In this segment, which is a continuing part of a series of articles on the ongoing implementation of Corporate Tax in the UAE, the focus will be laid on the subject of free zone entities and the special treatment of free zone entities under the new tax regime. Several enterprises in the HVACR industry in the UAE are incorporated as free zone companies (FZCs) and as free zone entities (FZEs), and the following insights would be highly relevant to them. The Corporate Tax Law for Free Zone-based enterprises revolves around the definition of “Qualifying Free Zone Persons”.

What are “Qualifying Free Zone Persons”?

According to Article 18 of the Corporate Tax Law, a “qualifying free zone person” is a free zone juridical person (FZC, FZE, etc.), who meets ALL of the following conditions:

1. Maintains adequate substance (of operations) in the State

2. Derives “Qualifying Income”

3. Has not elected to be subject to (regular) Corporate Tax, under Article 19 of the Corporate Tax Law

4. Maintains an arm’s length on all transactions with related parties

5. Maintains records on all transactions with related parties, including on transfer pricing

Krishnan Unni Madathil

It is to be noted that the above set of tests to determine whether an entity qualifies as a “Qualifying Free Zone Person” or not has to be performed for each tax period under consideration. The status of a free zone-based enterprise, as to whether or not they are a “Qualifying Free Zone Person”, can change from tax period to tax period, based on changing circumstances.

The above test is in addition to the “de-minimis” test to determine “Qualifying Free Zone Person” status, the latter which is discussed further below. In short, there are two tests to be performed each year to determine “Qualifying Free Zone Person” status, and the remainder of the tax treatment follows on from there.

What is the special corporate tax treatment given to “Qualifying Free Zone Persons”?

“Qualifying Income”, made through the performance of “Qualifying Activities” by “Qualifying Free Zone Persons”, will have their taxable income charged to Corporate Tax at the rate of zero per cent for the remainder of the tax incentive period, stipulated in the applicable legislation in their designated Free Zone. For example, this rate would apply for the remainder of the tax incentive period of 50 years in some free zones.

As an alternative, a Qualifying Free Zone Person can, as per Article 19 of the Corporate Tax Law, elect to have their entire taxable income subject to the standard Corporate Tax Rate of nine per cent on profits above AED 375,000.

What about free zone entities which do not or cannot qualify as “Qualifying Free Zone Persons”?

Entities, juridical persons based out of free zones that do not qualify as “Qualifying Free Zone Persons”, will be treated as regular UAE-based juridical persons, and will have their taxable incomes above AED 375,000 subject to Corporate Tax at nine per cent.

What is “Qualifying Income”?

Cabinet Decision No. 55 of 2023, supplementing Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“the Corporate Tax Law”), defines qualifying income as income derived from “qualifying activities”.

What are “Qualifying Activities”?

As per Ministerial Decision No. 139 of 2023, supplementing Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (“the Corporate Tax Law”), the list of “qualifying activities” is as follows:

1. Manufacturing of goods or materials. The definition of “manufacturing” here can be taken to include “assembly” of goods from parts

2. Processing of goods or materials

3. Holding of shares and other securities

4. Ownership, management and operation of ships

5. Regulated reinsurance services

6. Regulated fund management services

7. Regulated wealth and investment management services

8. Headquarter services to Related Parties (“Foreign Permanent Establishments”)

9. Treasury and Financing services to Related Parties (“Foreign Permanent Establishments”)

10. Financing and leasing of aircraft and aircraft parts

11. Distribution of goods or materials in/from a designated zone to a non-final consumer customer

12. Logistics services

13. Ancillary activities related to the above

What are non-qualifying or “Excluded Activities”, and what is the corporate tax treatment for revenues from such activities?

Activities that are not “qualifying activities”, as listed above, are “excluded activities”, and these include:

1. Transactions with natural persons

2. Regulated banking activities

3. Regulated insurance activities

4. Regulated Finance and Leasing activities

5. Ownership and exploitation of immovable property, other than free zone-to-free zone commercial property transactions

6. Ownership and exploitation of IP assets

7. Ancillary activities related to the above

Since these “excluded activities” are, by definition, not “qualifying activities”, revenue from such “excluded activities” will be subject to corporate tax at nine per cent, without the AED 375,000 minimum threshold. That is, the whole amount from such activities will be subject to corporate tax at nine per cent.

What is the “de-minimis” test to determine whether “Qualifying Free Zone Persons” enjoy the benefits to the special corporate tax treatment for a particular tax period?

The lower of the following two conditions should be considered when assessing whether a Qualifying Free Zone Person can benefit from the special Corporate Tax treatment attributable to them in any particular tax period:

1. The ratio of revenue from non-qualifying or “excluded” activities, as a percentage of overall revenue (revenue from “excluded” activities, plus revenue from “qualifying” activities) should not be greater than five per cent.

2. The revenue from non-qualifying or “excluded” activities should not be greater than AED 5,000,000.

For the purpose of computing the aforementioned de-minimis limits, above, revenue from Domestic Permanent Establishments (DPEs) or Foreign Permanent Establishments (FPEs) of the Qualifying Free Zone Person, will not be taken into consideration.

If the de-minimis requirements as described above are not met, then the Free Zone Person will not be a “Qualifying Free Zone Person” for a period of a minimum of five years from the tax period in which the requirements were determined to not be met, and the taxable income will be subject to Corporate Tax as a regular juridical person in the UAE – that is, at nine per cent on all taxable income above AED 375,000.

Krishnan Unni Madathil, Auditor, Bin Khadim, Radha & Co Chartered Accountants, writes a bi-monthly macro-analysis on geopolitics, incumbent political structures, global business and finance exclusively for Climate Control Middle East. He may be contacted at krishnan.madathil@binkhadimradha.com.