Cabinet & Ministerial Decisions Released Corporate Tax Rules For Free Zones

 

Brief

The recent release of the Corporate Tax Rules for Free Zones brings much-anticipated clarity to the taxation
framework. Cabinet Decision No 55 of 2023, along with Ministerial Decision No. 139 of 2023, sets out the
criteria for determining qualifying income and activities. These decisions are now in effect, providing a
comprehensive understanding of the rules under the CT Law.

Key Highlights

According to the UAE CT Law, Qualifying Free Zone Persons (QFZPs) are subject to specific tax rates: 0% on
Qualifying Income and 9% on Taxable Income that does not fall under the category of Qualifying Income. The
definition of “Qualifying Income” has been eagerly anticipated and has now been clarified to include the
following:

• Income derived from transactions with other Free Zone Persons, except for income generated from
  “Excluded Activities.”
• Income obtained from transactions with Non-Free Zone Persons, but only for “Qualifying Activities” that
  are not considered Excluded Activities.
• Any additional income is considered Qualifying Income, provided that the QFZP satisfies the specified de
  minimis requirements.

Excluded Activities encompass certain categories, including:

• Transactions involving natural persons (with specific exceptions for Qualifying Activities related to
  shipping, aircraft, fund, wealth, and investment management).
• Regulated activities in banking, finance, leasing, and insurance.
• Ownership or utilization of intellectual property assets.
• Ownership or utilization of immovable property, except for transactions with Free Zone Persons involving
  commercial property within a Free Zone.

Qualifying Activities encompass a range of operations, including:

• Manufacturing and processing of goods or materials.
• Holding of shares and other securities.
• Ownership and operation of ships.
• Regulated reinsurance and fund/wealth management.
• Provision of headquarters and financing services to related parties.
• Financing and leasing of aircraft.
• Logistics and distribution of goods in or from a designated zone, subject to specific
  conditions.

It should be noted that the definitions of excluded and qualifying activities generally align
with the meanings assigned to them under the applicable laws governing these activities
unless stated otherwise.

De Minimis Requirements:

To meet the de minimis requirements, non-qualifying revenue should not exceed either 5% of
total revenue or AED 5,000,000, whichever is lower. Non-qualifying revenue comprises
income derived from excluded activities or activities that do not qualify, involving non-Free
Zone persons.

Certain types of revenue are excluded from the calculation of non-qualifying revenue and
total revenue. This includes revenue related to specific immovable property within a Free
Zone, revenue from a Domestic or Foreign Permanent Establishment, and commercial
property transactions with non-Free Zone persons.

It is crucial to note that if a Free Zone Person fails to meet any of the qualifying conditions
specified in the UAE CT Law and these Decisions, they will be treated as a Taxable Person
subject to a 9% corporate tax rate for a minimum duration of five years.

Domestic Permanent Establishment (“PE”):

The concept of a Domestic Permanent Establishment (PE) is introduced in the Decisions,
applicable to Qualifying Free Zone Persons who have a presence or place of business outside
the Free Zone within the UAE.

Income attributed to a Domestic PE will be calculated separately as if it were a distinct and
independent entity, subject to a 9% corporate tax rate. However, the existence of a Domestic
PE will not affect the eligibility of the Free Zone Person to benefit from a 0% corporate tax
rate on Qualifying Income, nor will it be considered in the de minimis test mentioned earlier.
To determine whether a Qualifying Free Zone Person has a Domestic PE, the regular PE rules
outlined in Article 14 of the CT Law will be applied. Generally, a mainland branch of a
Qualifying Free Zone Person will be deemed a Domestic PE and subject to a 9% corporate
tax rate.

Adequate Substance in Free Zone:

In order to ensure adequate substance, a Qualifying Free Zone Person is required to:

• Conduct its core income-generating activities within a Free Zone.
• Maintain sufficient assets, employ a satisfactory number of qualified personnel, and incur
  an appropriate level of operating expenses relative to the activities carried out within the
  Free Zone.
• It is permissible for the Qualifying Free Zone Person to outsource its activities to a
  Related Party or a third party, as long as they are supervised by the Qualifying Free Zone
  Person.

KCG Insights

The recent Decisions regarding Corporate Tax in Free Zones mark a significant change in the
UAE’s tax framework. The introduction of a de minimis threshold has the potential to subject
Free Zone entities to full taxation under the new rules. It is crucial for companies to promptly
evaluate their readiness to register and adhere to the revised regime to ensure compliance.

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