How UAE Free Zone firms can capitalise on 0% corporate tax

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Free zones are vital to the UAE economy, driving growth both domestically and internationally.

These zones offer businesses significant advantages including relaxed foreign ownership rules, simplified administrative procedures, modern infrastructure, developed business communities, and additional legal entity options.

The introduction of corporate tax in the UAE represented a major change.

While aligning with global standards, the law was designed to preserve the attractiveness of free zones, both designated and non-designated.

Standard corporate tax in the UAE is 9 per cent on taxable income exceeding Dh375,000. However, corporate tax rules allow qualifying free zone companies to benefit from a 0 per cent tax rate on certain qualifying activities and transactions.

How it works

The Corporate Tax Law applies this 0 per cent rate to the qualifying income of a qualifying free zone person (QFZP) from transactions with other free zone persons and specific activities performed within a free zone.

Each free zone operates under its own authority with unique local regulations.

These authorities oversee business establishment, including legal entities and branches, and manage trade licences for activities conducted in or from the free zone.

The 0 per cent corporate tax rate applies for the remainder of the tax incentive period as specified in the legislation registered.

Qualifying free zone person requirements

A QFZP is a free zone person meeting all conditions in Article 18 of the Corporate Tax Law, as detailed in Cabinet Decision No 55 of 2023.

To qualify, a free zone person must:

■ Derive qualifying income from relevant transactions.

■ Maintain adequate substance in the UAE.

■ Satisfy the de minimis requirement.

■ Not elect to be subject to standard corporate tax rules and rates.

■ Comply with arm’s length principle.

■ Follow transfer pricing rules.

■ Prepare and maintain audited financial statements.

If a free zone person fails to meet all these conditions, he loses QFZP status and becomes subject to standard corporate tax rules and rates.

This distinction is crucial because not all free zone companies automatically qualify for 0 per cent corporate tax, and not all income generated by a QFZP necessarily qualifies for this rate.

Maintaining adequate substance

To maintain QFZP status for a tax period, a free zone person must maintain adequate substance in a free zone (or in

a designated zone for distribution activities) throughout that period.

This requires the free zone person to:

■ Perform core income-generating activities for that business in the free zone (or designated zone for distribution).

■ Maintain adequate assets and qualified full-time employees within the free

Core income-generating activities are the essential, value-adding activities that generate revenue from the business operations in a free zone, or designated zone.

A free zone person may outsource these core activities to other entities in a free zone (or designated zone for distribution), provided they adequately supervise the outsourced work.

For research and development related to Qualifying Intellectual Property, outsourcing may extend to any entities in the UAE, or non-related parties outside the UAE, with proper supervision.

Qualifying income should reflect the level of core activities performed in the free zone, or designated zone, consistent with arm’s length principles.

A free zone person may perform noncore activities (those that don’t directly drive sales or are routine) outside a free zone without affecting their status.

Consider Company A, a free zone person with a warehouse in a designated zone used for storage and distribution. Its registered office and employees are in a non-designated free zone, where it performs core distribution activities.

Since core distribution activities must be performed in a designated zone, Company A fails to meet the adequate substance requirement despite having a warehouse in a designated zone.

However, if all Company A’s customers are free zone persons who are beneficial recipients of Company A’s goods, it could still benefit from the 0 per cent rate based on transactions with free zone persons.

Determining adequate substance

To meet substance requirements, a free zone person needs enough qualified fulltime employees in the free zone to perform all core income-generating activities necessary for qualifying income.

Since businesses vary, ‘adequate substance’ is determined case by case using specific criteria, including number of qualified full-time employees, adequate operating expenditure and physical (not virtual) assets.

Sunil Singh is a senior journalist, working in the UAE