Understanding the Free Zone Corporate Tax Regime – Part 1

Welcome to the fourth part of our series on Comprehensive Corporate Tax Insights, where we delve into the intricacies of the Free Zone (FZ) Corporate Tax Regime in the UAE. This series aims to provide a thorough understanding of corporate taxation principles, building upon the foundation laid in our first article covering the Basics of Corporate Tax. The Corporate Tax Regime, offering a 0% Corporate Tax rate to eligible Free Zone companies and branches, plays a pivotal role in the UAE’s economic landscape. Designed to support the growth of Free Zones and bolster economic activities, this regime presents a wealth of opportunities for businesses. Join us as we explore the purpose, coverage, compliance requirements, taxation principles, and more of the FZ Corporate Tax Regime, guiding you through the intricate details of this essential aspect of UAE’s corporate taxation.

(For those new to the series, you can find the first article on the Basics of Corporate Tax here.)

Definition of Free Zone Corporate Tax Regime

The FZ Corporate Tax regime offers a 0% Corporate Tax rate to eligible Free Zone companies. This includes both companies and branches that meet specific criteria.

Purpose and Background

The FZ Corporate Tax regime was introduced to support Free Zones, which are crucial for the economic growth of the UAE. These zones contribute significantly to local and international economic activities.

Entities Covered Under Free Zone Regime

A FZ Person is a legal entity established under Free Zone regulations. This includes branches of mainland UAE or foreign entities within Free Zones. Additionally, a foreign company relocating to a UAE Free Zone also qualifies as a FZ Person.

Qualifying Free Zone Person

To benefit from the FZ Corporate Tax regime, entities must meet specific conditions. These conditions include maintaining adequate substance in a Free Zone, deriving Qualifying Income, and avoiding electing the regular UAE Corporate Tax regime.

Free Zone Compliance Requirements

Qualifying Persons must adhere to the arm’s length principle and transfer pricing rules. Additionally, they are required to prepare and maintain audited financial statements.

Penalties for Non-compliance

Failure to meet the conditions results in a loss of qualifying status. Entities cannot benefit from the FZ Corporate Tax regime for five Tax Periods.

Tax Treatment and Exclusions Taxation of Qualifying Free Zone Persons

Qualifying FZ Persons enjoy a 0% Corporate Tax rate on income from qualifying activities. Transactions with other FZ Persons are also subject to this preferential rate.

Excluded Activities

Certain activities, termed as Excluded Activities, may not qualify for the 0% rate. Profits from Permanent Establishments outside Free Zones are taxed at 9%.

Double Tax Treaty Relief

Relief is available under the UAE’s double tax treaty network, preventing foreign Permanent Establishment profits from being taxed twice.

Taxation of Immovable Property

Income from Immovable Property transactions with non-Free Zone entities is subject to a 9% tax. The distinction between Commercial and Residential Property for tax purposes is crucial.

Duration and Eligibility Expiration of Benefits

The benefits of the FZ Corporate Tax regime end as per FZ legislation. Extension of benefits requires a Cabinet Decision in accordance with the Corporate Tax Law.

List of Free Zones

For eligibility confirmation, entities can contact the relevant Free Zone Authority. This ensures clarity on the 0% Corporate Tax rate eligibility.

Difference Between Designated Zones and Free Zones

Designated Zones are Free Zones recognized for VAT purposes. They offer the 0% Corporate Tax rate for wholesale distribution of goods.

Uniformity and Eligibility Criteria

The criteria for Qualifying Free Zone Persons remain consistent across all UAE Free Zones. Regardless of their, eligibility requirements are the same.

Exclusion of Natural Persons

Only juridical persons, such as companies and partnerships, can benefit from the FZ Corporate Tax regime. Sole establishments and unincorporated partnerships are not eligible.

Foreign Companies and Ownership

Foreign companies can establish branches in Free Zones. Ownership structures do not restrict eligibility for the 0% Corporate Tax rate.

Timing of Establishment

Entities do not need to be established in a Free Zone before the first Tax Period. Newly established entities can immediately benefit from the FZ Corporate Tax regime.

Ease of Access for Foreign Entities

Foreign companies can swiftly benefit by registering branches in Free Zones. No specific prior requirements hinder access to the 0% Corporate Tax rate.

Benefits and Duration

The benefits of the FZ Corporate Tax regime expire per Free Zone legislation. The Cabinet Decision can extend these benefits, according to the Corporate Tax Law.

Foreign Company Eligibility

Foreign companies can register branches in Free Zones and benefit from the 0% Corporate Tax rate for Qualifying Income attributed to the Free Zone branch.

No Ownership Restrictions

Free Zone companies can benefit regardless of ownership by foreign persons. There are no restrictions on the level of foreign ownership.

Establishment Timing

Newly established entities can immediately benefit from the Free Zone Corporate Tax regime. No prior establishment in a Free Zone is required before the first Tax Period.

Juridical Persons Eligibility

Sole establishments and unincorporated partnerships are not eligible. Only juridical persons such as companies and partnerships qualify.

Foreign Company Transfers

Foreign companies can become Free Zone Persons by relocating to a UAE Free Zone. This allows them to continue as an entity incorporated or established in a Free Zone.

Extensive Benefits

Relief from Corporate Tax available under the UAE’s double tax treaty network. This prevents double taxation for foreign Permanent Establishment profits.

Taxation of Immovable Property

Income from Immovable Property in Free Zones is subject to a 9% Corporate Tax rate. This applies to transactions with non-Free Zone entities for Commercial Property.

Uniform Conditions

Qualifying Free Zone Persons must meet conditions set under the Corporate Tax Law. Conditions apply uniformly across all Free Zones in the UAE.

Benefits of Designated Zones

Designated Zones offer the 0% Corporate Tax rate for wholesale distribution of goods. This benefit extends to domestic and foreign businesses.

Cabinet Decision Extensions

Benefits of the FZ Corporate Tax regime can be extended through a Cabinet Decision. This follows the provisions of the Corporate Tax Law.

Establishment and Ownership

There are no limitations or restrictions on who can establish or own a Free Zone Person under the FZ Corporate Tax regime. This includes both local and foreign entities, ensuring equal opportunity for tax benefits.

Transition for Foreign Entities

Foreign or mainland UAE entities can transfer their place of incorporation to a Free Zone to become Free Zone Persons. This transition subjects them to the laws and regulations of the Free Zone, aligning them with locally established entities.

Scope of Tax Regime

The FZ Corporate Tax regime applies solely within the designated areas of the Free Zones. It covers income derived from transactions with other Free Zone Persons and Qualifying Activities conducted within the Free Zone.

Operations Outside Free Zone

Qualifying FZ Persons can operate outside the Free Zone, either in the mainland UAE or foreign jurisdictions. However, income from such operations is subject to the regular UAE Corporate Tax rate of 9%.

Relief from Double Taxation

Foreign Permanent Establishments of Qualifying FZ Persons can claim relief from double taxation. This relief can be sought under the Corporate Tax Law or relevant double tax treaties.

Minimum Investment and Employment

The FZ Corporate Tax regime does not impose minimum investment or employment requirements. Instead, entities must demonstrate adequate staff, assets, and operating expenditure relative to their Qualifying Income.

Qualifying Income Definition

Qualifying Income includes revenue from transactions with other FZ Persons and specified Qualifying Activities. Income from Excluded Activities is not eligible for the 0% Corporate Tax rate.

Automatic Application of Tax Regime

Entities meeting all relevant conditions automatically benefit from the FZ Corporate Tax regime. No formal election or application to the Federal Tax Authority is required.

Compliance and Document Maintenance

Alongside audited financial statements, entities must maintain relevant documents to evidence compliance. These documents include records of substance within the Free Zone and activities generating Qualifying Income.

Disqualification for Non-Compliance

Failure to meet conditions results in disqualification for five Tax Periods. During this period, entities are subject to the standard UAE Corporate Tax rate.

De Minimis Rules for Non-Qualifying Income

De minimis requirements allow entities to continue benefiting from the 0% tax rate for small amounts of non-Qualifying Income. These requirements prevent immediate disqualification for minor instances of non-eligible income.

Evaluation of Adequate Substance

Adequate substance is assessed based on the nature, scale, and location of activities. It includes having sufficient staff, assets, and operational expenditure aligned with income generation.

Supervision and Control in Outsourcing

While outsourcing is allowed, entities must maintain control and supervision over the outsourced activities. This ensures that outsourced activities contribute to the overall substance of the entity.

Determination of Substance Location

Entities can maintain substance in the Free Zone of registration or any other designated Free Zone. Activities conducted by related or unrelated parties within these zones contribute to the entity’s overall substance.

Verification and Determination by Federal Tax Authority

The Federal Tax Authority is responsible for verifying compliance with the FZ Corporate Tax regime. They determine eligibility and ensure adherence to the conditions set forth in the Corporate Tax Law.

In conclusion, the FZ Corporate Tax Regime presents a wealth of opportunities for entities operating within UAE’s Free Zones. With a 0% Corporate Tax rate on qualifying activities, relief from double taxation, and uniform eligibility criteria across all Free Zones, businesses can leverage these advantages for sustainable growth. However, adherence to compliance requirements, maintaining adequate substance, and understanding the delineation of Qualifying Income are crucial for maintaining eligibility. As the UAE continues to position itself as a hub for global business, the FZ Corporate Tax Regime stands as a cornerstone, offering a competitive edge to companies seeking to establish and expand their presence. By staying informed and compliant, entities can harness the full potential of this regime, paving the way for success in the vibrant economic landscape of the UAE’s Free Zones.

To stay updated with Corporate Tax Law and related implementing decisions you can visit this link.