Disclaimer:
The official sources of information on Federal Taxes in the UAE are the Ministry of Finance and the Federal Tax Authority. The present article is not intended to provide official interpretation of the law and we draw the attention of our readers to the Public Notice published on the website of Ministry of Finance.
https://mof.gov.ae/corporate-tax/
1 – INTRODUCTION
Corporation Tax has been introduced in UAE with the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses, hereinafter referred as the Corporate Tax Law (CTL) and has come into effect for financial years commencing on or after June 1, 2023
According to Article 3 of the CTL, Corporate Tax (CT) applies to Qualifying Free Zone Persons (QFZPs) at the following rates:
- 0% on Qualifying Income
- 9% on income that is not Qualifying Income (QI)
Art. 18 of the CTL outlines the conditions that a Free Zone Person (FZP) must meet to be classified as a QFZP and also refers to a “decision issued by the Cabinet at the suggestion of the Minister” for the definition of QI.
The long-awaited Cabinet Decision 55 of 2023, which determines the concept of QI, and Ministerial Decision No. 139 of 2023, regarding Qualified Activities (QA) and Excluded Activities (EA), have finally being approved and were published on June 1, 2023.
2 – KEY DEFINITIONS
To gain a better understanding of the tax treatment for free zone companies, it is important to focus on certain terms as each has a specific definition in the law, and there are various interactions among these definitions:
- Free Zone FZ
- Free Zone Person FZP
- Designated Zone DZ
- Qualified Free Zone Person QFZP
- Qualifying Income QI
- Qualified Activities QA
- Excluded Activities EA
3 – ARE YOU A QUALIED FREE ZONE PERSON?
Determining whether a free zone company qualifies as a QFZP is not a straightforward question.
To be recognized as a QFZP, you must first be a FZP.
According to the CTL, a FZP is a “juridical person incorporated, established or otherwise registered in a FZ”. This brings us closer to the answer, but what exactly is a Free Zone (FZ)?
As per the definitions in the CTL, a FZ 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.”
At the time of writing this article, I have been unable to locate a Cabinet Decision that specifies all the designated and defined geographic areas within the UAE that qualify as FZs for the purposes of the CTL. I will assume that all companies registered with any of the 40+ free zones established in the UAE fall under the definition of FZP, however I recommend to monitor this topic hoping that the authorities will provide official guidance or will publish a Cabinet Decision with the list of all designated and defined geographic areas that qualify as FZ.
To be qualified as QFZP a FZP has to meet six conditions during each taxable period.
- derives Qualified Income;
- Non-Qualifying Revenue doesn’t exceed the de minimis requirements (5% of total revenues or 5m AED, whichever is lower);
- maintains adequate substance in the UAE;
- has not elected to be taxed ordinary;
- complies with the Arm’s length principles and transfer price documentation;
- maintains audited financial statements.
If a FZP fails to meet any of the above conditions it ceases to be a QFZP for the current tax period and the following four tax periods.
The first two conditions, QI and the de minimis, are definitely the key elements to be continuously monitored to assess the status as QFZP.
4 – QUALIFYING INCOME
In order to assess whether or not income earned by a FZP is QI, questions to be answered are the followings:
- with who the FZP is dealing with?
- What are the activities that the FZP is carrying out?
When dealing with non FZP (eg. mainland customers; overseas customers), only incomes from QA that are not expressly included in the list of EA shall be QI.
When dealing with other FZP, all incomes shall be qualified if not included in the list of EA.
Please refers to Schedule below.
5 – INCOME ATTRIBUTABLE TO IMMOVABLE PROPERTIES
Art. 6 of Cabinet Decision No. 55 regulates the income earned by FZP that is attributable to immovable properties located in a FZ. According to art. 6 income earned by a FZP from an immovable property located in a FZ is taxable income subject to 9%, exception made for incomes related to Commercial properties deriving from transactions with other FZP.
Taxable Revenues from immovable properties located in a FZ are disregarded for the computation of the De Minims ration.
Income from property located outside a FZ (either commercial or residential) is not a QI income since expressly included in the list of “EA.
Some examples may help to clarify the matter:
- FZP renting an office located in a FZ to another FZP 0%
- FZP renting an apartment located in a FZ to another FZP 9%
- FZP renting any immovable property located in a FZ to a non FZP 9%
FZP renting any immovable property located outside a FZ to either FZP or non FZP 9%
6 – THE DE MINIMS RATIO
Ministerial Decision N. 139 of 2023 introduced the “De Minimis” as an additional condition for eligibility as a QFZP.
Non-Qualifying Revenues in a tax period cannot exceed 5% of total revenues or 5 million AED, whichever is less.
The assessment of Non-Qualifying Revenues follows the same principles as described above for the QI:
- Revenues from transaction with either FZP or non FZP from EA non-qualifying
- Revenues from transaction with other FZP not from QA non-qualifying
Revenues from immovable properties located in a FZ and taxable at 9% are not included in the computation of the 5% De Minims ratio.
7 – PRACTICAL IMPACT ON CERTAIN BUSINESS ACTIVITIES
Few examples of typical businesses carried out by free zone companies may help to clarify and digest the new tax framework applicable to these companies.
Free Zone Companies providing generic management and consultancies services
These companies usually provide their services to a range of clients including natural person, mainland companies and overseas customers. It is unlikely that more than 95% of the revenues will be generated from FZP customers, hence these companies are likely to be subject to 9% CT due to failing the De Minimis condition.
Free Zone Companies acting as holding
Holding companies are typically engaged in activities that are included in the list of QA such as:
- holding shares and securities;
- headquarter services to related parties;
- treasury services to related parties.
In principle holding companies established in FZ may be able to take advantage of the zero-rate taxation as QFZP, however, they should be cautious about the de minimis requirement and should refrain to carry out any activity other than QA.
It is quite common for holding companies to have little revenues (no distribution of dividends from subsidiaries) hence even a small revenue from non-QA activities can affect the 5% threshold and disqualify the company for five tax periods.
Free Zone Companies involved in trading of commodities:
Dubai free zones attracted over the years a large number of companies involved in the trading of commodities.
The typical business model of these companies is based on the management of trading operations from the free zone, sourcing the commodities from overseas suppliers and reselling to overseas clients with direct shipping.
Paragraph (k) of Clause 1 of art 2 of Ministerial Decision 139 consider as QA the “Distribution of goods or materials in or from a Designated Zone ….” as defined for VAT purposes. Moreover, the Ministerial Decision specifies that “the activity of distributing goods or materials must be undertaken in or from a Designated Zone and the goods and material entering the State must be imported through the Designated Zone”.
Here there are two aspects to be outlined:
- Not all FZ are also DZ, for instance Dubai Multi Commodity Center Free Zone, that as the name may suggest is the most well-known free zone for the trading of commodities, is not included in the list of DZ.
- The specific wording “in or from a Designated Zone” may suggest that also companies operating from a DZ (eg. Jabel Ali FZ; Dubai Aviation City; Dubai Airport FZ), when operating with direct shipping of goods to overseas clients could not satisfy the conditions for QFZP since goods never hit the FZ territory.
8 – CONCLUSION
The qualification as QFZP involves an assessment of both the objects of the activities carried out and the subjects involved in the transactions. FZP willing to take advantage of the zero-rate taxation shall have to organize a strong compliance addressed to continuously monitor the respect of six conditions to be met, being aware that missing one of those conditions in a tax period disqualifies the company for five years.
Despite my expectation no specific relief has been given to free zone companies operating exclusively with foreign counterparties.
Given the complexity to assess and maintain the status of QFZP, small and medium free zone companies may find convenient to be treated as mainland companies that can enjoy zero tax rate on taxable profits up to 375.000 AED, or eventually the small business relief exemption (revenues below 3 million AED) for three years.
Official guidance from the Ministry of Finance and the Federal Tax Authority is likely to be published in the forthcoming months and will definitely help consultants and taxpayers in the application of the CT.
Stefano Menotti
Managing Director, Fidinam DMCC
Disclaimer: all information provided is of a general nature and is not intended to be a full analysis of the points discussed. This article is also not intended to constitute, and should not be taken as, legal, tax or financial advice by Fidinam. No one should act upon such information without appropriate professional advice after a thorough examination of the facts of the specific situation.