Is Corporate Tax Applicable for Freezone Companies?

Yes, corporate tax applies to Freezone companies in the UAE, but with specific conditions and benefits that differ from mainland companies. Under the new Federal Decree-Law No. 47/2022 on the Taxation of Corporations and Businesses, Free Zone entities, known as Free Zone Persons, can be categorised into Qualifying Free Zone Persons (QFZPs) and Non-Qualifying Free Zone Persons (NQFZPs).QFZPs may be eligible for a 0% tax rate on qualifying income if they meet certain conditions, such as having adequate substance in the UAE and deriving "Qualifying Income" as specified in the legislation. In this article, we will look into the Applicability of Corporate Tax on Freezone Company in Detail.

Filings.ae assists with UAE Corporate Tax Registration and return filing.

What is Corporate Tax?

Corporate Tax (CT) in the UAE is a form of direct tax imposed on the net income or profit of corporations and other business entities. It was introduced to strengthen the UAE's position as a global hub for business and investment, aligning its tax system with international standards and enhancing tax transparency. The Federal Decree-Law No. 47 of 2022, along with amendments made by Federal Decree-Law No. 60 of 2023, governs the CT, making it applicable to all businesses and commercial activities in the UAE, including those in Free Zones.

Categories of Persons under UAE Tax Law

To grasp how Corporate Tax affects Free Zone entities in the UAE, it's crucial to differentiate between the two main categories of persons under UAE tax legislation: Natural Persons and Juridical Persons.

Natural Persons

This group consists of individuals conducting business in their personal capacity, such as freelancers, sole proprietors, and civil companies. It's important to note that these individuals, even when operating within a Free Zone, are not classified as Free Zone Persons according to UAE tax regulations.

Juridical Persons

This category includes incorporated entities like Limited Liability Companies (LLCs). A key distinction is that these entities can qualify as Free Zone Persons if established within a Free Zone.

Classifications of Free Zone Entities Under UAE Corporate Tax

In the context of UAE Corporate Tax, entities within Free Zones are distinguished into two distinct categories, each with its own set of tax implications:

Qualifying Free Zone Person (QFZP)

This classification is assigned to Free Zone entities that fulfill certain criteria outlined in the tax legislation. QFZPs are eligible for specific tax advantages, such as a 0% tax rate on qualifying income, following the stipulated legal provisions.

Non-Qualifying Free Zone Person (NQFZP)

Conversely, an NQFZP refers to a Free Zone entity that falls short of meeting the requisite conditions to be deemed a QFZP. Consequently, NQFZPs may not be privy to the same tax benefits or exemptions available to QFZPs.

Tax Rates Applicable to Free Zone Companies

For Qualifying Free Zone Persons, the Corporate Tax will be applied as follows:

• 0% on Qualifying Income
• 9% on Taxable Income that does not constitute Qualifying Income

Eligibility for a Qualifying Free Zone Person Status

A Qualifying Free Zone Person (QFZP) is identified by fulfilling ALL the criteria listed below:

• Establishing Adequate Substance in the UAE: This involves engaging in core income-generating activities within a Free Zone, possessing the necessary assets, employing a sufficient number of qualified staff, and incurring adequate operational expenses for these activities.
• Earning "Qualifying Income": As outlined in cabinet decision no. 55 of 2023, a QFZP must generate income that meets specific qualifications outlined in the legislation (details to be expanded later in the article).
• Opting Out of the 9% Tax Rate: A QFZP should not elect to be taxed at the standard 9% corporate tax rate applicable to other entities.
• Adherence to Arms Length & Transfer Pricing Regulations:strong> Compliance with the Arms Length Principle (Article 34) and Transfer Pricing Guidelines (Article 55) as mandated by the Decree-Law is essential.

Fulfilling Additional Requirements in Cabinet Decision No. 139 of 2023 includes ensuring non-qualifying revenue falls below a certain threshold and maintaining audited financial statements.

Business Activity Classifications for Free Zone Taxation

The UAE's tax framework, particularly under Cabinet Decision 139 of 2023, categorises Free Zone business activities into three main types, each with its tax implications:

• Qualifying Activities: This group consists of 13 defined activities specified in Cabinet Decision 139 of 2023. Free Zone enterprises conducting these activities while fulfilling specific criteria are recognised as engaging in Qualifying Activities. Such businesses may be eligible for specific tax advantages or exemptions.
• Excluded Activities: The legislation identifies 7 activities as Excluded Activities. Companies in Free Zones undertaking these activities might not qualify for the tax benefits or exemptions available to those involved in Qualifying Activities.
• Other Activities: This broad category includes all other business activities not explicitly listed as Qualifying or Excluded. The tax treatment for these activities depends on their characteristics and how they align with the prevailing tax laws.

List of Qualifying Activities for Free Zone Tax Benefits

The UAE's Cabinet Decision 139 of 2023 specifies a range of business activities that qualify for certain tax benefits within Free Zones. Entities engaged in these activities, subject to meeting specific criteria, can access various tax exemptions or reduced rates. The qualifying activities include

• Manufacturing: The production of goods or materials.
• Processing: The transformation of goods or materials through various processes.
• Holding of Securities: Ownership and management of shares and other financial securities.
• Ship Operations: Ownership, management, and operation of maritime vessels.
• Reinsurance Services: Provision of insurance services to other insurance companies.
• Fund Management: AWealth and Investment Management:dministration and handling of investment funds.
• Services related to managing individual or corporate wealth and investments.
• Headquarter Services: Provision of centralised management and administrative services to related entities.
• Treasury Services: Financial management services, including cash flow management, funding, and investment activities for related parties.
• Aircraft Financing and Leasing: Financial services related to the acquisition, financing, and leasing of aircraft, including engines and rotatable components.
• Distribution in Designated Zones: Distribution of goods or materials within or from a Designated Zone, mainly when such goods are intended for resale or further processing by the purchaser.
• Logistics Services: Provision of logistics and supply chain management services.
• Ancillary Activities: Any activities that support or are supplementary to the qualifying activities.

These activities are recognized for their potential to contribute significantly to the UAE's economic diversification and are thus incentivised under the tax framework for Free Zones. Businesses in these areas must thoroughly understand the specific conditions and regulations to benefit from the available tax advantages fully.

List of Excluded Activities for Free Zone Tax Benefits

Under the UAE's tax framework, certain business activities are designated as Excluded Activities, meaning entities engaging in these activities may not qualify for the tax benefits or exemptions typically available to Free Zone businesses. These Excluded Activities include:

• Transactions with Natural Persons: Generally, transactions with natural persons are excluded, with exceptions for:
  • Ownership and management of ships
  • Fund management services
  • Wealth management services
  • Financing and leasing of aircraft
• Banking Activities: Traditional banking services are excluded from qualifying for Free Zone tax benefits.
• Insurance Activities: This excludes all insurance-related activities except for reinsurance services.
• Finance and Leasing Activities: Excluded with exceptions for:
  • Treasury and financing services provided to related parties
  • Financing and leasing of aircraft
• Ownership or Exploitation of Immovable Property: Generally excluded except for:
  • Commercial properties located within a Free Zone, provided transactions concerning such properties are conducted with other Free Zone entities.
• Ownership or Exploitation of Intellectual Property Assets: Activities related to intellectual property ownership or commercial exploitation are excluded.
• Ancillary Activities: Any activities that support or are supplementary to the aforementioned excluded activities are also not eligible for Free Zone tax benefits.

Entities within Free Zones should carefully assess their business activities against this list to determine their eligibility for tax advantages under the UAE's Corporate Tax regime.

Defining Qualifying Income Under UAE Free Zone Tax Rules

Qualifying Income plays a pivotal role in the UAE Free Zone tax framework, shaped by the specifics of business dealings and the entities involved.

Interactions Within Free Zones:

• Definition: Qualifying Income encompasses earnings from all engagements, barring those from Excluded Activities.
• Implication: Revenue generated from transactions among Free Zone companies qualifies if the activities aren't listed as exclusions.

Engagements with Entities Outside Free Zones:

• Definition: Qualifying Income is limited to earnings from activities deemed as Qualifying.
• Implication: Income from transactions that involve Excluded Activities with entities outside the Free Zones does not qualify.

Other Sources of Income:

• Definition: Encompasses additional income streams for a Qualifying Free Zone Person, conditional on meeting de minimis requirements related to specific thresholds or limits.
• Implication: Certain income types might qualify if they adhere to these conditions, which will be clarified regarding de minimis calculations.

Exclusions:

Earnings from Domestic or Foreign Permanent Establishments (like branches in the Mainland or abroad), revenue from transactions involving immovable commercial property with entities outside the Free Zones, and income from non-commercial property transactions, irrespective of the counterparties are excluded from Qualifying Income.

Taxation on Income from Domestic and Foreign Permanent Establishments

• Under the UAE's tax framework, income generated by a Free Zone entity through either a Domestic Permanent Establishment or a Foreign Permanent Establishment is subject to a 9% Corporate Tax rate. Here's a breakdown:
• Domestic Permanent Establishment: This refers to any fixed place of business within the UAE's mainland areas, outside the Free Zones, where a Free Zone entity conducts its business operations, partially or entirely. Income earned through such establishments is taxed at 9%.
• Foreign Permanent Establishment: This relates to a business operation or fixed place of business outside the UAE. Income attributed to such overseas establishments is also liable for taxation at the 9% rate.

Tax Treatment of Income from Immovable Property in Free Zones

In the UAE, the tax treatment of income from immovable property situated within Free Zones varies depending on the property type and the nature of the transactions involved:

Income from Commercial Property

Commercial property, used solely for business activities and not as residential accommodation, is subject to different tax rates based on the counterparty:

• Transactions with Non-Free Zone Persons: Income arising from dealings with entities outside the Free Zone is subject to a 9% tax rate.
• Transactions with Free Zone Persons: Income from transactions between Free Zone entities is classified as Qualifying Income, attracting a 0% tax rate.

Income from Non-Commercial Property

This encompasses immovable property not utilised for business operations. The tax rate applied is uniform at 9%, irrespective of whether transactions are with Free Zone or Non-Free Zone entities.

Types of Freezone Business Transactions applicable for Corporate Tax

The new corporate tax regime in the UAE has implications for various freezone business transactions. Here's a breakdown of how different scenarios are treated:

• Export of Goods and Services: Transactions between a free zone company and a business outside the UAE are completely tax-exempt. This means free zone businesses pay no corporate tax on profits earned from international trade.

• Intra-Free Zone Trade: Profits generated from trade with other companies within the same free zone also benefit from a 0% tax rate. This fosters a thriving internal market within the free zone.

• Passive Income from Mainland (Limited Cases): Even without a mainland presence, a free zone person can receive certain types of passive income from the UAE mainland without incurring corporate tax. This includes interest, royalties, dividends, and capital gains from holding shares in mainland companies (subject to specific conditions).

• Mainland Branch Income: If a free zone person has a branch operating on the UAE mainland, the branch's income derived from mainland sources will be subject to the standard 9% corporate tax rate. However, the branch's income from non-mainland sources remains tax-exempt.

• Payments from Mainland Group Companies: While income received by a free zone person from group companies based on the mainland is not taxed in the free zone, the corresponding expense for the mainland group company may not be tax-deductible. This means the mainland company might still face a 9% tax burden on the payment.

• Sales to Mainland Importer: If a free zone person sells products to a UAE mainland company and the mainland company acts as the record importer (responsible for customs duties), the free zone person enjoys a 0% tax rate. However, any deviation from this structure could lead to a 9% tax implication.

• Non-Qualifying Mainland Income: Any other type of income a free zone person generates from the UAE mainland that doesn't fall under the tax-exempt categories (points 1-3) will be subject to the standard 9% corporate tax rate.

Conclusion

In conclusion, while Corporate Tax applies to Freezone companies in the UAE, the specific conditions and benefits they enjoy differ significantly from mainland companies. If a Free Zone company meets certain conditions, like doing the right kind of business and having a real presence in the UAE, it could pay 0% tax on some of its earnings. This new tax system aims to make the UAE attractive for businesses while keeping up with global tax standards.

Filings.ae offers assistance in obtaining Corporate Tax Registration and preparing and submitting Corporate Tax returns.