Introduction

The UAE has positioned as a leading global business hub, attracting entrepreneurs and companies from around the world. Its strategic location, business friendly policies, and tax incentives particularly through Free Zones make it an attractive destination for startups and multinational entities.

Certain business activities are classified as qualifying activities, including the manufacturing and processing of goods or materials, the distribution of goods or materials within or from designated zones, logistics services, headquarter services for related parties, treasury and financing services for related parties, and the holding of shares and other securities for investment purposes.

As a result, multinational entities can benefit from the 0% corporate tax rate by relocating their headquarter services and treasury functions to Free Zones or establishing holding entities within the freezone, provided they meet all required criteria.

This article explores the benefits of setting up a Free Zone company in the UAE, with a particular focus on corporate tax advantages and the requirements for qualifying for the 0% tax rate.

Free Zones offer significant incentives, including full foreign ownership, advanced infrastructure, and tax benefits, making them a crucial part of the UAE’s economic landscape. With the introduction of the Federal Decree Law No 47 of 2022 on Corporate Tax, attention has turned to the conditions under which Free Zone entities can qualify for a 0% tax rate on eligible income.

A Free Zone Person is a legal entity incorporated or established under Free Zone regulations or a branch of a mainland UAE or foreign company registered in a Free Zone. Additionally, foreign companies that relocate their place of incorporation to a UAE Free Zone are also considered Free Zone Persons.

Free Zones are designed for specific business activities, with examples including Jebel Ali Free Zone, Dubai Airport Free Zone, DAFZ Industrial Park, Sharjah Healthcare City, and Ras Al Khaimah Maritime City. Entities operating within these zones may qualify for a 0% corporate tax rate if they meet the criteria to be classified as Qualifying Free Zone Persons (QFZP). Each Free Zone is governed by its own set of regulations and overseen by its respective Free Zone Authority.

Benefits of Free Zones

The 0% Corporate Tax Rate

The UAE’s Federal Decree Law introduced a 0% tax rate for Qualified Free Zone Persons (QFZPs) on qualifying income. However, to benefit from this, Free Zone entities must satisfy specific criteria

Conditions to Qualify as a Qualified Free Zone Person

To be eligible for the 0% corporate tax rate on qualifying income, a Free Zone Person must meet the following conditions:

1. Maintain Adequate Substance in the UAE: The entity must conduct its core business activities within the Free Zone. This includes having sufficient assets, employees, and operational expenditure in the Free Zone to substantiate its business activities. Activities can be outsourced to another Free Zone entity, provided adequate supervision is maintained.
2. Derive Qualifying Income: Qualifying income encompasses:
3. • Transactions with other Free Zone Persons.
   • Transactions with non-Free Zone Persons related to qualifying activities.
   • Income from qualifying intellectual property.
   • Other income, provided it meets the de minimis requirement (non-qualifying revenue does not exceed AED 5,000,000 or 5% of total revenue). However, certain types of income, such as from domestic or foreign permanent establishments and non-commercial properties, do not qualify and are subject to a 9% tax rate.
4. Elect Not to be Subject to Corporate Tax: The Free Zone Person must not have opted to be subject to corporate tax under Article 19 of the Corporate Tax Law.
5. Comply with Arms Length Principle and Transfer Pricing Documentation: Transactions between related parties and arrangements with permanent establishments must comply with transfer pricing rules, ensuring that transactions are conducted at arms length price.
6. Maintain Audited Financial Statements: Free Zone entities must prepare and maintain audited financial statements, regardless of their revenue levels.

Non-Qualifying and Excluded Activities

Certain activities and income streams are excluded from qualifying income and hence are subject to the standard corporate tax rate of 9%:

• Transactions with natural persons unless related to specific regulated services.
• Banking, insurance (except for reinsurance and captive insurance), and finance and leasing activities not connected to ships or aircraft.
• Ownership or exploitation of immovable property, except commercial properties in Free Zones transacting with other Free Zone Persons.

Qualifying Income and Tax Rate Applicability in Free Zones

To benefit from the 0% tax rate applicable to qualifying income within a Free Zone, the income must be derived from specific sources as outlined below. It is crucial for entities operating in Free Zones to understand these conditions to ensure compliance and optimal tax benefits.

Sources of Qualifying Income

1. Transactions with Another Free Zone Person:
2. • Income generated from transactions with another Free Zone Person is considered qualifying income, provided the recipient is theBeneficial Recipientof the transaction and the activities are not categorized as excluded activities.
3. Transactions with Non-Free Zone Persons:
4. • Income from transactions with non-Free Zone Persons qualifies if it relates toqualifying activitiesthat do not fall under excluded activities.
5. Ownership or Exploitation of Qualifying Intellectual Property:
6. • Income derived from the ownership or exploitation ofintellectual propertythat meets the qualifying criteria is deemed qualifying income.
7. Other Income:
8. • Additional income can be considered qualifying income if the Free Zone entity meets the de minimis requirement.

Specific Considerations for Qualifying Income

• Commercial Property Transactions:
• • Income from transactions with a Free Zone Person involving commercial property located within the Free Zone is treated as qualifying income. Consequently, this income is tax at 0%.
  • For mixed-use properties in a Free Zone, income must be allocated on an arm's length basis to distinguish between qualifying and non-qualifying income.
• Start of Qualifying Income:
• • A Qualified Free Zone Person (QFZP) that has not yet derived qualifying income is not disqualified from being recognized as a Free Zone Person for tax purposes.

Income Subject to 9% Corporate Tax

Despite the above criteria for qualifying income, certain types of income are subject to a 9% corporate tax rate, regardless of their origin or activity:

1. Foreign Permanent Establishment Income:
2. • Income attributable to a foreign permanent establishment is subject to a 9% corporate tax rate.
3. Domestic Permanent Establishment Income:
4. • Income arising from a domestic permanent establishment incurs a 9% corporate tax rate.
5. Immovable Property Income:
6. • Income from immovable properties, excluding income from commercial property transactions involving a Free Zone Person, is subject to a 9% tax rate.
7. Non-Qualifying Intellectual Property Income:
8. • Income from the ownership or exploitation of intellectual property, unless it is derived from qualifying intellectual property, will be taxed at 9%.

This income is excluded from the calculation of total revenue and non-qualifying revenue for the de minimis requirement.

Non-Qualifying Revenue:

1. • Transactions with a Free Zone Person where the recipient is not the beneficial recipient.
   • Transactions with a Non-Free Zone Person Where the activities are not qualifying activities
   • Excluded Activities

Conclusion

Businesses must strategically align their operations to comply with the requirements for maintaining QFZP status. This includes ensuring that they maintain adequate substance, derive qualifying income, adhere to transfer pricing regulations and maintain audited financial statements. The 0% tax rate on qualifying income, combined with the comprehensive support infrastructure of Free Zones, continues to make the UAE an attractive destination for foreign investment.

References:

• Federal Decree Law on Corporate Tax, UAE
• Federal Tax Authority (FTA) Guidelines on Free Zone Corporate Tax
• Cabinet Decision No. 59 of 2017 on Free Zone Tax Regulations

Excluded Activities

Certain activities are designated as excluded and do not qualify for the favourable tax treatment in Free Zones. These activities include:

1. Transactions with Natural Persons:
2. • Generally, transactions with natural persons are excluded unless they relate to:
   • • The ownership, management, and operation of ships.
     • Fund management services regulated by the competent UAE authority.
     • Wealth and investment management services regulated by the competent UAE authority.
     • Financing and leasing of aircraft, including engines and rotable components.
3. Banking Activities:
4. • All traditional banking activities are excluded from qualifying for tax benefits.
5. Insurance Activities:
6. • General insurance activities are excluded, except for:
   • • Reinsurance services.
     • Captive insurance activities that are part of headquarters services to related parties.
7. Finance and Leasing Activities:
8. • Standard finance and leasing operations are excluded, except for:
   • • Ownership, management, and operation of ships.
     • Treasury and financing services provided to related parties.
     • Financing and leasing of aircraft, including engines and rotable components.
9. Ownership or Exploitation of Immovable Property:
10. • Owning or exploiting immovable property is generally excluded unless it involves commercial property in a Free Zone, where transactions are conducted with other Free Zone Persons.

Qualifying Activities

Certain activities are designated as qualifying and may benefit from the 0% tax rate in Free Zones. These activities include:

1. Manufacturing of Goods or Materials:
2. • The production or assembly of goods or materials.
3. Processing of Goods or Materials:
4. • Transforming or refining raw materials or semi-finished products.
5. Trading of Qualifying Commodities:
6. • Engaging in the trade of designated commodities that meet qualifying criteria.
7. Investment in Shares and Securities:
8. • Holding shares and other securities for investment purposes.
9. Management and Operation of Ships:
10. • Ownership, management, and operational activities related to ships.
11. Reinsurance Services:
12. • Providing reinsurance support and coverage.
13. Fund Management Services:
14. • Managing investment funds under regulatory oversight.
15. Wealth and Investment Management Services:
16. • Offering wealth management and investment services under regulatory oversight.
17. Headquarter Services to Related Parties:
18. • Providing central management and support services to related parties.
19. Treasury and Financing Services to Related Parties:
20. • Managing finances and providing treasury services to related entities.
21. Financing and Leasing of Aircraft:
22. • Engaging in financing and leasing activities related to aircraft.
23. Distribution and Logistics Services:
24. • Distribution of goods or materials within or from a Designated Zone.
    • Offering logistics and supply chain services.
25. Ancillary Activities:
26. • Supporting activities closely related to a primary qualifying activity. These are necessary or make a minor contribution to the main qualifying activity and are not considered separate activities. For example, post-sales support and customer services for car manufacturers during the warranty period are ancillary activities.

Qualifying Intellectual Property ( QIP)

QIPs are Patents, Copyrighted Software and any right functionally equivalent to a Patent that is both legally protected and subject to a similar approval and registration process to a Patent, such as utility models, intellectual property assets that grant protection to plants and genetic material, orphan drug designations, and extensions of Patent protection, but not including any marketing related intellectual property assets, such as trademarks.

In relation to the QIP, the Free zone person can satisfy the adequate substance requirements if it involves:

1. Research & Development (R&D):
2. • R&D activities conducted within the Free Zone
   • Supervision of outsourced R&D activities from the Free Zone.
3. Outsourced Core Income-Generating Activities:
4. • Core activities related to qualifying IP can be outsourced to any entity within the UAE or to an unrelated party outside the UAE.