UAE corporate tax: Free zone companies need to tick multiple boxes on compliance
Their entitlement to 0% corporate tax rate requires extensive prepping and compliance
The UAE's free zone specific corporate tax rules are designed to bolster economic growth by offering a favorable tax environment for entities operating within designated free zones. The rules provide a significant advantage by offering a 0 per cent tax rate on qualifying Income.
However, understanding the distinctions between qualifying and non-qualifying activities, the de minimis requirements, and the treatment of real estate is crucial for businesses to fully leverage the benefits.
Conditions to be a qualifying free zone person
- The entity must be a juridical person incorporated, established, or registered in a free zone.
- Adequate substance: The entity must maintain adequate assets, full-time employees, and operating expenditures in the free zone.
- Qualifying income: Income must be derived from transactions with other free zone persons, activities within the scope of qualifying activities, or the ownership or exploitation of qualifying intellectual property.
- Transactions with related parties must comply with the arm's length principle.
- Proper documentation for transfer pricing must be maintained.
- The entity must prepare and maintain audited financial statements.
- De minimis requirements: Non-qualifying revenue should not exceed the lower of Dh5 million or 5 per cent of total revenue.
Identifying qualifying activities
Qualifying activities are essential for entities to benefit from the 0 per cent corporate tax rate. These include:
- Production of goods within the free zone.
- Trading in raw metals, minerals, energy, and agriculture commodities.
- Ownership, management, and operation of ships.
- Fund and wealth management services
- Treasury and financing services to related parties
- Distribution of goods from designated zones.
- Logistics services
Categories of non-qualifying activities
- Transactions with natural persons.
- Banking and insurance activities.
- Finance and leasing.
- Ownership or exploitation of immovable property located outside the free zone.
De minimis requirements
The de minimis requirement allows a free zone entity to derive a certain amount of income from non-qualifying sources without losing the QFZP status.
For instance, if a free zone entity derives Dh10 million in total revenue of which Dh600,000 is from non-qualifying sources, the non-qualifying revenue constitutes 6 per cent of total revenue. This does not meets the de minimis requirement, disqualifying the entity to retain its QFZP status for the current and following four taxable years.
Treatment of real estate
Income from immovable property located outside a Free Zone is treated as non-qualifying. However, income from commercial property transactions within a free zone with other free zone entities can qualify for the 0 per cent corporate tax rate. Proper classification and compliance are crucial to maintain the favorable tax treatment.
Provisions of GAAR
The General Anti-Avoidance Rule (GAAR) is a critical component of the UAE's tax framework, designed to prevent tax evasion and ensure that tax benefits are not obtained through abusive tax arrangements.
The GAAR provisions allow the Federal Tax Authority (FTA) to disregard or re-characterize transactions that lack commercial substance or are primarily aimed at gaining a tax advantage. Companies must ensure that their tax planning strategies are robust, commercially driven, and compliant with GAAR to avoid potential penalties.
Companies operating in free zones must go through the regulations and compliance requirements.
Compliance with substance requirements
Maintaining adequate substance is vital for retaining QFZP status. Companies must ensure they have sufficient assets, employees, and operational expenditures within the Free Zone.
Accurate transfer pricing
Adhering to the arm's length principle and maintaining comprehensive transfer pricing documentation is crucial. This ensures that transactions with related parties reflect fair market values and withstand scrutiny from tax authorities.
Meeting de minimis Requirements
Regular monitoring of revenue sources is essential to ensure compliance with the de minimis requirements. Exceeding these thresholds can lead to the loss of QFZP status and the associated tax benefits.
Proactive GAAR Compliance
Companies should evaluate their tax arrangements to ensure they are commercially substantive and not solely designed for tax benefits. Proactive compliance with GAAR provisions mitigates the risk of adverse tax assessments and penalties.