Businesses operating out of free zones are eligible for 0 per cent tax rate. But those companies into trading and distribution have more compliance checks to do. Image Credit: Vijith Pulikkal/Gulf News

Dubai: Companies based in UAE free zones and engaged in trading and distribution activities are going through an extensive check of their operations to see if they are – or will be - in full compliance with corporate tax rules.

Business owners with free zone companies said their internal audits and those done by external consultants have highlighted ‘some grey areas’ that will need to be cleared with the UAE tax authorities. It was last month that the Federal Tax Authority released an updated guide on what free zone businesses should do under the corporate tax regime.

This assumes heavy significance given that the UAE has mandated free zone businesses get to have the 0 per cent corporate tax eligibility. (The UAE’s corporate tax rate is set at 9 per cent.)

“We are using these latest guidelines to make sure we are eligible for the 0 per cent rate,” said the founder of a distribution business based out of a free zone in Dubai. “We conform to all the requirements – such as having audited financial statements and ‘adequate substance’ in the free zone.

“But we will still need final sign-off from the FTA (Federal Tax Authority) once we do the registration.” (His business will be registering before the end of this month, as per the FTA timetable.)

A business would need to check that the free zones have a tax-free period envisaged under their respective charters of formation

- Pankaj S. Jain of AskPankaj Tax Advisors

The stakes are high for trading companies operating out of free zones. Under the UAE rules, such businesses must operate from ‘designated zones’ to avail of the 0 per cent rate.

“While the preferential 0 per cent tax rate is generally aimed at all free zone entities, those engaged in distribution of goods can do so only in or from a designated zone,” said Pankaj S. Jain, Managing Director at AskPankaj Tax Advisors. “Certain free zones in the UAE have already been recognized as ‘designated zones’ under the VAT laws, based on criteria such as supervised movement of goods and people, etc.”

According to Jain, businesses in designated zone must prioritize these points:

  • Maintaining adequate substance. (This is essentially about a business having a certain number of employees who carry out income-generating activities from their licensed base.)
  • Detailed documentation on the financials.
  • Monitoring compliance with the ‘de-minimis’ threshold. (Where a business must show that the non-qualifying revenue has not exceeded the lower of these amounts: Dh5 million or 5 per cent of its total revenue for that year.

Only sell through a reseller - and do KYC

Another key eligibility criteria for trading companies in designated zones is that they can sell goods only through a reseller. “And that reseller must not the end user of these goods, but intends to sell them further,” said Ali Nawaz Abbasi, Senior Client Accounting Manager, Sovereign Corporate Services.

“Businesses need to carry out proper KYC (know your customer) to satisfy this requirement.”

Be sure about compliance

The FTA in all its communications has been insistent on one point - at every step, businesses need to check where they stand on the tax compliance rules. 

If a company wants to avail 0% tax regime, then trade and distribution can only be done via a designated zone, not any free zone.

- Ali Nawaz Abbasi of Sovereign Corporate Services

Same holds true for free zone companies wanting the 0 per cent tax rate. "Non-compliance can lead to the revocation of the 'qualifying free zone company' status and associated benefits for the current year - and a subsequent four years," said Naveen Sharma, co-founder and Chairman of Taxation Society.

"Companies must ensure they meet the de-minimis requirements to maintain these benefits. Additionally, proper KYC is vital to ensure compliance, particularly for distribution companies verifying that the buyer is not the end-user."

A proper KYC is vital to ensure compliance, particularly for distribution companies verifying that the buyer is not the end-user

- Naveen Sharma of Taxation Society
Existing free zone businesses with trading divisions
In the past, some free zone businesses may have had active trading operations apart from their core activities, and which are not eligible for 0% tax rate. Now, these businesses must do a rethink.

"If other business operations are not covered under 'qualifying activities', that company may consider segregating the trading activity to protect itself from de-minimis threshold," said Pankaj S. Jain. "However, the impact of anti-abuse rules needs to be examined carefully."

Check out tax status ASAP

What these businesses must not do is put off consulting the tax authority and the respective free zones about their corporate tax status.

“The corporate tax rules and ‘tax holidays’ will vary in different free zones,” said Abbasi. “It is important to get guidance specifically for your business.

“The lines between business conducted on the mainland and a free zone have been blurred. Therefore, the ‘qualifying income’ for 0 per cent tax has been confusing for businesses to navigate.

“There has been overlapping business between the two jurisdictions before the introduction of UAE corporate tax - and now businesses are having a harder understanding of their requirements.”

What a new trading business in UAE should focus on
Free zones in the UAE continue to pull in new businesses launching operations in the UAE. If the business is in trading and distribution overseas or selling to resellers in the UAE, 'then setting up in a designated zone would be beneficial as they get 0% tax rate', said Ali Nawaz Abbasi of Sovereign Corporate Services. "But if the company intends to sell to end-users within the UAE, then setting up a mainland entity is the choice."