Welcome to the fifth part of our series on Comprehensive Corporate Tax Insights. Operating within the UAE’s distinctive tax landscape, Qualifying Free Zone (FZ) Persons must comply with specific regulations. The transition from Economic Substance Regulations to the new UAE Corporate Tax regime introduces new reporting obligations. In this guide, we explore essential aspects of the Corporate Tax regime. This includes transfer pricing rules, income categorization, and compliance requirements.
For those new to the series, you can find the first article on the Basics of Corporate Tax here.
Adherence to Transfer Pricing Rules
For these entities, adherence to transfer pricing rules is essential. They must conduct transactions with Related Parties and Connected Persons, both within the UAE and abroad, at arm’s length terms and must maintain comprehensive transfer pricing documentation, regardless of the tax regime the counterparty falls under. This requirement applies irrespective of whether the Related Party or Connected Person also benefits from the Free Zone Corporate Tax regime, is subject to the standard UAE Corporate Tax regime, or is subject to the tax regime of a foreign country.
Free Zone Documentation Requirements
They also must prepare and maintain records supporting the arm’s length pricing of transactions, including a transfer pricing master file and local file, as stipulated by Ministerial Decision No. 97 of 2023.
Free Zone Financial Transparency
Qualifying FZ Persons are mandated to keep audited financial statements, ensuring accountability and accuracy in their financial reporting. An independent audit firm must audit these financial statements for accountability and accuracy in their financial reporting.
Income Categorization
Income derived from transactions with other FZ Persons generally qualifies as Qualifying Income. However, this excludes scenarios where the recipient is not the beneficial party or if the income stems from an Excluded Activity.
Beneficial Recipient Definition
Understanding who qualifies as the beneficial recipient of a transaction is crucial. When a Free Zone Person has the right to use and benefit from the supply without obligations to pass it on to another party, they are considered as such. Free Zone Persons acting as intermediaries, agents, or conduits on behalf of another person would not qualify as the beneficial recipient of the relevant transaction with the Qualifying FZ Person.
Excluded Activities
Excluded Activities play a significant role in determining tax treatment. These activities disqualify a Qualifying FZ Person from the FZ Corporate Tax regime, irrespective of whether the activities are performed exclusively within the FZ and regardless of whether the related income derives from transactions with a FZ Person or as part of undertaking a Qualifying Activity. The Ministerial Decision No. 139 of 2023 Regarding Qualifying Activities and Excluded Activities specifies the following Excluded Activities:
- Transaction with natural persons, except in relation to:
- Ownership, management, and operation of ships
- Fund management services*
- Wealth and investment management services*
- Financing and leasing of aircraft
- Regulated banking activities
- Regulated insurance activities, other than reinsurance services
- Regulated finance and leasing activities, other than intra-group treasury and financing activities and aircraft finance and leasing activities
- Ownership or exploitation of Immovable Property, other than Commercial Property located in a Free Zone
- Ownership or exploitation of intellectual property assets
Also, we will consider ancillary activities performed by the Qualifying FZ Person that serve no independent function but that are necessary for the performance of an Excluded Activity as Excluded Activity.
*subject to regulatory oversight of the competent authority in the UAE
Qualifying Activities
Conversely, Qualifying Activities are those that benefit from the FZ Corporate Tax regime. These include:
- Manufacturing of goods or materials
- Processing of goods or materials
- Holding of shares and other securities
- Ownership, management, and operation of ships
- Reinsurance services*
- Fund management services*
- Wealth and investment management services*
- Headquarter services to Related Parties
- Treasury and financing services to Related Parties
- Financing and leasing of aircraft, including engines and rotables
- Distribution of goods or materials in or from a Designated Zone
- Logistics services
Any ancillary activities performed by the Qualifying FZ Person that serve no independent function but that are necessary for the performance of a Qualifying Activity will also be considered a Qualifying Activity. Except for shipping, wealth and asset management, and aircraft finance and leasing activities, income from Qualifying Activities would only benefit from the FZ Corporate Tax regime where the income is derived from a juridical person. This is because transactions with natural persons are considered an Excluded Activity.
*subject to regulatory oversight of the competent authority in the UAE.
Guidance on Specific Activities
For those wondering about the specifics of Qualifying and Excluded Activities, Ministerial Decision No. 139 of 2023 is the go-to resource. It contains an exhaustive list, offering clarity on what falls under each category. The list of Qualifying Activities and Excluded Activities can be found in Ministerial Decision No. 139 of 2023 Regarding Qualifying Activities and Excluded Activities. A copy of this decision can be found on the Ministry of Finance website.
Equal Treatment of Transactions
Transactions with UAE domestic and foreign entities are treated equally under the Free Zone Corporate Tax regime. The location of a Free Zone entity, particularly in a Designated Zone, can impact the type of income it earns, whether Qualifying or Taxable.
Income from Intellectual Property
Royalties, license fees, and other forms of separately identifiable income from intellectual property assets such as patents, copyrights, and trademarks are income from an Excluded Activity. Where the revenue earned from intellectual property assets and other Excluded Activities exceeds the de minimis threshold, the Qualifying FZ Person will not be eligible to benefit from the FZ Corporate Tax regime.
Property Transactions
Income from commercial property within a Free Zone enjoys a 0% Corporate Tax rate for transactions with FZ Persons. However, income from property transactions with other entities, including natural persons, mainland, or foreign companies, is subject to the standard UAE Corporate Tax rate.
The treatment of income from Immovable Property, both within and outside Free Zones, is crucial. Income derived from transactions with a Free Zone Person in respect of Commercial Property located in a Free Zone is Qualifying Income that can benefit from the 0% Corporate Tax rate. Income derived from transactions with a natural person, a mainland or foreign company, or any other Person that is not a FZ Person in respect of Commercial Property (whether located in Free Zone or mainland UAE) is treated as Taxable Income that is subject to the standard UAE Corporate Tax regime at 9%.
The AED 375,000 zero tax band does not apply to income subject to the 9% Corporate Tax rate, excluding Qualifying FZ Persons from this benefit.
Permanent Establishments
Determining permanent establishments, whether domestic or foreign, follows established criteria in the Corporate Tax Law. Generally, a domestic or foreign Permanent Establishment would arise where the Qualifying FZ Person:
- has a fixed or permanent place outside of a Free Zone through which the business of the Qualifying Free Zone Person is carried on; or
- There is a person who has and habitually exercises an authority to conduct business outside of a Free Zone on behalf of the Qualifying FZ Person.
Proper attribution of income and expenditure to a domestic or foreign Permanent Establishment of a Qualifying FZ Person must be performed in accordance with internationally accepted profit attribution methods such as the Authorised OECD Approach and the relevant provisions of the Corporate Tax Law for the determination of Taxable Income. This requires the application of the arm’s length principle.
Double Taxation
Mitigating double taxation on income from foreign Permanent Establishments involves utilizing double tax agreements, exemptions, or claiming credits for foreign taxes paid. These mechanisms are available to ensure that income derived from foreign Permanent Establishments is not subject to double taxation and that Qualifying FZ Persons are not disincentivized from engaging in international trade or investment.
Mixed-Use Properties
Mixed-use properties within Free Zones require careful income attribution, separating Qualifying and non-Qualifying Income as per the arm’s length principle. This entails maintaining comprehensive transfer pricing documentation and other records to support the accurate allocation of income and expenditure.
Tax Group Limitations
Qualifying Free Zone Persons cannot join Tax Groups or access certain reliefs under the Corporate Tax Law, maintaining clarity on their tax obligations. This includes Small Business Relief or Business Restructuring Relief.
Reporting Obligations
All Free Zone Persons, regardless of qualification, must register and file UAE Corporate Tax returns, ensuring transparency and compliance with tax laws. This includes both Qualifying and non-Qualifying Free Zone Persons.
Domestic or foreign permanent establishments do not file separate returns; instead, they are included in the Qualifying Free Zone Person’s consolidated return.
Branches of mainland or foreign juridical persons within Free Zones also do not file separate returns; their profits are included in the parent company’s return.
Withholding Tax Considerations
Payments to Qualifying Free Zone Persons are not subject to withholding tax in the UAE. However, foreign withholding tax may apply, with possible exemptions based on double tax treaties. The UAE has an extensive network of double tax treaties in place to mitigate the impact of withholding taxes on cross-border transactions.
Deductibility of Payments
The deductibility of payments to Qualifying Free Zone Persons follows general Corporate Tax Law rules, ensuring fair treatment of business expenditures. This includes adherence to the arm’s length principle and the requirement for transactions to be conducted on commercial terms.
Future Global Tax Standards
In the future, Qualifying Free Zone entities may be subject to global minimum tax rules, aligning with international tax standards. This will apply to large multinational groups.
Residency and Treaties
For tax purposes, Free Zone Persons are generally treated as Resident Persons in the UAE, except for branches, which are considered Non-Resident Persons.
Accessing double tax treaties is possible for Free Zone Persons, subject to meeting residency and other treaty-specific requirements. This allows for the reduction or elimination of withholding taxes on cross-border transactions.
In conclusion, Qualifying Free Zone Persons in the UAE navigate a complex landscape of regulations and requirements. From transfer pricing to income categorization, understanding and complying with the Corporate Tax regime are essential for these entities. With detailed guidelines on Qualifying and Excluded Activities, as well as proper documentation and reporting, Qualifying Free Zone Persons can ensure tax compliance while maximizing benefits within the Free Zone Corporate Tax regime.
To stay updated with Corporate Tax Law and related implementing decisions you can visit this link.
