Introduction
On the 1st of June 2023, provisions of the Federal Decree-Law No. 47 of 2022 – Taxation of Corporation and Businesses (further also as the ‘UAE CT Law’) entered into force and became an immanent part of the UAE tax landscape. As a result, the UAE has introduced corporate tax at the rate of 9% for most taxpayers.
On the first day of June 2023, the Cabinet and the Minister of Finance released for the public one of the most anticipated decisions regarding the corporate tax regime for the companies located in the UAE Free Zones[1].
The UAE CT Law introduced a category of taxpayers that can be subject to corporate tax at the reduced rate of 0% – the Qualifying Free Zone Persons (QFZPs).
Since the above creates a preferential treatment, an entity must meet certain conditions to benefit from being taxed at 0% in the UAE:
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- Incorporation, establishment, or otherwise registration in a free zone (including a branch of a non-resident person registered in a free zone);
- Maintenance of adequate substance in the UAE;
- Sourcing “Qualifying Income” as described by the Cabinet Decision No. 55 of 2023 and Ministerial Decision No. 139 of 2023;
- Compliance with transfer pricing provisions of the UAE CT Law;
- Does not apply to become a regular UAE CT taxpayer in the form of an election.
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Qualifying Income – what is this?
One of the biggest question marks for businesses operating in free zones that are contemplating an application for the QFZP was what will be considered as the Qualifying Income and whether sourcing income from the mainland will impact the QFZP status.
According to the CD No. 55 of 2023, the Qualifying Income can be derived from:
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- Transactions with other Free Zone Persons (also including those Free Zone Persons that do not have an attribute of the QFZP) that is not falling under the Excluded Activity.
- Transactions with mainland companies (or non-residents) that are falling under the Qualifying Activity but not under the Excluded Activity.
- Any other income that satisfied de minimis requirements.
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Qualifying and Excluded Activities – what are those?
The Minister of Finance, in the MD No. 139 of 2023 included lists of activities that are to be considered Qualifying Activities and Excluded Activities.
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- Qualifying Activities:
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- Manufacturing and processing of goods and materials.
- Holding shares and other securities.
- Ownership, management, and operation of ships.
- Activities that are subject to the regulatory oversight of the competent authority in the UAE:
- Reinsurance services.
- Fund management services.
- Wealth and investment management services.
- Services provided to Related Parties:
- Headquarters services.
- Treasury and financing services.
- Financing and leasing of aircraft (including engines and rotatable components).
- Logistics services.
- Distribution of goods/materials in or from a Designated Zone[2] for further distribution.
- Ancillary services to the above activities.
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- Excluded Activities
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- Any transactions with natural persons, except transactions concerning:
- Ownership, management, and operation of ships.
- Fund management services.
- Wealth and investment management services.
- Financing and leasing of aircraft (including engines and rotatable components).
- Activities that are subject to the regulatory oversight of the competent authority in the UAE:
- Banking activities.
- Insurance activities.
- Finance and leasing activities, except for those relating to treasury and financing for the Related Party and financing and leasing of aircraft.
- Ownership or exploitation of immovable property other than the property that is used exclusively for a business and not used for residential purposes that are in a Free Zone.
- Ancillary services to the above activities.
- Any transactions with natural persons, except transactions concerning:
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De minimis requirement – how it can impact the business?
The QFZP may derive revenue also from sources that do not fall under the Qualifying Income scope as long as de minimis requirements are met.
Based on the MD No. 139 of 2023, the amount that does not fall within the scope of the Qualifying Income cannot exceed 5% of the total revenue of the QFZP in the tax period of AED 5,000,000, whichever is lower. The Decision also provides information on how the above limit should be calculated.
Observing the above limit, along with maintaining the audited financial statements has been listed as one of the conditions to benefit from the QFZP.
Consequences for failing any of the conditions are rather significant since the business that breaches any of the conditions for the QFZP will cease to be a QFZP from the beginning of the tax period where the breach took place and for the subsequent four years.
In practice, if the QFZP exceeds the amount derived from the non-qualifying source above de minimis then all the taxable income generated in that period and four subsequent ones will be subject to the corporate tax at 9%. That can have a material impact on such businesses.
Maintaining substance in the Free Zone as a condition for the QFZP
The latest decisions also provided some clarity on how the condition of maintaining substance in the UAE should be understood by the business.
Under the CD No. 55 of 2023, the business needs to undertake its core income-generating activities in the Free Zone, and satisfying this condition will be made taking into account whether the business:
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- Has adequate assets in the Free Zone.
- Has an adequate number of qualified employees in the Free Zone.
- Incur adequate amount of operating expenditures in the Free Zone.
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The adequacy will be measured against the level of activities carried out by the business applying for the QFZP status.
The Decision also mentioned that outsourcing is allowed, however, it is possible only for entities located in the Free Zone that are either Related Parties or the QFZP has adequate supervision of the outsourced activity.
What is next for the business operating in the Free Zone?
Decisions provided much-needed guidance and understanding of conditions that need to be satisfied by a taxpayer to obtain the QFZP status. Some of the conditions, especially around substance, can still create some blurred lines, hence we recommend seeking professional advice to assess whether the business meets all criteria for the QFZP.
Like any business-related decision, an in-depth pros and cons analysis should be conducted by the business to decide whether an application for the QFZP status is beneficial for the organization.
Our team of experienced tax professionals is happy to assist you and provide guidance in the above matters.
[1] A. Cabinet Decision No. 55 of 2023 on Determining Qualifying Income for the Qualifying Free Zone Person for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (further also as the ‘CD No. 55 of 2023’) B. Ministerial Decision No. 139 of 2023 Regarding Qualifying Activities and Excluded Activities for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (further also as the ‘MD No. 139 of 2023’).
[2] It is a different zone than a Free Zone. List of all Designated Zones can be found in a separate Cabinet Decision.
If you would like more information about this topic, then please contact us at tax@amereller.com
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