Understanding Free Zone Corporate Tax Rules

(FTA Guide released as on 20.05.2024)

Introduction and Free Zone Tax Rules

Free Zones are integral part of the UAE economy, fostering economic growth and transformation both in the UAE and internationally. They offer numerous benefits, including relaxed foreign ownership restrictions, streamlined administrative procedures, modern infrastructure, developed business communities, and availability of additional legal entity forms and commercial activities.

 

To recognise the importance of Free Zones, the UAE Corporate Tax rules allow Free Zone companies and branches that meet certain conditions to benefit from a 0% Corporate Tax rate on certain Qualifying Activities and transactions. Generally, the Corporate Tax rules for Free Zones are intended to provide a 0% Corporate Tax rate on Qualifying Income from:

 

• Transactions between Qualifying Free Zone Persons (QFZPs) and other Free Zone Persons, where the Free Zone Person is the Beneficial Recipient.
• Certain activities performed within the designated geographical areas of a Free Zone (or a Designated Zone for distribution activities).

 

The list of Designated Zones for VAT purposes is specified in Cabinet Decision No. 59 of 2017. All taxpayers should verify with their respective Free Zone Authority whether they operate in a Free Zone or Designated Zone for Corporate Tax purposes.

 

Taxation of a QFZP/Corporate Tax Rate for QFZPs:

A QFZP meeting all conditions is taxed at:

• 0% on Qualifying Income
• 9% on Taxable Income that is not Qualifying Income

QFZPs cannot benefit from the 0% rate on Taxable Income up to AED 375,000 and are excluded from certain tax reliefs.

 

Taxation of a FZP that is not a QFZP:

If a Free Zone Person does not meet the criteria to be a QFZP, it will be subject to the standard Corporate Tax rates from the beginning of that Tax Period (unless it qualifies to be an Exempt Person). The standard rates are:

• 0% on Taxable Income up to AED 375,000.
• 9% on Taxable Income exceeding AED 375,000.

 

Losing QFZP Status:

An FZP that elects standard Corporate Tax rules or fails QFZP criteria loses QFZP status from the start of the relevant Tax Period and for the next four Tax Periods.

 

Conditions to be a QFZP

A Free Zone Person (FZP) must meet all conditions in the CT Law and implementing decisions to be considered a Qualifying Free Zone Person (QFZP). Failure to meet these conditions will result in the FZP being subject to standard Corporate Tax rules and rates. An FZP is deemed a QFZP unless it fails a condition or elects to be subject to tax.

 

1. 1. Must be a Free Zone Person

A Free Zone Person (FZP) is defined as a juridical person incorporated, established, or otherwise registered in a Free Zone including a branch of a Non-Resident Person or a UAE juridical person that is registered in a Free Zone. For clarity, this includes the relevant Free Zone authorities and other Government Controlled Entities that are established in a Free Zone.

The term “Free Zone Person” refers to the juridical person as a whole. This means that a Free Zone Person may:

1. 1. • have its head office in a Free Zone and have a branch outside the Free Zone, or
      • have a head office in the UAE (outside a Free Zone) or another country and have a branch within a Free Zone. In this situation the head office would be generally considered a Domestic or Foreign PE, respectively.

Disclaimer: Please note that FTA has not issued/specified any list of free zones which are considered as Free Zones for corporate tax purposes.

 

1. 1. Adequate Substance in a Free Zone

The FZP must conduct core income-generating activities in a Free Zone (or Designated Zone for distribution) with adequate assets, full-time employees, and operating expenditures. These activities may be outsourced within the Free Zone (or Designated Zone) with adequate supervision.

 

1. 1. Deriving Qualifying Income

Qualifying Income must be derived from:

1. 1. • Transactions with other Free Zone Persons (not including Excluded Activities)
      • Qualifying Activities (not Excluded Activities)
      • Ownership/exploitation of Qualifying Intellectual Property
      • Other income meeting de minimis requirements

Income from Domestic or Foreign Permanent Establishments, Immovable Property (except certain Commercial Property in a Free Zone), and non-Qualifying Intellectual Property is subject to the 9% Corporate Tax rate.

 

1. 1. Not Elected to be Corporate Tax Rules and rates

The FZP must not have elected to be subject to standard Corporate Tax rules and rates under Article 19 of CT Law.

 

1. 1. Compliance with Arm’s Length Principle

The FZP must adhere to the arm’s length principle for transactions with Related Parties and arrangements involving Permanent Establishments, ensuring profits reflect functions, assets, and risks appropriately.

 

1. 1. Maintenance of Transfer Pricing Documentation

The FZP must maintain Transfer Pricing documentation, including a master file, local file, and disclosure form, to support the arm’s length nature of transactions with Related Parties and Connected Persons.

 

1. 1. Audited Financial Statements

The FZP must prepare and maintain audited Financial Statements regardless of Revenue amount.

 

1. 1. De Minimis Requirements

Non-qualifying Revenue must not exceed the lower of AED 5,000,000 or 5% of total Revenue. Certain income sources do not count towards total or non-qualifying Revenue for this calculation.

 

Corporate Tax for FZP

Types of Income

A QFZP can derive either Qualifying or Non-Qualifying Income as mentioned below:

 

Qualifying Income

Qualifying Income is defined in relation to the following categories:

• Transactions with a Free Zone Person who is the Beneficial Recipient of the transaction (excluding Revenue from Excluded Activities)
• Transactions in respect of Qualifying Activities (excluding Revenue from Excluded Activities)
• Qualifying Income from Qualifying Intellectual Property
• Other sources (including Revenue from Excluded Activities) if the QFZP satisfies the de minimis requirements.

Income from Immovable Property located in Free Zone and is derived in a transaction with a Free Zone Person with respect to Commercial Property.

 

Taxable Income that is not Qualifying Income:

Revenue from the following sources is not considered as Qualifying Income:

• Revenue attributable to a Domestic or Foreign Permanent Establishment
• Revenue in respect of Immovable Property (except when it is considered as Qualifying Income as mentioned above)
• Revenue from the ownership or exploitation of intellectual property (except Qualifying Income as mentioned above)

A QFZP must perform the below in respect in Income that is not Qualifying Income:

• Separate the Revenue in its Financial Statements into Revenue pertaining to the Qualifying Income component and the Taxable Income component.
• Allocate expenses in its Financial Statements against those components in a reasonable manner, consistent with the arm’s length principle.
• Apply Article 20 of the Corporate Tax Law to determine the Taxable Income that is not Qualifying Income.

 

Allocating Expenses:

Where a QFZP derives both Qualifying Income and Taxable Income that is not Qualifying Income, it needs to allocate its expenses between these components using the arm’s length principle. The Foreign Permanent Establishment or Domestic Permanent Establishment must be treated as separate and independent Persons transacting at arm’s length.

A two-step approach is required:

Step 1: Conduct a functional analysis to identify the functions, assets, and risks of the Foreign or Domestic Permanent Establishment and the Free Zone Business.

Step 2: Determine the compensation relating to arrangements between the Foreign or Domestic Permanent Establishment and the Free Zone Business.

Where expenses are incurred specifically for a determined income component, those expenses should be allocated directly. For non-directly attributable expenses, allocation keys (e.g., headcount, floor space, usage, time spent) should be used, ensuring the allocation is consistent with the arm’s length principle and is applied consistently across Tax Periods unless justified by a change in fact pattern.

 

Taxable Income Subject to the 9% Rate of Corporate Tax:

To determine the amount of Taxable Income that is not Qualifying Income and subject to the 9% Corporate Tax rate, QFZP should start with income and expenses that do not pertain to Qualifying Income and apply the standard rules of the Corporate Tax Law (excluding Exempt Income and certain reliefs that a QFZP cannot benefit from, such as Small Business Relief, Qualifying Group Relief, Business Restructuring Relief, Tax Loss transfers, and Tax Group membership)

 

Adequate supervision

A Free Zone Person should be able to demonstrate that it has adequate supervision through appropriate documentation, such as contractual agreements that set out how the supervision will be conducted and implemented from both practical and operational standpoints. The contractual arrangements should also be confirmed by the actual conduct of the parties.

If core income-generating activities are outsourced to another Person without adequate supervision, those activities would not be considered to be performed by the Free Zone Person and the requirement to maintain adequate substance in a Free Zone would not be met.

 

List of Qualifying Activities & Excluded Activities:

Qualifying Activities	Excluded Activities
Manufacturing of goods or materials	Any transactions with natural persons, except:
Processing of goods or materials	•       Ownership, management and operation of Ships
Trading of Qualifying Commodities	•       Fund management services
Holding of shares and other securities for investment purposes	•       Wealth and investment management services
Ownership, management and operation of Ships	•       Financing and leasing of Aircrafts
Reinsurance services	Banking activities
Fund management services	Insurance activities except reinsurance services, and headquarter services
Wealth and investment management services	Finance and leasing activities except treasury and aircraft financing,
Headquarter services to Related Parties	Ownership or exploitation of immovable property (other than Commercial Property located in a FZ where the transaction in respect of such Commercial Property is conducted with other FZPs.)
Treasury and financing services to Related Parties
Financing and leasing of Aircrafts
Distribution of goods or materials in or from a Designated Zone
Logistics services
Any activities that are ancillary to the Qualifying Activities specified in paragraphs (a) to (m) of this Clause.

 

Immovable Property

Immovable Property located in a Free Zone:

• Income from transactions with a Free Zone Person in respect of Commercial Property located in a Free Zone is treated as Qualifying Income. Hence income from such transactions will not be treated as Taxable Income.
• Any other type of income from immovable property located in a Free Zone is not considered as Qualifying Income and is disregarded for the purpose of calculating the de-minimis requirements.

Immovable Property located outside a Free Zone:

• Income from transactions with any person in respect of any type of Property located outside a Free Zone is treated as Income from Excluded Activity. Hence such transaction is considered for applying de-minimis requirements and is taxable at 9%.

 

Mix use property located in Free Zone

Income derived from a mixed-use property located in a Free Zone shall be subject to Corporate Tax at 0% and 9%, based on the use of the respective components of the property.

 

Intellectual Property

The Free Zone rules provide a benefit to QFZPs that carry out R&D activities to create Qualifying Intellectual Property. A QFZP will derive Qualifying Income from Qualifying Intellectual Property if there is a direct connection (a technical term for this is a “nexus”) between the income from Qualifying Intellectual Property and the qualifying R&D expenditures contributing to that income.

The fundamental principle underlying the nexus approach is that Qualifying Income only arises to the extent that the QFZP itself incurred the R&D expenditures that contributed to the Qualifying Intellectual Property, either directly or by outsourcing such activities to another Person

If a QFZP acquires Qualifying Intellectual Property or outsources the R&D to a Related Party outside the UAE, the portion of the income that is attributable to the acquisition cost or outsourced R&D does not give rise to Qualifying Income.

Intellectual property generally refers to intangible assets owned and legally protected by a Person from outside use or implementation without consent (for example, trademarks, patents, copyrights, brands, technical know-how).

Income derived from the ownership or exploitation of intellectual property is subject to the following treatment:

• Income derived from the ownership or exploitation of Qualifying Intellectual Property, determined in accordance with the formula in Article 4(1) of Ministerial Decision No. 265 of 2023 is treated as Qualifying Income.
• Income derived from the ownership or exploitation of Qualifying Intellectual Property that exceeds the amount determined under the formula in Article 4(1) of Ministerial Decision No. 265 of 2023, as well as other income derived from the ownership or exploitation of intellectual property, is treated as Taxable Income that is not Qualifying Income (subject to the 9% rate)

Tracking systems to demonstrate nexus

If a QFZP has only one Qualifying Intellectual Property asset that it has fully self-developed and that provides all of its Qualifying Intellectual Property income, the ratio in the formula given will be 1:1 (100% when expressed as a percentage). The QFZP would be able to satisfy the tracking requirements by demonstrating that it incurred the relevant R&D expenditures.

When a QFZP has more than one Qualifying Intellectual Property asset, engages in any degree of outsourcing or acquisition, or derives Revenue other than from Qualifying Intellectual Property, detailed tracking becomes essential. The QFZP will need to be able to track the link between expenditures and income of the Qualifying Intellectual Property asset and provide evidence of this to the FTA upon request.

Distribution of goods or materials in or from a Designated Zone

Distribution typically includes the process of transporting products from a manufacturer, storing them, and selling them to different stores and customers. A key feature of a distribution activity is that the distributor holds title to the products.

The distribution of goods or materials in or from a Designated Zone includes the buying and selling of goods, materials, component parts or any other items that are tangible or movable and may include the importation, storage, inventory management, handling, transportation and exportation of those goods or materials to a customer that resells such goods or materials, or parts thereof or processes or alters such goods or materials or parts thereof for the purposes of sale or resale, provided

There are no limitations on the mode of distribution. The distribution of goods does not include the distribution of intangible products and services such as licences, software and financial products or services. However, if any goods have embedded software or firmware, income for which cannot be separately identifiable.

If goods or materials are distributed to a customer that is the “end user”, (i.e. uses or consumes the product), then such activity will not be treated as a Qualifying Activity

Activities that might constitute the Qualifying Activity of distribution of goods or materials include:

• Purchase and resale of goods or materials
• Warehousing
• Transportation, delivery and logistics
• Inventory management
• Order processing
• Packaging and repackaging.(Guide clearly mention the meaning of the following terms)

Activities that might be treated as ancillary to the Qualifying Activity of distribution of goods or materials, meet the conditions for ancillary activities include:

• Marketing and advertising
• Quality control and inspection
• Customer support services
• Revenue from Excluded Activities is treated as non-qualifying Revenue for the purposes of the de minimis requirements, unless the Revenue is attributable to a Free Zone Person’s Foreign Permanent Establishment or Domestic Permanent Establishment or Free Zone guide for clear meaning of this words)

 

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