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.
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:
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.
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 Person||FZP|
|Qualified Free Zone Person||QFZP|
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 Free Zone 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.
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.
In order to assess whether or not income earned by a FZP is QI, questions to be answered are the followings:
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 refer to Schedule 1 below:
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 Minimis 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%|
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 immovable properties located in a FZ and taxable at 9% are not included in the computation of the 5% De Minimis ratio.
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.
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.
Holding companies are typically engaged in activities that are included in the list of QA such as:
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.
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:
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.
By Stefano Menotti, Managing Director at Fidinam DMCC