Free zones are an important aspect of the UAE economy and hold a crucial position in the process of changing the economy of the UAE and the global economy. Some of the benefits that accrue from engaging in business in the Free Zones of UAE include the following: commercial freedom, less formalities on the commercial processes, variety of business structures, open door policy on foreign investment, informal disposition of business entities, and well-developed infrastructure. The UAE corporate tax law provides an option that enables free zone enterprises and branches to be eligible for a zero percent tax on certain qualifying income and activities of such free zones to promote their significance in the economic development of the country.
1. 0% Corporate Tax on Qualifying Income of the Free Zone
The corporate tax laws about free zones are generally designed to offer 0% corporate tax on qualifying income from:
Transactions with Qualifying Free Zone Persons (QFZPs) and Individuals in Free Zone who are the intended beneficiaries of the free zone.
Qualifying Activities Carried Out in the Free Zone
Cabinet Decision No. Section 59 of Uganda’s Value Added Tax Act of 2017 has a list of zones that have been deemed appropriate for VAT. In as much as the matters of corporate tax are concerned, all the taxpayers should verify whether they are in a free zone or a designated zone through the free zone authority.
2. Qualifying Free Zone Persons (QFZPs) Requirement
Free zone persons must satisfy the criteria of the UAE Corporate Tax Law and the regulations for implementation to be considered as QFZPs. A Free Zone Person’s status as a Qualifying Free Zone Person (QFZP) will be withdrawn and its revenue will fall under the normal Free Zone Corporate tax laws and rates in the event of any of the above-stated conditions being violated. Any natural person shall be presumed to be a Qualifying Free Zone Person (QFZPs) if he does not choose otherwise or if he does not meet any of the requirements set above.
3. Definition of a Free Zone Person
Any company incorporated, established, or registered in any of the Free Zone areas of UAE, a state-owned company operating in the UAE, or any legal entity or branch of a non-resident entity which is registered in the Free Zone or the Free Zone authority is called the Free Zone person. This juridical person is set up to carry out the activities of the free zone.
3.1. Criteria for Being a Free Zone Person
Therefore, any person who fulfills any of the following conditions in the free zone of the UAE could be a “free zone person” carrying out an economic activity:
Head Office in the UAE Free Zone: Having a head office in the UAE free zone.
Branch in the UAE Free Zone: Having a branch in the UAE free zone while having the head office in any other country in the world.
Fixed Place PE or Deemed PE:-The head office would normally be regarded as either a fixed place PE or a deemed PE depending on the circumstances. However, it is only the free zone extractive and non-extractive business of the company, which can be the part of the business registered in the free zone, which is subjected to the zero percent corporate tax on the eligible income.
Tax Implications for Branches and Head Offices:-For instance, in the second of the above-discussed scenarios, while the branch established in the free zone will be subjected to 0% corporate tax, the head office and foreign permanent place of business will not.
Categorization of Activities:-Categorizing the activities that a Free Zone Person engages in within a free zone as ‘free zone parent’ and the activities that it carries out in other areas as ‘domestic permanent establishment’ or ‘foreign permanent establishment’ if the entity has a business presence in another country.
3.2. Substance Requirement for Free Zone Persons
Adequate Substance Requirement:-A Free Zone Person must have adequate substance in a free zone to qualify for the 0% corporate tax rate on the qualified income. The Free Zone Person has to meet certain criteria in order to be able to perform its main commercial function such as possessing sufficient assets, staff, and operating costs in the Free Zone (or a designated area for distribution).
Core Value-Creating Activities:-The business activities that a free zone person undertakes to generate revenue from a free zone venture are called the core value-creating activities. It may be acceptable for a free zone entity to outsource its main value-added activities that bring in most of its revenues to other persons residing in a free zone (or any other area designated for distribution), given that the outsourced activities are closely supervised.
Outsourcing and Supervision:-In this respect, a free zone entity may enter into a contract with any person in the United Arab Emirates or any person in third countries, which are not related to the United Arab Emirates, for carrying out research and development (R&D) in relation to the generation of qualifying intellectual property to the extent that the free zone entity can exercise sufficient control over the contracted activities.
3.3. Adjustments to Qualifying Income
The Free Zone Person must make the necessary adjustments to the qualifying income. One or more of the following sources of qualified income must be used by the free zone person:
Chart: Different sources of qualifying income
Source of Qualifying Income | Description |
Business with other Free Zone Persons | Business transactions with other Free Zone Persons where they are the intended beneficiaries. |
Sale of goods and services associated with qualifying IP | Sale of goods and services related to qualifying intellectual property where the IP is qualifying. |
Other activities connected with qualifying activities | Any other business activity related to qualifying activities and not prohibited. |
Other income subject to de minimis rules | Additional income sources that meet de minimis criteria and are eligible for the tax benefits. |
However, unless the income is free from corporate tax under another provision, revenue from the following sources (even if included in the above list) will not result in qualifying income and will be taken into consideration for calculating the taxable income @ 9% corporate tax rate:
Source of Income | Description |
Income from the business or from interest, dividends, or royalties for a period not exceeding 183 days | Revenue from the use of goods or rights for business purposes, including interest, dividends, or royalties for a period not exceeding 183 days. |
Income from operations of ships or aircraft for international transport | Revenue from the operations of ships or aircraft for international transport. |
Income from operations of Prelude for exploration and exploitation of oil and natural gas | Revenue from the operations of Prelude vessel for exploration and exploitation of oil and natural gas. |
Revenue arising from a fixed place of business situated in another territory | Income derived from a fixed place of business located in a territory other than the resident country. |
Revenue arising from a fixed place of business situated in the resident country | Income derived from a fixed place of business located in the resident country. |
Revenue from movable property | Income generated from movable property. |
3.4. Adherence to UAE corporate tax in Free Zone persons
A Free Zone Person may make an election to adopt the normal corporate tax rates as if one has not made an election under Article 19 then he or she should qualify to pay normal corporation tax laws and rates.
3.5. The Principle of arm’s length and Free Zone Person.
The arm’s length principle must always be observed by the free zone persons in case they are undertaking business deals with companies that are local or international or in case they are dealing with related parties in business contracts. Thus in terms of bona fide methods of profit splits like the separate entity approach, it is incumbent upon the Free Zone parent to generate and report distinct operating profits or losses on the activity, assets, and risks actually undertaken or incurred by Free Zone parent and its domestic or foreign PE’s respectively.
3.6.Transfer Pricing Documentation Laws:-
Under the transfer pricing documentation laws, the free zone person must adhere to the contracts and transactions it engages in with related parties or associated companies, as well as connected individuals. Compliance with transfer pricing regulations necessitates the preparation of a master file, a local file, and a disclosure form for the Free Zone Person. Additionally, the Free Zone Person must retain records supporting that transactions were conducted on an arm’s length basis.
3.7. Arm's Length Principle and Corporate Tax Rate
If the Free Zone Person is subject to a corporate tax rate, such as the standard 9%, due to its foreign or domestic permanent establishment, it must demonstrate that profits attributed to its Free Zone parent are proportional to the functions performed, resources used, and risks assumed by the Free Zone parent. It's essential to ensure that the total operating profit attributed to the Free Zone parent aligns with the arm’s length principle.
3.8.Audited Financial Records
The Free Zone Person is obligated to maintain audited financial records. Even if the Free Zone Person does not generate any income, it is still required to prepare and present audited financial statements to ensure compliance with regulatory standards.
3.9. De Minimis Requirements
Revenue that does not meet certain criteria must fulfill the de minimis requirements. This includes revenue thresholds, such as:
Five million AED, or
Paid 5% of the total sale revenues.
3.10. Excluded Activities
Certain activities are not considered for exemption from corporate tax or qualifying revenue, including:
Transactions involving parties that do not qualify as free zone activities.
Business transactions with individuals residing in a free zone who are not the intended beneficiaries of the imported goods or provided services.
4. Qualifying and non-qualifying Income Sources:-
In the following table, income source is illustrated and differentiated into total income and non-qualifying revenue based on the previous example :
| Income Source | Amount (AED) | Qualification |
| Total Income | 10,000,000 | |
| From Foreign Source | 8,000,000 | Qualified |
| From Domestic Permanent Establishment | 2,000,000 | Qualified |
| Non-Qualifying Revenue | 2,000,000 | |
| Excluded Activities | 5,000,000 | N/A |
In the table above, the income sources are categorized into total income and non-qualifying revenue based on the provided example. If the income of the Free Zone Person is 10,000,000 AED, then the total income for the de minimis computation comprises 8,000,000 AED derived from a foreign source and 2,000,000 AED from a domestic permanent establishment. Subsequently, the two million AED considered as non-qualifying will be determined. If the Free Zone Person is earning 5,000,000 AED from excluded activities that could otherwise result in non-qualifying revenue, then there will be no non-qualifying revenue according to the de minimis calculation.Nevertheless, if the funds relate to a fixed place of business situated in the home country and generating income attributable to a business that is taxed at the corporate tax rate of 9%, the income will be considered non-qualified revenue.
4.1. Taxing Qualifying Free Zone Persons (QFZPs):-
Corporate Tax Rates
- Qualifying income = 0%
- The Non-Qualifying taxable income = 9%
Threshold to Taxable Income:- A QFZP is subjected to tax of 9% to other income apart from the qualifying income and does not benefit from the law that categorizes entities liable to 0% corporate tax on taxable income that exceeds a threshold of 375,000 AED.
Standard Corporate Tax Application:- Corporate Tax UAE Article 20 clearly states that the Free Zone Person shall be allowed to elect the standard corporate tax of 9%. Thus, the Foreign Permanent Establishment is thus ruled out for any other sources of income other than the ones that would give the qualifying income. Therefore, qualifying income might not be taxable income.
5. Cessation of Qualifying Free Zone Persons (QFZPs):-
Therefore, a QFZP will not be allowed to be known as a QFZP for the tax period for which the QFZP wants to be taxed under the normal corporation tax regime or where it fails to satisfy the requirements for the categorisation of a QFZP. This is possible if it chooses to accept responsibility for a corporate tax or loses its QFZP status for four subsequent fiscal years.
FAQs
What are the conditions to qualify as a Free Zone Person in the UAE?
The Free Zone Person in the UAE requires the business to be incorporated, established, or registered in the UAE Free Zone, adequate substance requirements, and undertake the core business activities within the Free Zone.
What documentation is required for Free Zone qualification?
They include incorporation or registration certificates, proof of adequate substance such as assets, staff, operating costs, and transfer pricing documentation that includes master file, local file, and disclosure form.
How does corporate tax apply to Free Zone Persons?
Free Zone Persons are subjected to a zero percent corporate tax on qualifying income. Non-qualifying income is taxed at the standard rate of 9%.
Can a business lose its Free Zone Person status?
Yes, a business can lose its Free Zone Person status if it does not meet the conditions for qualifying, if it breaches the conditions or if it chooses to go for the normal.
Mostafa is a seasoned Tax Consultant with over 5 years years of experience gained in diverse taxations matters. He has vast expertise in settling tax disputes with the Federal Tax Authority and handling of tax procedures in compliance with tax laws. He is adept in investigating underlying tax intricacies and offering expert tax advisory. He is also well-versed in conducting tax analysis’s and negotiations with the Tax Regulators, upon tax preparation and filing. Mostafa specializes in the areas of Tax law, Auditing, Accounting and Banking law.
