The tax authorities have updated the FAQs for free zone businesses, and they will need to check on their eligibility for the preferential 0% tax rate. Image Credit: Shutterstock

Free zone companies must take an immediate notice of the updated frequently asked questions (FAQs) by the Ministry of Finance. Over 50 new Q&A have been added/updated on the free zone tax regime pursuant to the announcement made during the awareness sessions held last month.

Scope and Tenure of 0% tax rate

On the question of the list of free zones part of the preferential 0 per cent corporate tax rate, businesses are advised to contact their free zone authority to confirm the eligibility. On the question of the tenure, it has been clarified that the benefits of the preferential rate expire by the end of the tax incentive period stated in the legislation of the relevant free zone. Such period could be extended in accordance with relevant laws.

The FAQs have also clarified that the preferential per cent rate is open to existing and newly established free zone companies and branches. Natural persons, unincorporated partnerships and sole establishments are not eligible for the preferential rate.

There is no requirement for a Qualifying Free Zone Person (QFZP) to make a formal election or submit an application for the preferential rate - it will be applicable automatically if all the conditions are met.

Distribution business from designated zones

Qualifying income (QI) – subject to 0 per cent tax - includes income from distribution of goods in or from a designated zone for specified purposes.

The updated FAQs has highlighted the relevance of being located in a designated zone for a distribution business. A qualifying free zone person in a free zone that is a designated zone can earn qualifying income from the wholesale distribution of goods and materials to domestic and foreign businesses.

And one that is established in a free zone but not a designated zone can only earn qualifying income from the sale of goods and materials to other free zone persons.

Guidance on qualifying activities

Qualifying activities form the bedrock of preferential 0 per cent tax rate. Over 13 activities have been specified as qualifying activities. The FAQs state that more details and guidance regarding the scope and meaning of each qualifying activity will be provided as required in due course.

Businesses should take note that the scope of each qualifying activity will determine whether their operations would qualify for 0 per cent tax rate.

Domestic vs foreign customers

Free zone companies have wondered if the transactions with foreign customers will be treated differently to transactions with mainland customers. It has been clarified that the transactions with UAE mainland and foreign persons are treated the same for corporate tax purposes.

Adequate substance

No minimum investment, job creation or business expansion requirements are applicable as an eligibility for the 0 per cent rate. However, a qualifying free zone person must have adequate staff and assets and incur adequate operating expenditure in a free zone relative to the qualifying income it earns.

It has been clarified that the economic and operational substance must be maintained in the free zone where the business is established/registered or in any other free zone. Activities performed by related or unrelated parties in the same or in another free zone on behalf and under the supervision of the qualifying free zone person would be considered for determining maintenance of adequate substance.

Further information will be provided in due course regarding the transition from the existing Economic Substance Regulations (ESR) compliance under the CT regime.

Documentation and administration

It is known by now that a qualifying free zone person should maintain audited financial statements and adequate transfer pricing documentation. The FAQs have clarified that the free zone businesses should maintain all relevant documents and records to evidence its compliance with the eligibility conditions for the 0 per cent tax rate. They should also maintain documentation in relation to the substance maintained in a Free Zone, the types of activities performed and income earned.

The Federal Tax Authority (FTA) is responsible for the administration and enforcement of the corporate tax. The FTA can verify and make a final determination of whether a qualifying free zone person has complied with all the conditions of the preferential tax rate.

Failure to meet one or more of the conditions will result in a disqualification from the 0 per cent rate for 5 years, starting from the tax period in which any of the conditions are no longer met.

Way forward

The updated FAQs is a welcome step for the free zone companies to understand the tax implications on operations. It is important for companies to understand the subtle details of each qualifying activity and qualifying income to project the tax impact.

Any failure in tax compliance or meet eligibility conditions could also result in tax arrears and penalties. It is thus important for companies to ask the right questions for them to seek the right answers.