UAE Corporate Tax: Free zone-based businesses need to do a forensic on income streams

The history of UAE free zones dates back to the 1980s. Since then, they have been the backbone of the economy, with tax incentives to free zone persons (FZP), along with ease of regulations, world-class infrastructure, and strong government commitment, the catalysts for their development and growth.

With the introduction of Corporate Tax (CT) in the UAE, the question is whether the free zones will lose their sheen or continue to shine as before. While the UAE CT Public Consultation Document (PCD) provides for honouring the existing tax incentives to free zones, it is not that straightforward.

FZPs will have to maintain adequate substance, comply with regulatory requirements and get financial statements audited to benefit from a zero per cent CT rate. Let’s discuss various scenarios which emerge for the future.

Tax implications on FZPs in case of transactions with the mainland will be one of the critical aspects in the UAE CT regime. FZP undertaking transactions with the mainland will have to be cautious with respect to the permissibility of the said transactions as non-compliance with the regulatory requirements shall lead to denial of benefit of 0 per cent CT rate for all income streams.

The method of allocation of income to a mainland branch of a FZP can be subjective in the absence of detailed guidance in this regard. It also needs to be seen whether compliance with economic substance regulations would be sufficient. Some clarifications in the final law in this regard may help.

The Government has shown its commitment to keeping free zones attractive by extending the corporate tax incentives. Businesses operating in free zones will have to review their existing supply chain and operating structure and remodel the same wherever needed to make sure compliance with conditions for claiming the benefit of 0 per cent CT rate.

It would be interesting to see whether the 0 per cent CT rate benefit will be extended to MNEs (multinational enterprises) breaching the Pillar Two threshold and operating in free zones.

Perhaps, this is the ideal time to review business operations and maximize profits under the 0 per cent tax rate and prepare for the 9 per cent corporate tax.