UAE Corporate Tax: Pros and cons for free zone businesses to on-board

The UAE Ministry of Finance has announced corporate tax awareness sessions on June 21 and 22 June in Sharjah and Dubai. Among businesses and stakeholders, free zone companies earning income from trading activities would be keen to understand their future under the corporate tax laws.

Last week, we raised the issue of potential tax impact on direct shipment transactions. The issue merits a detailed discussion.

Scope of qualifying income

Qualifying Income – taxable at 0 per cent - includes income derived from distribution of goods in or from a designated zone to a non-free zone person. The activity of distributing goods must be undertaken in or from a designated zone.

Direct international shipments

A clarification is needed whether the condition ‘in or from DZ’ should be tested for the location of the distributor or for the location of the goods. In case of latter, not only income from direct shipments could potentially be taxed at 0 per cent, it could result in breaching the de-minimis condition also if such income is more that Dh5 million (or 5 per cent of total revenue).

This will apply irrespective of the location within or outside the designated zone.

In case of former, companies established in such free zones that are not designated zones will face a peculiar conundrum. A qualifying free zone person (QFZP) - eligible for 0 per cent tax rate – could be based in a free zone (whether or not it is a designated zone).

However, the qualifying activity of distribution must be undertaken in or from a designated zone. Companies established in such free zones – that are not designated zones - could fail to treat their trading income from direct international shipments as qualifying income.

Warehousing in designated zones

If direct shipments are held to be non-eligible for qualifying income, the next best alternative for evaluation will be to warehouse the goods in a designated zone. One could possibly contend that the distribution activity was conducted in a designated zone and should qualify as qualifying income.

However, could 0 per cent tax rate be claimed for distribution income if the goods are physically warehoused in a designated zone even though the distributor is not located in one?

To be eligible as a qualifying free zone person, the entity shall inter-alia undertake its ‘core income-generating activities’ (CIGA) in a free zone and maintain adequate substance. The CIGA can be outsourced to a related party or a third-party, in a free zone. A view is being proposed on social media that the warehousing (in a designated zone) could be outsourced by a non-designated zone free zone company.

However, could the qualifying activity itself be outsourced? One needs to understand if there is a difference between CIGA and qualifying activities. To illustrate, can a free zone company outsource manufacturing activity and still be eligible for 0 per cent tax rate?

Source of procurement

The distribution activity - listed as a qualifying activity - does not specify the source of procurement of the goods. It is not yet clear if the goods, sold in or from the designated zone (including exports), could be procured from a mainland supplier.

It also needs to be examined if the mainland suppliers could include related parties. A clarity on these points could influence the restructuring of business operations and potential anti-abuse implications.

Place of management

It must be remembered that the income earned by a free zone company could be taxable if it is attributable to a domestic permanent establishment, i.e., mainland. This would include a place where management and commercial decisions that are necessary for the conduct of the business are, in substance, made.

For trading companies operating both in the mainland and in a free zone/designated zone, the place of management will be an essential compliance point. To remain eligible for 0 per cent tax rate, they should ensure that the trading income is not attributable to a domestic permanent establishment.

As said multiple times, taxation will be a paradigm shift for UAE businesses. It is important for business owners to ask the right questions to seek a comprehensive understanding of the tax implications on their operations.