Free Zone Companies in the United Arab Emirates are renowned for their numerous benefits, including 100% foreign ownership, simplified administrative procedures, and attractive tax incentives such as exemption from import VAT and customs duties, as well as exemption from income tax. However, with the introduction of the new Corporate Income Tax Law in January 2022, effective from the fiscal year commencing on or after June 1, 2023, the question arises: Is the era of tax exemption in these zones over?
The newly introduced Corporate Income Tax (hereinafter "CIT") of 9% generally applies to all companies in the UAE. However, there is an opportunity for companies in the Free Zones to avail a 0% tax rate if they can obtain the status of a "Qualified Free Zone Person” (hereinafter "QFZP"). The criteria for this status and its associated implications are crucial for tax planning and are discussed in detail below.
Meeting the Criteria for QFZP Status
To be recognized as a QFZP, a company must meet the following conditions:
- Demonstration of adequate substance in the Free Zone
- No application for regular taxation
- Compliance with the arm's length principle
- Adherence to transfer pricing documentation requirements
- Fulfillment of De-Minimis-Requirements
- Submission of audited financial statements
- Generation of so-called “Qualifying Income”
What constitutes Qualifying Income?
Cabinet Decision No. 100/2023 defines income that qualifies as Qualifying Income, distinguishing between transactions with other Free Zone companies and those with non-Free Zone companies. Income from transactions between Free Zone companies is considered Qualifying Income, provided it does not result from harmful activities. However, for dealings with individuals or entities outside the Free Zones (Mainland or abroad), income must stem from non-harmful activities to be recognized as Qualifying Income.
Harmful and non-harmful activities
Non-harmful activities include manufacturing, processing, and trading in goods and materials, trade, financial services to related entities, as well as logistics services. Harmful activities primarily encompass dealings with natural individuals, regulated financial and insurance activities, and trading in real estate.
Legal consequences of obtaining QFZP status
Companies that attain QFZP status benefit from certain advantages, but are also subject to specific obligations. These include the requirement to submit audited financial statements and disclose certain information in their tax returns. Additionally, these companies are not allowed to avail the exemption threshold of AED 375,000 or be part of a group. Given these circumstances, it is crucial to carefully assess the application for QFZP status for potential positive and negative implications to avoid undesirable tax consequences.
Conclusion
While Free Zone companies may potentially be exempt from CIT, this largely depends on the business model and the ability to obtain and maintain QFZP status. Companies in the Free Zones are advised to examine this issue thoroughly to ensure timely and accurate registration as well as the submission of their initial tax return.
