The taxation aspect at UAE free zones is back into focus. A new cabinet decision and a corresponding ministerial decision - repealing earlier decisions – have been issued with retrospective effect from June 1, 2023. These have introduced new concepts and clarified pertinent issues.
As usual with taxation, some interesting discussion points have also emerged.
Trading of Qualifying Commodities
A big relief has been provided to commodity traders operating from free zones that have not been deemed ‘designated zones’. Income derived from trading of ‘qualifying commodities’ with non-free zone persons (domestic or overseas) would also be eligible for 0 per cent tax rate.
Qualifying commodities means metals, minerals, energy and agriculture commodities traded on a recognised commodities exchange market - in the UAE or overseas - in raw form. It applies to physical trading activities of such commodities and associated derivative trading used to hedge against risks involved in such activities.
Qualifying intellectual property
Income from the ownership or exploitation of all intellectual property assets was earlier specifically excluded from 0 per cent rate. Under the revised decisions, a certain portion of the income derived from the ownership of ‘Qualifying Intellectual Property’ is eligible for 0 per cent rate.
Qualifying IP includes patents and copyrighted software. Any other rights that are functionally equivalent to a patent are also included. (For example, utility models, IPR for plants and genetic material, orphan drug designations, and extensions of patent protections.) However, any marketing related IPR - such as trademarks - would not be eligible.
The proportion of the expenses incurred to fund R&D activities directly connected with the creation, invention or significant development of such qualifying IP - along with a deemed ‘uplift expenditure’ - will determine how much income from qualifying IP could enjoy 0 per cent rate.
Clarity on adequate substance
Maintaining ‘adequate substance’ is an important compliance requirement to claim 0 per cent tax rate. Adequate substance requires conducting core income-generating activities (CIGA) and maintaining adequate assets, a certain number of employees and incurring operating expenditure.
Core income-generating activities mainly consist of those functions that drive the business value and are not mostly support activities. It requires an adequate number of qualified full-time employees. The adequate substance should be maintained in such free zone - or a designated zone - where the qualifying activity is required to be conducted. Even the third-parties to whom core income-generating activities could be outsourced should meet this location condition.
Points to ponder
Income from headquarter services to related parties - eligible for 0 per cent - has now been explained in detail. ‘Headquarter services’ includes the administering, overseeing and managing of business activities of related parties, including the provision of senior and general management, captive insurance services, administrative services, procurement services, business planning and development, risk management, coordination of group activities, and in general incurring expenditures on behalf of related parties and providing other support services to related parties.
The ‘headquarter services’ should be treated carefully. Apart from the anti-abuse rules, a question remains if a mainland company – otherwise ineligible for 0 per cent rate and/or operating mainland retail stores – could restructure its management activities (including owners’ salaries) into a separate free zone company.
Similarly, free zone companies - otherwise ineligible for 0 per cent - should split their management activities into a separate free zone company. Even though transfer pricing will apply, the corporate group may be able to enjoy 0 per cent on a fair portion of its overall profits.
The activity of distribution of goods or materials in or from a designated zone has been explained in detail, thereby addressing pertinent concerns of taxpayers. I have come across many interesting scenarios that still need careful evaluation - be it the distribution of equipment not intended for resale, ensuring that overseas customers are resellers, trading of goods that are not qualifying commodities, or third-port shipment sales.
With more clarity available on free zone tax incentives, business owners need to ensure that they ask the right questions to optimise the tax impact and compliance requirements…