Free zone businesses in the UAE have work to do retain their qualifying status for 0% corporate tax. Image Credit: Shutterstock

Let’s give some attention to the recent notice issued by the Ministry of Finance that the public should rely on official publications and trusted sources of information regarding the Corporate Tax law and the associated cabinet and ministerial decisions on free zones.

The importance thereof cannot be understated. The scope of free zone tax incentives has numerous subtle points.

As taxation is new to the region, a well-researched analysis of tax provisions - factoring substance over form - could alone assist the business owners. Tax advisory is not complete by serving businesses with a mere rewording of the tax provisions without explaining the implications or provide recommendations.

Business owners should prefer thorough analysis over verbal discussions to maintain the decision making trail for future audits. Certain critical issues are examined below on the free zone tax incentives.

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Trading and drop shipments

Qualifying Income (QI) – taxable at 0 per cent - includes income derived from distribution of goods or materials in or from a designated zone (DZ) to a non-free zone person who:

  1. Resells such goods or parts thereof;
  2. Processes or alters such goods or parts thereof for the purposes of sale or resale.

An evaluation is required if the end-use condition of resale/processing for sale also applies to distribution from DZ to overseas customers. If applicable, how does one ensure compliance and the consequences of non-compliance.

Further, taxability of plant and machinery, office furniture/equipment etc. sold from DZ needs to be reviewed as such goods are neither resold or further processed for sale.

The activity of distributing goods must be undertaken in or from a designated zone. Whether this condition should be tested considering the location of the distributor or the location of the goods is of critical importance especially for direct shipments.

Direct shipments refer to shipment of goods directly from, say, a supplier in India to a customer in Europe but the intermediate purchase and sale is booked by a UAE company. Whether income from direct shipments could be covered under qualifying income or becomes taxable will hinge on the scope the expression ‘in or from a DZ’.

The goods entering the UAE must be imported through the designated zone. Free zone persons need to also consider other important aspects of income from distribution activities.

Manufacturing income

Qualifying income includes income derived from transactions of manufacturing or processing activities with a non-free zone person. From an economic perspective, the manufactured goods need to be sold to derive income.

The manufacturing/processing activity itself could derive income if performed for a third-party, i.e., through contract manufacturing. A question thus emerge whether qualifying income covers only contract manufacturing for non-free zone persons?

Alternatively, if income from independent manufacturing and subsequent sale of goods is also covered under qualifying income, one needs to examine if the end-use conditions of resale/processing - as applicable on distribution from designated zone – would also apply on income from manufacturing activities.

Service income from overseas customers

With the exception of certain activities, income from services provided to non-free zone persons (including overseas customers) are generally not covered under qualifying income. Accordingly, income from consulting, commissions, etc., could become taxable under the corporate tax laws.

4-year disqualification

If the non-qualifying revenue of a free zone person exceeds the de-minimis threshold, that leads to the ceasing of being a qualifying free zone person (QFZP) for all income, even if covered under qualifying income.

Once disqualified, the free zone person is not eligible for the free zone tax incentives for the following four tax periods/years. It is therefore pertinent for business owners to determine the scope of qualifying income and their eligibility as a QFZP.

Tax practices and positions evolve over a period of time. As in VAT, corporate tax issues are expected to be clarified by the authorities through public and private clarifications. Meantime, business owners should ensure that they are asking the right questions.