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With the arrival of the UAE corporate tax, a new factor has entered the debate on whether a business should consider a free zone license or opt for the mainland. Image Credit: WAM

Dubai: Overseas businesses with plans to launch in the UAE are not taking a wait-and-watch approach on taking free zone license until the full updates on the corporate tax are revealed.

Instead, these businesses are signing up as UAE free zones offer some of the most compelling rates and incentives to businesses that sign up now.

The first quarter had seen most of the bigger free zones in the UAE report increased intakes of new licensed businesses – and many of whom will also have extensive operations on the UAE mainland. Among the categories that have shown the biggest interest to seek new licenses are businesses in the crypto space, fintechs and other digital technology focussed entities, and also those in industrial activities.  

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“Free zones have already reduced their costs in recent years and probably continue to do so to remain competitive with both the mainland and other free zones (offering) set up options,” said James Swallow, Commercial Director at PRO Partner Group.

“Many clients are opting for mainland set ups with 100 per cent ownership (versus the free zone option) – as this is a significant benefit.

“The mainland seems to be the most compelling option for companies setting up in the UAE. This is mainly from ease of doing business, bidding for government contracts, generally reduced formation costs, transparent business set up costs, lower office rents, compliance when dealing with other mainland clients, and of course the ability to be 100 per cent foreign-owned now for most activities in mainland UAE.”

Competing with mainland on two counts

The UAE decision to open up 100 per cent ownership (and without the need for a UAE National sponsor) had in one stroke opened up a raft of possibilities. And more so for those new entrants launching operations here.

The other big factor in the free zone license vs. a mainland one relates to the corporate tax. A free zone enterprise will be exempt from the 9 per cent tax if they are in compliance with a prescribed set of requirements. If they are not and they derive extensive income from mainland operations, then the 9 per cent corporate tax kicks in.

While free zones formation rates are generally lower, the office space requirements can be costly. Free zones are struggling a little to compete with what mainland can offer. Mainland provides more flexibility for location, scope of work, government contact bids and no restrictions on trading, import and dealing with other mainland clients

- James Swallow of PRO Partner Group

‘Qualifying income’

This is where ‘qualifying income’ comes into the equation. This, according to the UAE corporate tax laws, will be income derived by a free zone entity from any transactions it may have with businesses outside of the UAE, or with another enterprise based in the same free zone, or in one of the UAE’s 40 odd free zone clusters.

This qualifying income will be taxed at zero per cent.

“One needs to await the UAE cabinet decision for guidance on this aspect,” said Atik Munshi, Managing Partner at Finexpertiza UAE, a consultancy. “Where part of the free zone business’s revenue (say 20 per cent) is from UAE mainland entities, then the balance would be considered as ‘qualifying income’.

“The business would nevertheless have to allocate and justify the relevant expenses towards such qualifying and non-qualifying to the satisfaction of the FTA (Federal Tax Authority).”

Federal Tax Authority allows free zone entities' mainland branch to be taxed separately. Practically, it is difficult to open the branch of the free zone company in UAE mainland. It is possible economic departments may allow such branch licenses on the mainland in the near future

- Atik Munshi of Finexpertiza UAE

This is why free zone businesses need to watch the space closely. “Currently, free zone entities that have qualifying income (benefit) will be exempt from the CT regime,” said Swallow. “However, if it is conducting any operations on the mainland, they would need to be wary of being subject to CT on the entirety of their free zone operations.

“So, companies are looking at their overall structure and potentially looking to set up in the mainland where required – either a branch, subsidiary or a completely new entity.”