Understanding Qualifying Free Zone Person

A Qualifying Free Zone Person is a business entity that generates sufficient substance, produces income specified by the Cabinet, and maintains the necessary documentation. When a Free Zone person earns non-qualifying income, they are liable to 9% tax. However, if the total non-qualifying income is not more than 5% of their total revenue or less than AED 5 million, then they will be exempted. As a result, revenues from foreign permanent establishments operating within a Free Zone will be subject to full 9% taxation

As stated in the law, A Free Zone is a designated and defined geographical area within the state that is specified in a decision issued by the cabinet at the suggestion of the minister. In recent years, Free Zones have become increasingly popular among businesses and entrepreneurs seeking to utilize unique economic benefits and simplified rules environments. But what exactly is a Free Zone, and how can one qualify as a Free Zone Person (QFZP)? This blog aims to provide a complete overview of the criteria, benefits, and processes associated with becoming a Qualifying Free Zone Person.

What is a Free Zone?

A Free Zone, also known as a free trade zone, is a designated area within a country where businesses enjoy special economic regulations that differ from the rest of the country. These zones are typically established to attract foreign investment, boost trade, and stimulate economic activity. Free Zones offer various incentives, including tax exemptions, simplified customs procedures, and more flexible business regulations. They are strategically located to facilitate international trade and are often equipped with Advanced facilities to support diverse business operations.

Understanding the fundamental aspects of Free Zones is essential for grasping the significance of becoming a Qualifying Free Zone Person. This status not only provides access to these economic benefits but also aligns businesses with a framework designed to enhance operational efficiency and global competitiveness. In the following sections, we will explore the specifics of qualifying for this status, exploring the criteria and the numerous advantages that come with it.

According to article 3 of the law, corporate tax on Qualifying free zone, Person will be applicable at the following rates

• 0% on Qualifying income
• 9% on Taxable income (Not qualifying income). Exempt and out of scope income will be excluded.

From the above requirement of the law, It is clear that CT is applicable to the free zone persons, and the tax rate can be zero percent and nine percent based on the nature of the income. Since the free zone person’s are taxable, they are liable to comply with the CT law.

What is a Free Zone Person?

A Free Zone Person refers to an individual or entity operating within a designated free zone, benefiting from unique regulatory, tax, and operational advantages. These zones are established to attract foreign investment and boost economic activity by offering incentives such as tax exemptions and simplified business procedures. Understanding the distinctions between a Natural Person and a Juridical Person within these zones is crucial for Understanding the full scope of Free Zone operations.

Natural Person: A Natural Person in the context of a Free Zone is an individual who engages in business activities within the Free Zone. This individual can be a freelancer, an entrepreneur, or a sole proprietor who operates under the free zone's regulatory framework. Natural Persons benefit from the free zone's incentives, such as 0% corporate tax on qualifying income and simplified customs procedures, making it an attractive option for personal business ventures.

Juridical Person: A Juridical Person refers to a legal entity, such as a corporation, partnership, or any other organization, that is recognized by law as having its own legal rights and obligations. These entities operate within the Free Zone under specific regulations that afford them various benefits, including significant tax advantages and regulatory ease. Juridical Persons in Free Zones can take advantage of a 0% corporate tax rate on qualifying income and simplified  processes for business operations, facilitating growth and international trade.

Understanding these distinctions helps clarify the diverse ways individuals and entities can Utilize the benefits of Free Zones to improve their business activities and achieve greater economic efficiency.

Who is Considered a Qualifying Free Zone Person?

A Qualifying Free Zone Person (QFZP) is an entity operating within a free zone in the UAE that meets specific criteria set by the government to benefit from favorable tax regulations. These entities enjoy various incentives, including a 0% corporate tax rate on qualifying income. To be recognized as a QFZP, the following conditions must be met:

Maintains Adequate Substance in the UAE

• Operational and Physical Presence: The entity must have a tangible and significant presence within the UAE. This includes having sufficient office space, employees, and operational activities within the Free Zone.
• Economic Substance Regulations (ESR): The entity must comply with the UAE's ESR requirements, which mandate that businesses engage in substantial activities related to their economic transactions. This ensures the entity is not merely a shell for tax purposes.
• Economic Activities: The entity must engage in Core Income-Generating Activities (CIGA) in the UAE. These activities are specific to the type of business and ensure that the entity is genuinely operating within the UAE. Examples include manufacturing, service provision, and other substantial operations.
• Operating Expenditure: Adequate operating expenses should be incurred within the UAE, reflecting the entity's business activities. This includes costs for salaries, rent, utilities, and other operational expenses
• Management and Control: The entity must demonstrate that its management and decision-making occur within the UAE. This involves holding regular board meetings in the UAE with a quorum of directors physically present and actively participating in these meetings.

Derives Qualifying Income as Stated In the Cabinet Decision

• Source of Income: The entity's income must come from activities that are recognized as "qualifying" under UAE tax laws. This typically includes revenues from specific sectors or services that the Free Zone incentivizes.
• Cabinet Decision Compliance: The types of income considered qualifying are detailed in specific Cabinet Decisions. These might include export trading, consultancy services, logistics, and more, depending on the strategic priorities of the Free Zone.

Complies with Prevailing Transfer Pricing Rules and Regulations

• Transfer Pricing Documentation: The entity must maintain proper documentation to show that transactions between related parties (such as subsidiaries or parent companies) are conducted at arm's length, meaning at fair market value.
• Arm’s Length Principle: This principle ensures that the prices charged in related party transactions are equivalent to those that would be charged between independent entities, preventing profit shifting and ensuring fair taxation.

Not Elected to be Subjected to Corporate Tax (CT)

• Corporate Tax Election: The entity must not have opted into the UAE's Corporate Tax regime. Free Zone entities often have the option to elect into or out of the general Corporate Tax system.
• Tax Incentives Utilization: By not electing to be subject to Corporate Tax, the entity can utilize the tax incentives provided within the Free Zone, such as lower tax rates or tax holidays.

Meets De Minimis Criteria

• Threshold Conditions: The entity must meet specific thresholds for revenue, assets, or activities that qualify it for special tax treatment. These thresholds are established to ensure that only entities with significant Free Zone activities benefit from the incentives.
• Limited Non-Qualifying Activities: The entity must ensure that any income derived from non-qualifying activities does not exceed a specified limit, which is typically a small percentage of the overall income.

Have Audited Financial Statements

In addition to the above criteria, a Qualifying Free Zone Person must have audited financial statements. This requirement ensures financial transparency and accountability, aligning with international standards and fostering trust with regulatory authorities.

• Independent Audit: The financial statements must be audited by an independent, licensed auditor to ensure they accurately represent the financial position and performance of the entity.
• Compliance and Reporting: Regular audits help verify that the entity complies with all relevant financial reporting standards and regulations, which is crucial for maintaining its status as a QFZP."
• Financial Integrity: Audited financial statements demonstrate the entity's commitment to maintaining high financial integrity and transparency, which is essential for benefiting from Free Zone incentives.

By fulfilling these detailed conditions, an entity can be considered a Qualifying Free Zone Person and enjoy the associated tax benefits in the UAE.

Benefits of Being a Free Zone Person

• Tax Incentives: Free zones offer significant tax advantages, including zero corporate and personal income taxes. These incentives make free zones highly attractive for businesses looking to maximize their profits and minimize their tax liabilities.
• Business Operation Advantages: Businesses in free zones can enjoy 100% foreign ownership, which is ideal for international investors seeking full control over their operations. Additionally, free zones typically provide streamlined licensing processes, which facilitate faster and easier business setup.
• Access to Specific Resources and Facilities: Free zones are strategically located and often come with superior infrastructure and facilities. They offer easy access to global markets and are designed to support various industries with specialized resources, such as logistics hubs, industrial facilities, and office spaces.

By Using these advantages, businesses in free zones can achieve operational efficiency, cost savings, and global market reach, making free zones an attractive option for companies of all sizes and sectors.

Corporate Tax Services For Free Zones - Reyson Badger

In conclusion, Understanding corporate tax responsibilities  in UAE free zones is crucial for businesses aiming to optimize their operations. Recognising the impact of corporate tax on free zone entities is essential for compliance and strategic financial planning. Even with the benefits of zero corporate and personal income taxes in free zones, it's important to note that free zone companies may still be subject to taxation under certain conditions, especially when dealing with mainland entities. Therefore, businesses must engage with expert corporate tax services to ensure compliance with UAE tax laws and to capitalize on available tax incentives. With the right guidance, companies can utilize free zone advantages while staying compliant and financially efficient in the competitive UAE market. Reyson Badger is dedicated to helping your business succeed in the competitive environment of free zones. Trust us to be your partner in achieving sustainable growth and operational excellence through effective tax management.