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UAE corporate tax: Who is considered a qualifying free zone person?

The UAE has recently introduced the corporate tax law, reshaping the nation’s fiscal landscape. This comprehensive article focuses on free zone persons—juridical entities within free zones—and explores the conditions that grant exemptions from corporate tax.

The corporate tax law seeks to achieve a balance between encouraging economic activity and ensuring a just tax environment, urging businesses to proactively engage with tax authorities for sustainable operations within this evolving regulatory framework.

A free zone person is a juridical person who is incorporated, established or otherwise registered in a free zone, including a branch of a UAE mainland or a foreign juridical person registered in a free zone.

In order for a free zone person to be exempt from corporate tax, it should at all times meet the following conditions:

• Maintains adequate substance in a free zone: The free zone person shall
 (i) undertake its core income-generating activities in a free zone, in addition to having an adequate number of qualified employees who are physically present in the UAE (temporary or long-term contracts)
 (ii) possess physical assets – to carry out the activity in a free zone, which can include offices or other forms of business premises
 (iii) incur adequate and appropriate operating expenditures;

• Has not elected to be, voluntarily, subject to corporate tax law;

• Complies with “Arm’s Length Principle” and “Transfer Pricing Documentation”: The Arm’s Length Principle stipulates that transactions between related parties should produce outcomes similar to those between unrelated parties in similar situations. To determine this, specific transfer pricing methods are used, such as comparable uncontrolled price, resale price, cost-plus, transactional net margin, or transactional profit split methods. If none of these methods are applicable, an alternative method satisfying certain conditions can be used.

The Federal Tax Authority assesses transactions based on the chosen method and adjusts taxable income if the transaction falls outside an acceptable range. If a foreign authority adjusts a transaction involving a taxable person, the person can apply for a corresponding adjustment to their taxable income.

• Derives qualifying income as specified in Cabinet Decision No. 55 of 2023 On ‘Determining Qualifying Income’, namely

 (i) income derived from transactions with other free zone persons,
 (ii) income derived from transactions with a non-free zone person, as long as such transaction does not include any of the excluded activities but only qualifying activities and
 (iii) any other income provided that the entity satisfies the de minimis requirements.

• Its non-qualifying revenue does not exceed the de minimis requirements: The de minimis requirement means that if non-qualifying revenue in a tax period is less than 5% of total revenue or Dh5,000,000 (whichever is lower), it is considered satisfied.

Non-qualifying revenue includes revenue from excluded activities and activities that are not qualifying activities with non-free zone entities. Certain types of revenue are excluded from this calculation, such as revenue from transactions involving immovable property in a free zone and revenue attributable to domestic or foreign permanent establishments of the free zone entity.

If the free zone entity meets the de minimis requirements:

1. 0% corporate tax is applied if income comes from transactions with other free zone persons, transactions with non-free zone persons from qualifying activities, and other income excluding specific categories.
2. 9% corporate tax is applied if income comes from excluded activities, income attributable to local or foreign permanent establishments, and income from ownership or exploitation of immovable property in certain cases.

If the free zone entity does not meet the de minimis requirements:

1. 0% tax is applied for taxable income up to Dh375,000.
2. 9% tax is applied for taxable income exceeding Dh375,000.

In case the de minimis requirements are not met, the free zone person loses its qualifying free zone person status for the current and subsequent four (4) tax periods.

• Prepares audited financial statements.

The differentiation in tax rates based on income thresholds and the application of the Arm’s Length Principle and Transfer Pricing Documentation underscore the UAE’s commitment to fair and transparent tax practices.

The implementation of the de minimis requirements introduces a pragmatic approach, offering flexibility to free zone entities. Meeting these requirements results in a tax exemption, while failure to do so may lead to the imposition of corporate taxes. The emphasis on audited financial statements adds an additional layer of accountability and transparency to the tax framework.

As businesses navigate this new regulatory landscape, collaboration with tax authorities and a proactive approach to meeting the outlined criteria will be essential for entities operating in the UAE.

Read the full article, as published in Finance Middle East: UAE Corporate Tax: Who is considered a qualifying free zone person.

This article was written by corporate lawyer Maroun Abou Harb and focuses on UAE Corporate Tax.

BSA is a regional Law Firm in the Middle East with offices in the UAE, Oman and Saudi Arabia. As a full-service law firm our practice areas include litigation, arbitration and corporate services, including M&A, banking & finance, Intellectual Property, TMT, Fintech, employment and insurance.

Published on 30 January, 2024.

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