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, fewer formalities on commercial processes, a variety of business structures, an open-door policy on foreign investment, flexible business setup, and well-developed infrastructure. The UAE Corporate Tax Law provides an option that enables Free Zone entities to be eligible for a 0% tax rate on certain qualifying income and activities, to support their role in the economic development of the country.
1. 0% Corporate Tax on Qualifying Income of the Free Zone
The corporate tax law allows Free Zone companies to benefit from 0% corporate tax on qualifying income arising from:
- Transactions with Qualifying Free Zone Persons (QFZPs) that are the Beneficial Recipients of the goods or services.
- Qualifying Activities carried out in the Free Zone.
Cabinet Decision No. 59 of 2017 on Designated Zones (as amended) lists the areas recognised as Designated Zones for VAT purposes. For Corporate Tax purposes, a Designated Zone carries the same meaning. Businesses should not assume Designated Zone status automatically and should confirm it directly with the relevant Free Zone Authority.
2. Qualifying Free Zone Persons (QFZPs) Requirement
A Free Zone Person must satisfy the criteria set out in the UAE Corporate Tax Law and its implementing regulations to be treated as a QFZP. If any of these conditions is breached, the entity’s QFZP status is withdrawn and its income falls under the standard Corporate Tax regime instead. A Free Zone Person is presumed to be a QFZP by default unless it elects otherwise or fails to meet the applicable conditions.
3. Definition of a Free Zone Person
A Free Zone Person is any company incorporated, established, or registered in a UAE Free Zone, a UAE government-owned entity operating in a Free Zone, or a branch of a non-resident entity registered in a Free Zone. This juridical person is set up to carry out the activities of the Free Zone.
3.1 Criteria for Being a Free Zone Person
A person may qualify as a Free Zone Person where it meets any of the following conditions:
- Head Office in the UAE Free Zone: Having a head office located in the UAE Free Zone.
- Branch in the UAE Free Zone: Having a branch in the UAE Free Zone while the head office is located in another country.
- Fixed Place or Deemed Permanent Establishment: Where a foreign head office has a branch in the Free Zone, only the Free Zone branch’s activities are eligible for the 0% Corporate Tax rate on qualifying income; the foreign head office is treated separately.
- Tax Implications for Branches and Head Offices: In this scenario, the Free Zone branch may benefit from 0% Corporate Tax, while the head office and any foreign permanent establishment will not.
- Categorisation of Activities: Activities carried out within the Free Zone are treated separately from activities carried out elsewhere, which may be categorised as a domestic or foreign permanent establishment where the entity has a business presence in another jurisdiction.
3.2 Substance Requirement for Free Zone Persons
- Adequate Substance: A Free Zone Person must maintain adequate substance in the Free Zone or Designated Zone to qualify for the 0% Corporate Tax rate. This includes sufficient assets, employees, and operating expenditure relevant to its core income-generating activities.
- Core Income-Generating Activities: These are the activities that generate the Free Zone Person’s revenue. Core activities may be outsourced to another person in the Free Zone or Designated Zone, provided the Free Zone Person maintains adequate supervision over the outsourced work.
- Outsourcing and Supervision: A Free Zone Person may contract with a person inside or outside the UAE to carry out research and development relating to the generation of Qualifying Intellectual Property, provided it retains sufficient control and supervision over the contracted activities.
3.3 Adjustments to Qualifying Income
A Free Zone Person’s qualifying income may be derived from one or more of the following sources:
| Source of Qualifying Income | Description |
|---|---|
| Business with other Free Zone Persons | Transactions with other Free Zone Persons where they are the Beneficial Recipients. |
| Sale of goods and services linked to Qualifying IP | Income from Qualifying Intellectual Property, calculated under the applicable nexus rules. |
| Other income connected with Qualifying Activities | Other business activity related to Qualifying Activities that is not an Excluded Activity. |
| Other income within the de minimis threshold | Limited additional income that falls within the permitted de minimis limit. |
Unless otherwise exempt from Corporate Tax, income from the following sources does not qualify as Qualifying Income and is subject to the standard 9% Corporate Tax rate:
| Source of Income | Description |
|---|---|
| Income attributable to a Domestic Permanent Establishment | Income from a fixed place of business situated in the UAE, outside the Free Zone. |
| Income attributable to a Foreign Permanent Establishment | Income from a fixed place of business situated in another country. |
| Income from operations of ships or aircraft for international transport | Revenue from the operation of ships or aircraft used in international transport. |
| Income from immovable property, other than qualifying Commercial Property transactions | Revenue from the ownership or exploitation of immovable property, except qualifying transactions involving Commercial Property between Free Zone Persons. |
| Income from movable property not connected to a Qualifying Activity | Revenue generated from movable property outside the scope of a Qualifying Activity. |
3.4 Election to Be Subject to the Standard Corporate Tax Regime
Under Article 19 of the Corporate Tax Law, a Free Zone Person may elect to be subject to the standard Corporate Tax regime instead of the Free Zone regime. Where no such election is made, and all conditions are met, the Free Zone Person is taxed under the Free Zone regime.
3.5 The Arm’s Length Principle and Free Zone Persons
Free Zone Persons must apply the arm’s length principle to transactions with Related Parties and Connected Persons, whether based in the UAE or abroad. Where a Free Zone Person has a domestic or foreign permanent establishment, it must report separate operating profits or losses attributable to the functions performed, assets used, and risks assumed by the Free Zone Person and by each permanent establishment.
3.6 Transfer Pricing Documentation Requirements
Under the transfer pricing rules, a Free Zone Person must maintain sufficient documentation covering its transactions with Related Parties and Connected Persons. Where the applicable thresholds are met, this includes a master file, a local file, and a disclosure form, along with records evidencing that transactions were conducted at arm’s length.
3.7 Arm’s Length Principle and the Corporate Tax Rate
Where a Free Zone Person is subject to the standard 9% Corporate Tax rate on income attributable to a domestic or foreign permanent establishment, it must demonstrate that the profit attributed to the Free Zone entity itself reflects the functions performed, assets used, and risks assumed by that entity, consistent with the arm’s length principle.
3.8 Audited Financial Statements
A Free Zone Person must prepare and maintain audited financial statements, regardless of its revenue level, even where it generates no income during the Tax Period.
3.9 De Minimis Requirement
A Free Zone Person may earn a limited amount of non-qualifying revenue without losing QFZP status. This non-qualifying revenue must not exceed the lower of:
- AED 5 million, or
- 5% of the Free Zone Person’s total revenue for that Tax Period.
3.10 Excluded Activities
Income from the following is generally treated as non-qualifying and does not benefit from the 0% Corporate Tax rate:
- Transactions that do not meet the conditions of a Qualifying Activity.
- Transactions with a Free Zone Person that is not the Beneficial Recipient of the goods or services supplied.
4. Qualifying and Non-Qualifying Income: Worked Example
The table below shows how income sources are classified for the de minimis calculation.
| Income Source | Amount (AED) | Classification |
|---|---|---|
| Total Revenue | 20,000,000 | — |
| Income from Qualifying Activities and transactions with other Free Zone Persons | 19,000,000 | Qualifying |
| Income from Excluded Activities and other non-qualifying transactions | 1,000,000 | Non-Qualifying |
Here, total revenue is AED 20,000,000. The de minimis limit is the lower of AED 5,000,000 or 5% of total revenue. 5% of AED 20,000,000 is AED 1,000,000, so the applicable limit is AED 1,000,000. Since non-qualifying revenue of AED 1,000,000 does not exceed this limit, the Free Zone Person retains its QFZP status for the Tax Period.
4.1 Taxing Qualifying Free Zone Persons (QFZPs)
Corporate Tax Rates:
- Qualifying Income: 0%
- Non-Qualifying Taxable Income: 9%
Threshold to Taxable Income: The AED 375,000 threshold that applies 0% tax to taxable income under the standard Corporate Tax regime does not apply to a QFZP’s non-qualifying income. Non-qualifying income is taxed at 9% from the first dirham.
Standard Corporate Tax Election: Under Article 19 of the Corporate Tax Law, a Free Zone Person may elect to be subject to the standard 9% Corporate Tax regime instead of the QFZP regime.
5. Cessation of QFZP Status
A Free Zone Person ceases to be treated as a QFZP for a Tax Period where it elects to be subject to the standard Corporate Tax regime, or where it fails to meet any of the QFZP conditions. Failure to meet the conditions results in loss of QFZP status from the beginning of that Tax Period and for the subsequent four Tax Periods.
