Demystifying Corporate Tax Exemption for Free Zone Entities in the UAE

The United Arab Emirates (UAE) has introduced a corporate tax on net profits of businesses which is effective from June 1, 2023, and Free Zone entities can still enjoy some tax privileges under certain conditions. On the other hand, there has been a growing misconception among businesses that the Free Zones are totally tax-free. In other words, many believe that Free Zone entities automatically enjoy a 0% corporate tax rate. This notion has spurred a surge in the setup of Free Zone companies, with some dubious “business setup consultants” capitalizing on this misunderstanding. But is it really that straightforward? Are all Free Zone entities exempt from corporate tax in the UAE? Let’s dive into the intricacies of this matter to uncover the truth.

The 0% Corporate Tax Mirage

The assumption that all Free Zone entities are exempt from corporate tax is not entirely accurate. While the UAE offers attractive tax benefits for companies operating within Free Zones, these benefits are not universal and come with conditions. Without a clear understanding of these conditions, businesses may make poor decisions about where to establish themselves. So, let’s set the record straight.

Qualifying Free Zone Person (QFZP) and Qualifying Income

To enjoy a 0% corporate tax rate as a Free Zone entity in the UAE, you must first qualify as a “Qualifying Free Zone Person” (QFZP) and earn what is known as “Qualifying Income.” But what exactly constitutes “Qualifying Income,” and how do you become a QFZP?

Determining Qualifying Income

Qualifying Income varies depending on the source of the revenue:

1. Transaction with a Free Zone Person: All revenue generated from transactions with other Free Zone entities is eligible for the 0% corporate tax rate, except for revenue derived from “Excluded Activities.”

2. Transaction with a Non-Free Zone Person (including those outside the UAE): Only income from “Qualifying Activities” qualifies for the 0% tax rate. This income must not be associated with Excluded Activities.

3. Any Other Income: As long as it meets the “de-minimis” threshold, it is eligible for the 0% tax rate. The threshold is either 5% of the total revenue or AED 5 million, whichever is lower.

Exploring Qualifying Activities and Excluded Activities

To better understand these terms, let’s delve deeper:

– Qualifying Activities: These encompass a wide range of strategic business areas, including manufacturing, processing, distribution for resale purposes, holding of shares and securities, shipping, logistics services, reinsurance services, fund and investment management services, and more. Additionally, income from specific services to related parties, such as headquarters services and treasury and financing services, is included. Activities ancillary to the aforementioned also fall under Qualifying Activities.

– Excluded Activities: These comprise certain transactions with natural persons, activities related to banking, insurance, leasing, activities connected to immovable property, and activities related to intangible property. Just like Qualifying Activities, ancillary activities are also excluded.

Conclusion: Understanding the Fine Print

In the UAE’s Free Zones, the prospect of a 0% corporate tax rate is indeed enticing, but it is vital to grasp the nuances of the eligibility criteria. Not all businesses automatically enjoy this benefit, and the type of income and activities involved play a significant role. Before setting up a company in a Free Zone or seeking advice from unknowledgeable “free zone experts”, it is crucial to determine if your entity qualifies as a QFZP and if your income aligns with the Qualifying Income guidelines. Moreover, although it is important, the taxation is not the only criteria that you have to consider before choosing between free zones and mainland.

In the complex landscape of corporate taxation, knowledge is power. Make informed decisions for your business, understand the conditions, and consult with experts who can guide you through the intricacies of Free Zone taxation in the UAE. Don’t fall for the unconditional 0% corporate tax mirage; instead, navigate the system with precision and clarity to reap the tax benefits the UAE offers.