Corporate Tax in UAE: Understanding Qualifying Free Zones and Key Regulations

The UAE's corporate tax landscape has undergone significant changes, especially with the introduction of the Corporate Tax Law in 2023. This new tax system affects businesses across the country, including those operating in Free Zones. This blog aims to demystify the concept of Qualifying Free Zone Persons (QFZPs), their eligibility for the 0% tax rate, and the detailed regulations businesses must comply with to ensure compliance with the UAE Corporate Tax Law.

Introduction to UAE Corporate Tax Law

The UAE Corporate Tax Law, effective from June 1, 2023, introduces a comprehensive tax regime aimed at aligning the UAE with global tax practices. The law applies to all businesses and taxable persons, with particular provisions for Free Zone Persons (FZP) and Qualifying Free Zone Persons (QFZP).

→ Standard tax rate: 9% on income exceeding AED 375,000 for mainland businesses.

→ 0% tax rate: For Qualifying Free Zone Persons (QFZP) on qualifying income derived from eligible activities within Free Zones.

This shift is pivotal for businesses that operate in the UAE’s Free Zones, as it presents both challenges and opportunities depending on the eligibility of their activities.

 What is a Qualifying Free Zone Person (QFZP)?

A Qualifying Free Zone Person (QFZP) is a Free Zone Person (FZP) registered in a Free Zone in the UAE that satisfies specific criteria laid out by the UAE Corporate Tax Law. To qualify for the 0% corporate tax rate on qualifying income for the relevant tax period, a Free Zone business must meet the following conditions:

1. Registered in a Free Zone: The business must be a juridical person legally established in a UAE Free Zone.

2. Maintain Adequate Substance in the UAE: The business must conduct its core income-generating activities (CIGAs) within the Free Zone and have adequate assets, employees, and operating expenditures there. This ensures operations are legitimate and productive.

3. Must derive Qualifying Income: The revenue must come from activities and transactions deemed eligible for tax exemptions.

4. No Election to Standard Tax Regime: The business must not have elected to be subject to the standard 9% tax rate.

5. Comply with Transfer Pricing Rules: The business must adhere to the arm’s length principle for transactions with Related Parties and maintain proper Transfer Pricing documentation.

6. Maintain Audited Financial Statements: QFZPs must prepare and maintain audited financial statements in accordance with IFRS or comparable standards.

7. De Minimis Rule Compliance: The business's non-qualifying income must not exceed a specified threshold (see below).

Key Regulations for Qualifying Free Zones in Corporate Tax UAE 

The United Arab Emirates (UAE) has historically been synonymous with tax-free business operations. However, the introduction of the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses—the UAE CT Law—effective for tax periods commencing on or after June 1, 2023, has ushered in a new era. This comprehensive corporate tax system aligns the nation with global tax transparency standards (like the OECD’s BEPS framework) while preserving significant tax incentives for strategic economic sectors, most notably those operating in the country’s Free Zones.

This guide aims to demystify the complex interplay between the new corporate tax regime and the continued benefits offered to a Qualifying Free Zone Person (QFZP), detailing the conditions required to maintain the privileged 0% tax rate.

 Qualifying Free Zone Activities

Certain Qualifying Activities enable a Free Zone Person to benefit from the 0% tax rate. These activities include, but are not limited to:

→ Manufacturing: Businesses involved in the production of goods and materials within the Free Zone.

→ Trading in qualifying commodities: Companies engaged in importing, exporting, or trading goods that meet the criteria for qualification.

→ Holding investments: Firms focused on managing and holding shares or other financial instruments, provided they meet the law's criteria for "investment."

→ Headquarters and operational services: Certain headquarters activities, such as overseeing operations of related companies or subsidiaries.

→ Treasury and financing services: Offering financial services within the Free Zone, including financing or leasing.

These activities, when carried out within the Free Zone, contribute to the generation of Qualifying Income that benefits from the 0% corporate tax rate.

 Qualifying Income

Qualifying Income is the income-generating activities revenue eligible for the 0% tax rate. It primarily includes:

→ Income from transactions with other Free Zone Persons (provided it's not from Excluded Activities).

→ Income from Qualifying Activities with Non-Free Zone entities (including non-free zone entities in the mainland or abroad).

→ Income from owning or exploiting Qualifying Intellectual Property.

→ Any other income that satisfies the De minimis Rule.

Understanding the Core: Tax Rates and the QFZP Status

The UAE government has established two primary tax tiers:

• Standard Rate: A 9% corporate tax applies to taxable income exceeding AED 375,000 for most entities, including mainland businesses and Non-qualifying Free Zone Persons (NFZP).

• 0% Rate: This preferential rate is exclusively available to a Qualifying Free Zone Person (QFZP) on their Qualifying Income.

To be classified as a QFZP, a free zone corporate tax refers to an entity that meets stringent conditions beyond just being registered in a free zone. These conditions focus heavily on the nature of its operations and income streams.

Free Zone and Designated Zone

A Free Zone is a designated area within the UAE that offers businesses a special regulatory and tax regime. Businesses established in these zones benefit from several incentives, including:

→ Tax exemptions: Including the 0% corporate tax rate for qualifying businesses.

→ No restrictions on foreign ownership: Most Free Zones allow 100% foreign ownership.

→ Customs duties exemptions: Many Free Zones offer exemptions on goods imported or exported within the zone.

Designated Zones are specific Free Zones recognized by the UAE tax authorities for certain activities, such as the distribution of goods. Businesses operating in Designated Zones must still comply with corporate tax rules but can benefit from favorable tax conditions for specific activities.

Corporate Tax in UAE for Non-qualifying Free Zone Persons

Non-Qualifying Free Zone Persons (NFZP) that fail to meet the necessary requirements for QFZP status are subject to the standard corporate tax rate of 9%.

NFZPs are generally businesses in Free Zones that:

→ Do not generate Qualifying Income.

→ Do not engage in Qualifying Activities.

→ Do not maintain sufficient substance in the UAE.

These businesses will fall under the same tax regime as mainland companies, subject to the 9% tax rate on their taxable income.

The Gate to 0% Tax: Qualifying Income and Activities

The eligibility for the 0% tax rate hinges on generating Qualifying Income from core income-generating activities. The tax refers to the tax benefits being tied directly to the substance and nature of the business in the UAE.

1. Qualifying Activities & Income Streams

Qualifying Activities are the engine room for a QFZP. They generally include:

• Manufacturing goods within the Free Zone.

• Trading in qualifying commodities (import/export).

• Holding investments, provided they meet specific legal criteria.

• Providing specific Headquarters and operational services to related parties.

• Certain Treasury and financing services.

Qualifying Income is revenue derived from these activities, primarily:

• Income from transactions with other FZPs (excluding Excluded Activities).

• Income from Qualifying Activities with Non-Free Zone entities (mainland or international).

• Income from owning or exploiting Qualifying Intellectual Property.

2. Maintaining Adequate Substance and the De Minimis Rule

A QFZP must maintain adequate substance in the UAE. This means having real operational presence—office space, employees, and expenditures—within the property within the free zone. Furthermore, the entity must pass the De minimis Rule:

• Non-qualifying income threshold: Income from non-qualifying activities (or transactions with natural persons) must not exceed 5% of total revenue or AED 5 million, whichever is lower. Exceeding this voids the QFZP status for that tax period. The law outlines four tax periods within which this compliance must be maintained.

Excluded Activities and Non-qualifying Income

Certain Excluded Activities will automatically disqualify the related income from the 0% rate:

→ Any transactions with natural persons, with the specific exceptions mentioned above.

→ Banking, finance, and leasing activities (other than specific services to related parties).

→ Ownership or exploitation of immovable property, except for transactions with Free Zone Persons regarding commercial property located in a Free Zone.

→ Activities carried out outside the Free Zone that constitute a Permanent Establishment (PE) in the mainland UAE. Income attributable to such a Domestic PE is taxed at the standard 9% rate.

Compliance and Tax Implications

To benefit from the tax benefits of the Free Zone tax regime, QFZPs must prioritize record-keeping and compliance. This includes:

→ Registration and Filing: All free zone entities must register for CT and file a CT return with the Federal Tax Authority for each tax period.

→ Transfer Pricing Compliance: Strict adherence to the arm’s length principle for transactions with Related Parties.

→ Audited Financial Statements: Mandatory preparation and maintenance of audited financial statements.

→ Adequate Substance: Continuous demonstration of adequate operations (assets, employees, expenditures) within the Free Zone.

The De minimis Rule and Non-qualifying Income Threshold

One key feature of the Qualifying Free Zone Person (QFZP) status is the De minimis rule. This rule states that if a QFZP earns non-qualifying income, that income must remain below 5% of total revenue or AED 5 million, whichever is lower.

→ If this threshold is exceeded, the business will lose its QFZP status and will fall under the standard 9% corporate tax rate.

→ Companies must closely monitor their income and ensure that their non-qualifying income does not breach this threshold.

 Compliance, Registration, and the Tax Period

Successful navigation of the UAE CT Law requires meticulous adherence to compliance and reporting obligations, irrespective of the tax rate applied to the income.

Registration and Filing

→ Mandatory Registration: Every Free Zone Person, whether a QFZP or an NFZP, must register for CT with the FTA and obtain a Corporate Tax Registration Number.

→ Tax Period and Return: Taxable Person are required to file a single CT return for each tax period within nine months from the end of the relevant tax period. For a company whose financial year aligns with the calendar year (January 1 to December 31), the first return is due by September 30, 2025.

Record-Keeping and Compliance

To maintain QFZP status and continue benefiting from the 0% corporate tax rate, businesses must comply with various regulatory requirements:

→ Transfer Pricing: Businesses must adhere to international transfer pricing regulations, ensuring that transactions between related entities are conducted at arm’s length.

→ Audited Financial Statements: QFZPs must prepare and maintain audited financial statements in accordance with international standards, such as IFRS (International Financial Reporting Standards).

→ Adequate Substance: Businesses must demonstrate that they have substantial operations in the Free Zone, including office space and employees, to ensure compliance with the substance requirements of the UAE Corporate Tax Law.

How Young & Right Can Help You with Transfer Pricing in UAE Corporate Tax

At Young & Right, we provide expert guidance on transfer pricing within the UAE's evolving corporate tax regime, particularly for businesses operating in free zones. Understanding the complexities of qualifying and non-qualifying income, tax rates, and business activities is crucial for ensuring compliance with the UAE Ministry of Finance and leveraging the benefits of operating in free zones.

For businesses operating within free zones in the UAE, our team offers a comprehensive guide on free zone regulations, including tax rate on qualifying income and the requirements for a juridical person to be classified as a qualifying free zone corporate tax entity. Understanding which types of income are considered qualifying income is essential for maximizing tax benefits under the UAE government's framework.

Conclusion

The new corporate tax in UAE has created a dual tax treatment for businesses operating in designated free zones. Understanding the QFZP status, the list of Qualifying Activities, and the limits imposed by the De minimis Rule is paramount. Companies must meticulously manage their tax obligations by segregating income, demonstrating substance, and maintaining proper records to ensure compliance and benefit from the 0% tax rate on their qualifying income.