UAE corporate tax: Free zone businesses wait on ‘qualifying income’

Dubai: Free zone-based businesses in the UAE have some serious thinking to do – whether they should sign up to pay 9 per cent corporate tax (CT) or not. Because if they do sign up for the 9 per cent annual tax payout, then these businesses will have greater flexibility on how they handle losses sustained by their companies operating on the mainland.

“If a free zone enterprise elects to pay corporate tax at 9 per cent and does not claim tax exemption, they can claim tax losses of their mainland subsidiary by forming a group or by way of transfer of losses, subject to conditions,” said Manoj Agarwal, founding Partner and CEO at AJMS Tax.

Under the UAE CT rules, a free zone-based business is taxed at 0 per cent. But vast numbers of those businesses with their regional HQs in UAE free zones also have extensive interests on the mainland. Free zone businesses thus have to decide fast whether they should sign up to be taxed at 9 per cent – and claim some of the benefits from doing so – especially when it comes to handling losses sustained in a financial year.

As per Article 37 of UAE CT Law, losses prior to the effective date of the law on a particular entity will not be allowed to be adjusted. As an example, a business with the tax year starting from January 2024 will not be able to offset losses prior to December 31, 2023. Further, losses are allowed to be offset only up to 75% of taxable income of that relevant tax period in which these losses are being offset.

- Manoj Agarwal of AJMS Tax

Here’s what the rule says:

> In case the ‘free zone person’ satisfies required conditions and becomes a ‘qualifying free zone person’ (QFZP), then the income derived by QFZP is termed as ‘qualifying income’ and this is taxed at 0 per cent.

> If the 0 per cent tax rate is applied, then a free zone enterprise and a mainland company cannot transfer tax losses.

Forming a group

There is still a way that a free zone enterprise with a mainland company can claim on tax losses. If the free zone entity elects to pay CT at 9 per cent and does not claim tax exemption, they can claim tax losses of their mainland subsidiary. This is done through forming a ‘group’ or by way of transfer of losses, subject to conditions.

“Typically, losses are allowed to carry forward for a certain period or are allowed to adjust with certain conditions, whereas UAE CT seems to be more liberal than other matured tax jurisdictions,” said Agarwal.

“Here losses are allowed to adjust up to 75 per cent of taxable income with certain conditions, such as holding equity/continuing same business activities. Globally, generally these conditions are not there, as the business entities are treated as separate legal entities for tax purpose.

“Plus, changing the business activities or continuing the same shareholding may create additional burden of probe on the businesses.”

Awaiting more clarity on CT rules

“When it comes to tax treatment applicable to free zone entities, the CT law makes multiple references to future UAE Cabinet decisions,” said Nasheeda, founder of Nishe Accounting & Consulting. “This renders it difficult at present for free zone businesses to determine their tax status and responsibilities.

“In my view, the need for clarity on this topic is quite understandable as the UAE CT rules have to conform to the tax benefits promised by free zones, which form an important part of the UAE economy. And maintain fairness between mainland and free zone businesses while keeping the tax rules simple and loophole-free.

“All of this evidently requires some deft managing.”

Where there is a 75% or more common ownership, the law allows offsetting taxable profit in one entity with tax loss in another entity. If the common ownership is 95 per cent or more with a parent-subsidiary structure, the law allows tax grouping of the entities such that only one combined tax return needs be filed for all the entities in the tax group.

- Nasheeda of Nishe

Signing up with FTA

Corporate tax-linked registrations have opened for UAE’s larger business groups, listed entities and those that have their financial year starting June. For now, only businesses that have been invited to sign up need to do so, but the net will widen soon enough as the timeline draws near to June 1, 2023, when the UAE corporate tax regime goes live.

“We applaud the Federal Tax Authority (FTA) for the successful launch of pre-registration on its EmaraTax platform,” said Hussain Sajwani, Chairman of Dubai-headquartered Damac. “With this measure, digital tax services in the UAE will be easily accessible and corporations in the country will be able to efficiently report their corporate taxes.”

The FTA has been conducting a series of workshops and seminars to filter its message through to businesses, and making it as less onerous as possible to register. What is keenly awaited is the FTA opening up the CT registration processes for more businesses.

As tax consultants and businesses owners say, signing up for VAT can help understand the process - but no one should make the mistake of thinking the requirements for both are the same.

SMEs, take note

Small businesses that rack up an annual income of Dh375,000 and lower will be charged 0 per cent corporate tax. But UAE SMEs can also tap other benefits from the new tax regime.

“There is the concept of small business relief. Using this, small businesses that have a revenue below a certain threshold (which is yet to be notified) may be subject to simplified compliance obligations,” said Dr. Nabeel Ahmed, Partner at DVS Management Consultancy. “And (these will) be treated as having no taxable income during the relevant tax period.

To claim small business relief, an ‘election’ must be made to the FTA. Simply put, SMEs must choose to avail this relief.

- Dr. Nabeel Ahmed, Partner at DVS Management Consultancy.

“As to who can claim this small business relief, any UAE resident juridical person or individual with revenues below the threshold defined by the minister and who meets any other conditions that may be set, can claim small business relief.”

The most keenly awaited updates on corporate tax

There are Cabinet decisions and executive regulations that businesses are awaiting with anticipation. Here are some of the topics that will be defined by further executive actions, as told by Dr. Nabeel Ahmed.

What will be the threshold for small business relief?

For companies established in free Zznes, the publication of the Cabinet decision detailing the concept of what amounts as ‘qualifying income’ would be crucial to clearly understand how the new CT will impact UAE business activities.

What categories of income derived by non-resident persons will be subject to withholding tax?

Any other expenditure that would amount to entertainment expenditure and be allowed deduction to the taxable income. And any other non-deductible expenditure other than the ones mentioned.

What is the test to determine the connection between the ‘state’ and non-resident person to determine taxable income?

UAE corporate tax and free zones

How the UAE corporate tax will define a ‘qualifying free zone person’ has become a topic of intense discussion from the moment the concept was mooted, because free zones specifically mention the absence of tax as a key incentive offered to companies wanting to register with them.

“By far, the most anticipated update by businesses is the list of designated free zones for corporate tax,” said Nimish Goel, Partner at WTS Dhruva Consultants. “Then there is the list of qualifying income for free zone person that’s taxable at 0 per cent.

“Given the number of entities in UAE free zones, this number is critical.”

In case the free zone person satisfies the required conditions and becomes a ‘qualifying free zone person’, then the income derived is termed as ‘qualifying income’.

The qualifying income is taxed at 0 per cent.

If the 0 per cent tax rate is applied, then a free zone enterprise and a mainland company cannot transfer tax losses.

Clause 1 of Article 38 states as one of the conditions on transfer tax losses that ‘neither is an exempt person nor qualifying free zone person’. A tax group can only be formed if neither the parent nor subsidiary is an exempt person.

If a free zone enterprise elects to pay corporate tax at 9 per cent and does not claim tax exemption, they can claim tax losses of their mainland subsidiary by forming a group or through transfer of losses.