Free Zone Corporate Tax

The Free Zone Corporate Tax in the UAE is a specialized tax framework designed to encourage economic growth and international investment within designated Free Zones. Under this regime, qualifying businesses can benefit from a 0% corporate tax rate, provided they meet specific requirements and maintain compliance with the regulations set by the UAE's Federal Tax Authority (FTA) and relevant Free Zone authorities. The primary aim is to create an appealing environment for foreign investors, who can establish their businesses with favorable tax benefits. However, not all Free Zone companies are automatically eligible for the 0% rate; eligibility depends on qualifying as a “Free Zone Person” and maintaining limited or no business transactions with the UAE mainland. Businesses operating within Free Zones should ensure continuous compliance to enjoy these tax benefits, as any deviation could result in a 9% corporate tax rate being applied.

Corporate tax on free zones has been significant in UAE corporate tax. Many papers have been published since the first corporate  tax law was released in January 2022, however each of these guides made various claims. Finally, in May 2024, the Federal Tax Authority issued a guide for Free Zone Corporate Tax Persons that clarified all of the miscommunications in prior guides.

Here is the latest update on UAE Corporate Tax for Freezones

UAE Corporate Tax

The UAE has introduced a new corporate tax system for all businesses and commercial activities in the country. This change aims to diversify the economy, reduce reliance on oil revenues, and create a sustainable financial system. The new corporate tax regime provides a clear and transparent tax environment for businesses in the UAE. It follows international tax standards, including the guidelines set by the Organisation for Economic Co-operation and Development (OECD). By adopting these standards, the UAE shows its commitment to fair tax practices and cooperation with the global tax community. This helps keep the UAE an attractive and competitive place for international businesses.

The new corporate tax regime will be implemented in stages. The announcement was made in January 2022, and the Federal Decree-Law No 47 of 22 (Corporate Tax Law) was issued in December 2022, and the amendment Federal Decree Law No.63 of 2023. The final update of UAE Corporate Tax for Free Zones was published on May 2024. The corporate tax will start for financial years beginning on or after June 1, 2023. For example, if a business's financial year starts on July 1, 2023, and ends on June 30, 2024, it will be subject to the new corporate tax from July 1, 2023. If a business's financial year follows the calendar year, it will be subject to the tax starting January 1, 2024. By following these timelines, businesses can prepare for the new tax requirements and take advantage of any tax planning opportunities.

According to Article 3 of the Corporate Tax Law, there will be two rates at which corporate tax will be applicable in the free zones:

• 0% on Qualifying Income
• 9% of taxable income, that is not qualifying (Non-Qualifying Income)

There were several myths that Corporate Tax is not applicable in Free Zones, which is not true. It usually depends upon the nature of the income. The Freezone Corporate Tax may vary from 0% to 9%. So compliance is mandatory for Freezone Persons.

According to the law, a Freezone is “A designated and defined geographic area within the state that is specified in a decision issued by the cabinet at the suggestion of the minister”

All Free Zones in UAE qualify as Free Zones for Corporate Tax.

What is a Free Zone Person?

A Free Zone Person refers to an individual or entity that operates within a designated Free Zone, benefiting from various regulatory, tax, and operational advantages. Free Zones are established in the UAE, to promote foreign investment and encourage economic activity by offering incentives such as tax exemptions and simplified business procedures.

There are two primary categories of Free Zone Persons:

• Natural Persons: These are individuals, such as freelancers or sole proprietors, who engage in business activities within the Free Zone. They enjoy benefits like a 0% corporate tax rate on qualifying income and streamlined customs processes, making it easier to manage their operations.
• Juridical Persons: This term refers to legal entities, such as corporations or partnerships, designated by the law as possessing unique legal rights and responsibilities. Juridical Persons in Free Zones can also benefit from significant tax advantages, including the same 0% corporate tax rate on qualifying income, thus supporting their growth and international trade activities.

Overall, being a Free Zone Person allows individuals and entities to make use of specific benefits designed to improve their business activities and uplift the economic efficiency.

Key Legislative Decisions

Cabinet Decision No. 55 of 2023: Ensuring Adequate Substance and Determining Qualifying Income

Cabinet Decision No. 55 of 2023 clarifies aspects of the corporate tax regime for businesses operating in free zones. This decision is important for defining what constitutes 'Qualifying Income' and ensuring businesses maintain adequate substance within the Free Zone.

Determining Qualifying Income

Cabinet Decision No. 55 of 2023 also plays a crucial role in defining 'Qualifying Income' under the new corporate tax regime. This decision specifies the types of income that free zone businesses can earn while still benefiting from the preferential 0% corporate tax rate. 

Ministerial Decision No. 139 of 2023: Qualifying Activities and Excluded Activities

Ministerial Decision No. 139 of 2023 provides a comprehensive list of 'Qualifying Activities' and 'Excluded Activities' relevant to the free zone corporate tax regime. The decision outlines specific activities that are eligible for the 0% tax rate, which include:

• Manufacturing and processing of goods or materials
• Holding of shares and securities
• Ownership, management, and operation of ships
• Reinsurance and fund management services
• Wealth and investment management services
• Headquarter and treasury services to related parties
• Financing and leasing of aircraft
• Logistics services and distribution from a designated zone

Excluded activities, which are not eligible for the 0% tax rate, include:

• Transactions with natural persons
• Certain regulated financial services activities
• Income from intangible assets and immovable property, except commercial immovable property in a free zone

Qualifying Freezone Person

In CT law, a qualifying free zone person is defined as a free zone individual who satisfies the criteria outlined in Article 18 of the law. These criteria include 

• Maintaining Adequate Substance in the UAE
• Earning qualifying income specified by the cabinet decision
• Adhering to Transfer Pricing Regulations
• Not opting to be subject to CT
• Meeting De minimis Requirement
• Possessing Audited Financial statements

To know more about Qualifying Free Zone Person, check out here.

Adequate Substance

For having Adequate Substance in UAE, two regulations needs to be followed

• CIGA in Free Zone: Core income-generating activities (CIGA) must be carried out within the Free Zone.
• Adequacy Test: Businesses must meet requirements for having adequate assets, a sufficient number of qualified employees, and appropriate operating expenses relative to their activities.

Outsourcing Activities

Outsourcing: Activities can be outsourced to a related party or a third party within the Free Zone, provided the Qualifying Free Zone Person maintains adequate supervision over the outsourced activities.

De-minimis Requirement

If a qualifying freezone person's non-qualifying income during a tax period does not surpass 5% of their total income for that tax period, or AED 5,000,000 (5 million dh), (whichever is lower), then the de-minimis requirement will be satisfied.

To calculate the 5% in De-Minimis Requirement

(Non-Qualifying Income ÷ Total Income) × 100  

To know more about De-Minimis Requirement, check out here.

Eligibility Criteria for the 0% Corporate Tax Rate

Role of Free Zone Authorities in Confirming Eligibility

Free Zone Authorities play a crucial role in confirming the eligibility of entities for the free zone corporate tax regime. They are responsible for:

• Issuing Licenses: Free Zone Authorities issue licenses to businesses operating within their jurisdiction, ensuring that these entities meet the necessary criteria for registration and operation within the free zone.
• Compliance Monitoring: Free Zone Authorities monitor the activities of Free Zone Persons to ensure compliance with regulations, including the engagement in qualifying activities and adherence to tax laws.
• Verification of Qualification: Free Zone Authorities work in collaboration with relevant government agencies, including the Ministry of Finance, to verify the eligibility of Free Zone Persons for the 0% corporate tax rate. This verification process may include audits, documentation review, and other measures to confirm compliance.

By working closely with Free Zone Authorities, entities can ensure that they meet the eligibility criteria for the free zone corporate tax regime and benefit from the associated tax incentives and advantages.

Qualifying and Excluded Activities

In the context of the UAE's Corporate Tax regime for free zones, it's essential to distinguish between Qualifying Activities, which can benefit from the 0% corporate tax rate, and Excluded Activities, which do not qualify for this preferential rate. Understanding these classifications helps businesses determine their eligibility and plan their operations accordingly.

Detailed List of Qualifying Activities

The UAE Ministry of Finance has specified a range of activities that are considered Qualifying Activities. These activities, when conducted exclusively within or from a free zone, are eligible for the 0% corporate tax rate. The main Qualifying Activities include:

Manufacturing of Goods or Materials:

• Involves the production or processing of raw materials into finished products.
• Includes activities such as assembly, packaging, and labeling.

Processing of Goods or Materials:

• Refers to the treatment or modification of materials to produce a different product.
• Can include refining, mixing, or combining substances.

Holding of Shares and Other Securities:

• Involves owning, managing, and controlling shares and securities of other entities.
• Includes holding companies and investment entities.

Ownership, Management, and Operation of Ships:

• Encompasses activities related to the maritime industry.
• Includes ship leasing, chartering, and operating shipping lines.

Reinsurance Services:

• Providing insurance to insurers, managing risks, and underwriting policies.

Fund Management Services:

• Managing investment funds that are under the regulatory oversight of the competent authority in the UAE.
• Includes activities related to asset management and investment advisory.

Wealth and Investment Management Services:

• Offering financial planning, investment advice, and portfolio management services.
• Must be regulated by the relevant UAE authorities.

Headquarter Services to Related Parties:

• Providing administrative, management, and support services to affiliated entities.
• Includes strategic planning, financial management, and corporate governance.

Treasury and Financing Services to Related Parties:

• Managing intra-group financing, liquidity, and risk management.

Financing and Leasing of Aircraft:

• Includes leasing aircraft and related components like engines and rotables.

Logistics Services:

• Managing the flow of goods and services, including warehousing, transportation, and distribution.

Distribution in or from a Designated Zone:

• Handling the distribution of goods within or from designated free zones that meet specific conditions.

Ancillary Activities:

• Activities that support the main qualifying activities listed above.

List  of Excluded Activities

Certain activities are explicitly excluded from the benefits of the Free Zone Corporate Tax regime. Income derived from these Excluded Activities will not qualify for the 0% tax rate, regardless of where they are performed. The main Excluded Activities include:

Transactions with Natural Persons:

• Income generated from transactions directly with individual consumers, rather than businesses or entities.

Certain Financial Services:

• Income from regulated financial services activities that are not specifically listed as Qualifying Activities.
• Includes certain banking and insurance services that fall outside the scope of the qualifying reinsurance activities.

Income from Intangible Assets:

• Revenue derived from intellectual property rights, patents, trademarks, and other intangible assets.
• Includes licensing fees, royalties, and other income from intangible assets.

Income from Immovable Property:

• Revenue from real estate and property transactions, except for commercial immovable property located within a free zone and transacted with other free zone persons.

Businesses that earn income from Excluded Activities or any non-qualifying income will be subject to the regular UAE Corporate Tax regime, which includes a 9% tax rate on taxable income exceeding AED 375,000. also, failing to meet the qualifying conditions or the de minimis requirements (where non-qualifying revenue must not exceed 5% of total revenue or AED 5,000,000) will disqualify the entity from the free zone tax regime for a minimum period of five years.

Understanding the distinction between Qualifying and Excluded Activities is important for businesses operating in the UAE free zones to ensure compliance and optimize their tax obligations

Tho know more about Qualifying and Excluded Activities, check out here.

Qualifying Income vs. Non-Qualifying Income

Businesses operating in the United Arab Emirates' free zones need to be familiar with the concept of qualifying income versus non-qualifying income under the Corporate Tax Law. This distinction significantly impacts their tax obligations.

Qualifying income refers to any earnings generated by a business with a Qualifying Free Zone Person (QFZP) status that benefits from a 0% corporate tax rate. This income must come from activities or transactions explicitly listed as qualifying and conducted entirely within the free zone. It's important to note that income from activities not on the approved list, such as banking or real estate, or transactions with entities outside the free zone (unless related to qualifying activities), does not qualify for the 0% tax rate.

In contrast, non-qualifying income means  any earnings that fall outside the qualifying criteria. This includes income from non-approved activities, transactions with non-free zone entities that don't involve qualifying activities, and any income exceeding a specific threshold. The good news is that there's a slight buffer zone. Even with some non-qualifying income, QFZPs can still enjoy the 0% tax rate if it meets the de minimis rule as discussed earlier. This rule allows for a small amount of non-qualifying income, either less than 5% of the total revenue or under AED 5 million (whichever is lower).

In simpler terms, qualifying income translates to no corporate tax, while non-qualifying income generally gets taxed at 9%. However, the de minimis rule offers some leniency for QFZPs with minimal amounts of non-qualifying income.

Tax Rates and Thresholds

• Qualifying Income: This refers to income earned by businesses that benefits from a 0% corporate tax rate. There's also a threshold - any qualifying income up to AED 375,000 is exempt from tax.
• Non-Qualifying Income: This income is subject to the standard corporate tax rate of 9%. It applies to income exceeding the AED 375,000 threshold or income derived from activities not classified as qualifying.
• Special Rates for Large Multinationals: There are additional considerations for multinational corporations (MNCs) with very high global revenues. These companies may be subject to a different tax rate under the Organisation for Economic Co-operation and Development's (OECD's) Base Erosion and Profit Shifting (BEPS) 2.0 framework.

This system creates a competitive tax environment, particularly for small and medium businesses, by offering a tax-exempt zone for a portion of their profits.

Compliance and Regulatory Requirements in UAE Corporate Tax

The UAE's corporate tax regime introduces new compliance and regulatory requirements for businesses, particularly those operating in free zones. Here's a breakdown of key aspects to ensure effective navigation of the system:

• Maintaining the 0% Tax Rate: Qualifying Free Zone Persons (QFZPs) benefit from a 0% tax rate on qualifying income. However, a small amount of non-qualifying income is allowed under the de minimis rule, capped at either 5% of total revenue or AED 5 million (whichever is lower). Staying within this threshold is crucial to retain the tax benefits.
• Consequences of Non-Compliance: Businesses failing to meet the qualifying criteria for income or activities lose the 0% tax advantage. This translates to a 9% corporate tax rate on all non-qualifying income.

Freezone Corporate Tax Filing Documents

Freezone Corporate tax in the UAE is calculated based on the net profit reflected in the company's financial accounts. To file tax returns and determine the amount of Corporate Tax owed, maintaining specific financial documents is essential. Here are the documents needed to prepare for filing Corporate Tax in the UAE:

• Financial statements for taxable income and exempt income calculation.
• Receipts for deduction claims.
• Records of asset depreciation for tax purposes.
• Documentation on transfer pricing and related party transactions.
• Information on financial reserve changes affecting taxable income.
• Proof of exemption status.
• Business loan documents for interest paid.
• Records of foreign taxes paid.

Freezone Corporate Tax Filing Timeline

Corporations and businesses operating in UAE freezones must adhere to specific deadlines for filing Corporate Tax. Here is a detailed timeline to help ensure compliance: 

Penalties  for the Free Zone Corporate Tax

 The UAE currently doesn't impose specific penalties related solely to the Free Zone corporate tax regime. However, the general UAE corporate tax framework outlines penalties for non-compliance that apply to both mainland and free zone businesses. Here's what you need to be aware of:

Exemptions from UAE Corporate Tax

The UAE's Corporate Tax Law offers exemptions for specific entities and income types. Here's a categorization to understand who qualifies for exemption:

Automatically Exempt Entities:

• Government and Related Entities: This includes the UAE Federal and Emirate governments, their departments, authorities, and other public institutions. also, companies wholly owned and controlled by a government entity carrying out mandated activities and listed in a Cabinet Decision are also exempt.

Entities Exempt Upon Notification:

• Natural Resource Businesses: Businesses engaged in extracting UAE natural resources or related non-extractive activities are subject to existing Emirate-level taxation. However, they can be exempt from the federal corporate tax upon meeting specific conditions and notifying the authorities.

Entities Requiring Application and Approval:

• Qualifying Investment Funds: Investment funds can apply for exemption if they meet the prescribed conditions set by the Ministry of Finance.
• Pension Funds: Public or private pension or social security funds can also seek exemption upon fulfilling the criteria specified in the relevant Ministerial Decision.
• Other Exempt Entities: There might be other entities eligible for exemption subject to application and approval by the Federal Tax Authority. It's advisable to consult the latest UAE tax regulations for a comprehensive list.

Reyson Badger - Freezone Corporate Tax Consultant

Freezone Corporate Tax in the UAE can be tricky, but it’s important to get it right. Filing your taxes on time and correctly helps avoid penalties and keeps your business running smoothly. Reyson Badger’s team is here to help you with every step, making sure you meet all the rules and requirements. With our full guidance , you can focus on growing your business while we handle your tax needs. Trust Reyson Badger to keep your tax matters in order, so you can achieve your business goals without any worries.