might not benefit from the zero percent tax rate. This interpretation raises important questions about the strictness of this definition, particularly in the absence of clear regulatory guidance.

Qualifying Distribution Activities Under UAE Tax Law

Ministerial Decision 265/2023 outlines activities eligible for the zero percent tax regime. These activities include:

• Production of a product or articles in or from a specific area for import or export.
• Export processing of goods or materials from or via a specified zone.
• Export trade for goods stored in a designated area for sale, use, or processing outside the UAE.
• Possessing and storing goods in a specified area for sale within the UAE.
• Transit activities in a specified area.
• Depreciation of fixed assets and holding shares and other securities in companies in a designated zone.
• Ship owning, management, and operation in a specified area.
• Reinsurance services obtained from a specific area.
• Fund management services from a specified center.
• Business support services, including wealth and investment services from an approved area.
• Headquarter services for related parties in the zone.
• Treasury and financing services for related parties in a specified zone.
• Transportation of products or substances across or to/from a certain region.

Read More : Guide to Qualifying Income in UAE Free Zones

Key Aspects of  Qualifying Distribution Activity Under Corporate Tax UAE

• Ownership: A distributor needs to take title of the products in distribution, which implies that he acquires ownership of the products and has to take the inventory on his balance sheet; he sells the products and is at risk if the products do not sell.
• Scope of Activities: It involves acquiring, marketing, and supplying; holding, stocking, and order; moving in and out, and conveying; and exporting and shipping of products or substances.
• Geographical Consideration: Distribution activities have to take place in or from a Designated Zone.

Exclusions from Distribution

Distribution excludes intangible goods and services, licenses, software, and financial goods and services. However, goods that contain an item that is software or firmware are considered to be part of the tangible product.

Distribution vs. Logistics Services

• Distribution: Purchases goods and resells them, and the distributor owns the inventory.
• Logistics Services: Concerned with the process of moving, positioning, and storing goods without ownership of the goods.

End User Consideration

Services should be delivered to clients who in turn repackage or sell the goods as they are, not to the final consumer.

Qualifying Activities in Distribution

• Purchase and Resale:- Buying from manufacturers the products at cheaper rates then selling them to the retailers at selected higher rates.
• Warehousing: Purchasing belongs to the operational logistics since it entails the storage of the purchased goods until they are ready for delivery.
• Transportation and Logistics: The process of transporting items from one location to another; it includes scheduling the transportation route, preparation of documents covering the shipment, and delivery of the goods at the rightful time.
• Inventory Management:- Controlling the stock position and new and sales orders to ensure it does not go out of stock or conversely overstocked.
• Order Processing:- Order taking, order processing, and sales order fulfillment involving arranging for the transfer of items to retailers/customers.
• Packaging and Repackaging:- Including the logo and message that needs to be conveyed through it as well as information about warranty, and enhancing the packaging.

Ancillary Activities

Following are the ancillary activities integrally and naturally complement the qualifying distribution activities subject to the satisfaction of conditions:

• Marketing and Advertising: Marketing to increase the amount of products sold.
• Quality Control and Inspection: Policies such as inspection of the goods before they are taken for distribution to clients in order to ensure that they have not spoiled.
• Customer Support Services: Addressing customers’ concerns whether they are inquiries, complaints, or comments they’d like to make.

Examples of Distribution Activities

• High Sea Sale or Third Ports Trading: Company C or free zone person formed in a designated zone for the purpose of export and import of certain goods, importing goods produced in country A for sale to a retailer/distributor of country B. Company C undertakes qualifying activities as the goods do not get imported into the UAE, but are transshipped in or from a designated zone.
• Export from the UAE: The Free Zone person in a designated zone in the United Arab Emirates with the name of Company E is importing goods from a juridical person of the UAE and exporting the same to a retailer/distributor outside the country. Products are transported from the manufacturer/importer that is mostly located in the UAE to the retailer/distributor in another country. Yes, Company E engages in qualifying activities, due to its operations that take place in or from a designated zone.
• Domestic Procurement and Sale: Al Ain Distribution Centre procures products in the domestic market within the UAE. In a designated zone, a free zone person having a supply chain of buying goods from UAE juridical persons and selling the same to distributors/retailers. The goods are moved directly from the manufacturer/importer to the retailer/distributor free from the designated zone. Qualifying activities are done by Company F because it engages in activities in or from a designated zone, which commenced with goods already in the UAE.

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Non-Qualifying Activities

• Sales Agents or Consultants: Activities related to helping in the selling or buying of commodities where the person or the company does not own the property are deemed not to be qualifying activities.
• Distributor: Importer, Company D, which is a free zone person, obtains books from a publisher and then sells them to bookstores while owning the title and managing the transportation. Qualifying activities are undertaken by Company D.
• Sales Agent: Company S is a free zone person where the publisher employs this company to sell books to bookstores without purchasing them and gets a commission on the books sold. Company S does not perform qualifying activities as it does not own titles in the books.

Practical Challenges and Non-Compliance

Since corporate tax in the UAE is regarded as a direct tax, can it be imposed on the customers, more so the international ones, in case they do not resell the goods? Or, could the designated zone distributor be punished, which might include exclusion from the beneficial zero percent tax rate anywhere from one to four years, for behavior over which they exercised no control? Both of these questions emphasize the importance of having clear rules to address these issues.

Complexities of Distribution Activities

The challenges described above highlight the complexities faced by distribution companies in free zones. Businesses require guidance and detailed analysis of these challenges to combat them effectively. Here are some key points to be addressed:

• Authorities' Guidelines: The UAE tax authorities should provide broader and clearer guidance on what constitutes a qualifying activity for receiving the lower tax rate concerning distribution activities. This should explain when the preferential rate applies, especially in B2B transactions.
• Double Taxation Measures: Procedures should be established to identify whether clients intend to or have in fact resold the goods. This mechanism should be practical and feasible for suppliers within the designated areas to implement.
• Resale Timeframes: The timeframe in which the goods should be resold should be specified. This allows suppliers within the specified zones to make better decisions regarding their operations and funding.
• Addressing Non-Compliance Issues: It is necessary to classify the consequences of non-fulfillment regarding the supply of the zone and its intended supplier or clients. This involves determining if there are penalties or disqualification from the preferential tax rate and the reasons for such actions.
• Customer Personnel and Consumption: Distinctions between customer personnel and their consumption of products and services should be made to avoid linking customer profiles to the actual use of goods. This is significant in defining the scope of distribution activities.
• Transactions with Natural Persons: The criterion for contracts with natural persons as buyers should be carefully defined to avoid denying bilateral transactions the right to use the simplified taxation scheme.
• Anti-Abuse Rules: New shifts in the business environment require the application of anti-abuse rules to prevent abusive behavior. These boundaries must be established to safeguard consumers and businesses’ abilities to regulate preprogrammed activities that may infringe on new legislation.

FAQs

What qualifies as a distribution activity in Free Zones?

Distribution activities in Free Zones involve acquiring, marketing, supplying, holding, stocking, ordering, moving in and out, and conveying, as well as exporting and shipping products or substances from a Designated Zone.

How is income from distribution activities taxed?

Income from qualifying distribution activities in Free Zones is taxed at a preferential zero percent corporate tax rate, provided the activities meet the criteria outlined in the Ministerial Decision 265/2023.

Are there any specific compliance requirements for distribution activities?

Yes, businesses must comply with the criteria set forth in Ministerial Decision 265/2023, including taking ownership of goods, conducting activities within a Designated Zone, and ensuring the goods are part of tangible products.

Can distribution activities affect QFZP status?

Yes, engaging in qualifying distribution activities can affect a business's status as a Qualifying Free Zone Person (QFZP) and enable them to benefit from the zero percent corporate tax rate on qualifying income. Non-compliance can lead to exclusion from the beneficial tax rate.