Free Zones UAE Tax

The New CIT Cabinet And Ministerial Decisions: Insights On The Free Zone Corporate Tax Regime

The New CIT Cabinet And Ministerial Decisions: Insights On The Free Zone Corporate Tax Regime

In January 2022, the UAE announced a new federal Corporate Tax (CT) applicable to business profits for financial years starting on or after 1 June 2023. This marked a significant shift in the UAE’s tax landscape, particularly impacting businesses operating within the nation’s Free Zone Regime.

The UAE Free Zone CT Regime provides a system of economic zones established in the UAE that offer favourable conditions for doing business in and outside the UAE. It provides various benefits, including 100% foreign ownership, certain tax incentives (such as a 0% CT rate), and simplified administrative procedures.

The Federal Decree-Law No. 47 of 2022, known as the “CT Law,” published on 9 December 2022, left some key elements undefined, notably the criteria for a Free Zone (FZ) Person to qualify as a Qualifying Free Zone Person (QFZP), a status enabling access to the FZ’s embedded 0% CT rate. Of the five conditions, two were critical for achieving QFZP status: the requirement to derive “Qualifying Income” and the requirement to maintain “adequate substance”. Yet, definitions of both these terms under the UAE CT law were ambiguous, awaiting further clarification by the UAE Ministry of Finance (MoF).

To address these critical aspects, the UAE MoF issued two landmark decisions on 1 June 2023: Cabinet Decision No. 55 of 2023 on Determining Qualifying Income and Ministerial Decision No. 139 of 2023 regarding Qualifying Activities and Excluded Activities. These decisions – effective immediately upon publication – provide essential guidance for businesses operating in one of the more than 40 multidisciplinary UAE’s FZ. We discuss those elements in further detail below.

1. Determining Qualifying Income for Free Zone (FZ) Persons

The cornerstone of Cabinet Decision No. 55 of 2023 is the definition of “Qualifying Income”. This term encompasses two key areas – transactions with FZ Persons and transactions with non-FZ Persons.

To fully grasp the nuances of this Cabinet Decision, it is essential to comprehend certain key terms. The term Beneficial Recipient, for instance, typically denotes the individual or entity that is the actual recipient of the income and has the power to utilize and enjoy the benefits accruing from it (reminiscent of the requirement for passive income under double tax treaties to be the beneficial owner). On the other hand, the term Good in the context of this Cabinet Decision refers, amongst others, to any tangible product or commodity that is involved in transactions within any of the UAE FZs.

Also it is crucial to understand what constitutes “Qualifying Income” for entities operating within the UAE’s Free Zones, as it directly impacts their tax obligations under the new UAE CT law.

Qualifying Income by a QFZP includes the following:

– Income derived from transactions with other FZ Persons, except for income derived from Excluded Activities
– Income derived from transactions with a Non-FZ Person, only in respect of Qualifying Activities and not Excluded Activities
– Any other income provided that the QFZP satisfies the so-called “De Minimis Requirements”

Transactions with FZ Persons are relatively straightforward, encompassing all income that a QFZP derives from activities and transactions carried out within the jurisdiction of a QFZP with another FZ Person.

In the context of the new UAE CT Law, Qualifying Income refers to the types of income that are subject to the 0% CT rate. Determining which income is a “Qualifying Income” involves carefully reviewing the types of income, amounts, parties, and transactions involved, as detailed in the charts below.

From the above flowchart, the starting point is analyzing the source of income earned by a QFZP, which can arise from the following 4 categories:

1. Income from Non-FZ Person

2.Income from FZ Person

3.Income from Real Estate
– Immovable Property located in a UAE FZ
– Immovable Property Located in UAE Mainland

4. Income from Permanent Establishment
– UAE Permanent Establishment
– Non-UAE Permanent Establishment.

This article will provide a breakdown of each category of the above flowchart and guide you through the flow to determine whether the source of income will ultimately be subject to 9% or 0%.

  • Non-FZ Person

Transactions with Non-FZ Persons refer to income generated from dealings with entities not registered or incorporated within a UAE FZ. The specific conditions and considerations for such transactions need to be thoroughly evaluated.

For income earned by a QFZP from a Non-FZ Person, a distinction to be made is between Qualifying Activities, Excluded Activities and Non-Qualifying (or Non-Excluded) Activities, the latter being a term which is not defined.

– If the source of income arises from a Qualifying Activity of an FZ Person, the income will be considered as Qualifying Income and is subject to 0%.

– If the source of income arises from an Excluded Activity of an FZ Person, the income will be considered Taxable Income and is subject to 9%. However, this is subject to the so-called “De Minimis Requirements” rule, which will be explained further below.

– If the source of income arises from a Non-Qualifying Activity of an FZ Person, the income will be considered as “Taxable Income” and is subject to 9%, which is also subject to the conditions outlined in the “De Minimis Requirements” rule.

So, what is Qualifying Activity? As per Ministerial Decision No. 139 of 2023, Qualifying Activities include a wide range of business activities and services provided to entities located outside of a UAE FZ, including:

  • Manufacturing of goods or materials;
  • Processing of goods or materials;
  • Holding of shares and other securities;
  • Ownership, management and operation of ships;
  • Reinsurance services;
  • Fund management services subject to UAE regulatory oversight;
  • Wealth and investment management services subject to UAE regulatory oversight;
  • Headquarter services to related parties;
  • Treasury and financing services to related parties;
  • Financing and leasing of aircraft, including engines and rotatable components;
  • Distribution in or from a Designated Zone that meets relevant conditions;
  • Logistics services;
  • Any activities ancillary (qualified as such if it has no independent function but is necessary to perform the main Qualifying Activity) to the above activities.

Excluded Activities, on the other hand, are those that are not considered Qualifying Activities and, therefore, cannot benefit from a 0% tax rate, including:

  • Banking activities subject to UAE regulatory oversight;
  • Insurance activities subject to UAE regulatory oversight;
  • Finance and leasing activities subject to UAE regulatory oversight;
  • Ownership and exploitation of immovable property (other than Commercial Property located in an FZ);
  • Ownership and exploitation of intellectual property assets;
  • Any transactions with a natural person, except certain transactions in relation to Qualifying Activities;
  • Any activities ancillary (qualified as such if it has no independent function but is necessary to perform the main Excluded Activity) to the above activities.

Any activity which does not fall under Qualifying Activity and Non-Qualifying Activity is referred to as Non-Qualifying Activity.

If the source of the income is from a Qualifying Activity, it will result in 0% tax on the Qualifying Income derived from the Qualifying Activity. However, if the source of income is from an Excluded Activity or Non-Qualifying Activity (together considered as Non-Qualifying Revenue), the taxable income will be subject to 9%, but it may be possible for the taxable income to be considered Qualifying Income if it fulfils the so-called “De Minimis Requirements” rule.

De Minimis Requirements” are fulfilled where Non-Qualifying Revenue derived by a QFZP are:

  • Max 5% of total revenue earned in a tax period by the QFZP;
  • Max AED 5 million of revenue earned in a tax period by the QFZP;

whichever is lower.  

If the Excluded Activity or Non-Qualifying Activity income level is above the “De Minimis Requirements” threshold, then the FZ Person would not be eligible to be treated as a QFZP, and all of its income would be subject to tax at the standard 9% CT rate in the relevant tax period. Such a business would also be excluded from seeking to be treated as a QFZP for the following four tax periods.

  • Free Zone (FZ) Person


For income earned by a QFZP from an FZ Person, the only distinction to be made is between Excluded Activities and Non-Excluded Activities. Excluded Activities are described above.

If the source of income arises from a Non-Excluded Activity of an FZ Person, the income will be considered as “Qualifying Income” and is subject to 0%.

If the source of income arises from an Excluded Activity of an FZ Person, the income will not be considered as Qualifying Income and is subject to 9%.

1.3 Income from Real Estate 

Cabinet Decision No. 55 of 2023 also provides a special tax regime for income attributable to immovable property located in the Free Zone, which we have shown in the chart below:


1.3.1 Immovable property located in a Free Zone

The source of income for an immovable property can be derived from immovable property located in a UAE Free Zone or Mainland and will have different tax treatments.

If the immovable property is located in a Free Zone, there is a demarcation between a Commercial Property and a Non-Commercial Property.

If the transaction of the Commercial Property is with a Non-FZ Person, the income derived from the transaction will be taxable at 9%.

If the transaction of the Commercial Property is with an FZ Person, the income derived from the transaction will be subject to a 0% tax rate.

On the other hand, any transaction or dealing with Non-Commercial Property by any other person will result in the income being taxed at 9%.

This regime may benefit some of the FZ authorities which are also landlords.

1.4 Income from Permanent Establishments

Decision No. 55 of 2023 also addresses revenue from UAE and non-UAE permanent establishments (PEs). This element plays a vital role in shaping the tax landscape for FZ entities, and a thorough understanding is essential for effective tax planning and compliance in UAE Free Zone Corporate Tax Regime.

A PE refers to a place of business or other form of presence as laid down in Article 14 of UAE CT law through which the business of an FZ Person is wholly or partly conducted. The income generated through a UAE or non-UAE PE should be evaluated under specific conditions.

If the source of income is derived from a UAE PE, the income is taxed at 9%.

If the income is derived from a non-UAE PE, the income is also taxable at 9%. However, foreign tax credit may be available.

It is also possible for an FZ Person to elect for having its non-UAE PE income exempt or disregarded for UAE CIT purposes. In such an event, however, no foreign tax credit will be available.

2. Adequate Substance in Free Zones and Outsourcing

For an FZ Person to qualify as a QFZP, it must derive Qualifying Income and maintain adequate substance. The latter requires the QFZP to undertake core income-generating activities within an FZ. Activities that generate the QFZP’s income must be conducted in a UAE FZ, not just managed from there.

The concept of “adequate substance” ties into the UAE’s Economic Substance Regulations, which aim to ensure that businesses genuinely carry out the substantial activity within the UAE rather than being “shell” or “letterbox” companies. The two legislations operate however independently, and there are subtle differences between them.

A QFZP is allowed to outsource activities to a third party or related party in an FZ, provided it maintains adequate supervision. This means that while the QFZP can outsource some of its activities, it must still have sufficient control and oversight over those outsourced activities. This ensures that the QFZP is still considered to be performing the core income-generating activities within an FZ.

Furthermore, to maintain adequate substance, the QFZP must demonstrate the adequacy of the following commensurate to the activities carried out by the FZ Person:

  • Adequate assets;
  • An adequate number of qualified employees;
  • An adequate amount of operating expenditures.

Contrary to the Economic Substance Regulations, there is no directed and managed criterion for the substance requirements.

3. Practical Examples

3.1 Example 1

FZCo1 is a limited liability company that is incorporated, controlled, and managed in the Dubai International Financial Centre (DIFC), a UAE Free Zone. FZCo1 is a holding company of the FZCo1 Group, which includes many companies conducting different types of businesses in and outside the UAE. The company employs a few persons in its headquarters in DIFC, mainly accounting personnel. The company also has different bank accounts and active credit lines with financial institutions in the DIFC. FZCo1 has established a branch in the UAE mainland and another branch in the UAE’s Free Zone of Abu Dhabi Global Market (ADGM).


FZCo1 is likely to meet the condition of maintaining adequate substance in the UAE to qualify as a (QFZP). It can therefore benefit from 0% UAE Corporate Tax (CT) on the relevant “Qualifying Income” (i.e., “holding of shares and other securities”). The company conducts its core income-generating activities in a UAE’s FZ (i.e., DIFC). It has adequate assets (i.e., headquarters premises), employees (i.e., accounting personnel), and operating expenditures (i.e., as demonstrated through the bank accounts and active credit lines, and other expenses) therein, considering the nature and level of activities performed. Provided that all the other relevant conditions are met, FZCo1’s branch in the UAE’s Free Zone of Abu Dhabi Global Market (ADGM) can also benefit from 0% UAE CT in respect of income attributable to it. FZCo1’s branch established in the UAE mainland is instead subject to 9% UAE CT in respect of income attributable to it.

3.2 Example 2

FZCo2 is a limited liability company that is incorporated, controlled, and managed in the Jebel Ali Free Zone Authority (JAFZA) of the UAE. FZCo2 conducts multiple activities across different business lines. One of its business activities consists of licensing patents and trademarks of pharmaceutical products to other companies in that industry. FZCo2 also owns several commercial properties in JAFZA, which it leases out to FZ and non-FZ persons to conduct business in that UAE’s FZ. Moreover, FZCo2 owns several commercial properties in the UAE mainland, which are rented to FZ and non-FZ Persons to conduct business therein.


Even if provided that FZCo2 meets all the relevant conditions to be treated as a QFZP, income from the licensing of patents and trademarks of pharmaceutical products is regarded as income from an “Excluded Activity” (i.e., “ownership or exploitation of intellectual property assets”). Therefore, income from such an Excluded Activity cannot benefit from 0% UAE CT but is subject to the standard 9% UAE CT rate, despite the activity being conducted in a UAE’s FZ (i.e., JAFZA).

As regards income from the lease of immovable property, a distinction must be drawn depending on the type, location and other party involved in the relevant transaction. Only income from the lease of commercial property by FZCo2 in an FZ (i.e., JAFZA), where the other party is also an FZ Person, can benefit from a 0% UAE CT rate. In all other instances, the standard 9% UAE CT rate applies.


4. Other Considerations for a Qualifying Free Zone

Other key considerations associated with qualifying for a FZ person and their implications for businesses are as follows:

  • Elective taxation at 9%;
  • Elective taxation at 9% effective from the commencement of the tax period in which election is made; (or)
  • Commencement tax period following the tax period in which the election was made;
  • Cannot be a member of Tax Group;
  • Cannot transfer/offset losses to/from taxable (related) persons;
  • Participation Exemption applies in relation to income from QFZP (subject to conditions);
  • Must file a tax return;
  • May be required to file disclosure form along with tax return (to be notified by Authority);
  • Must prepare and maintain audited financial statements;

5. Our Take 

The newly issued Cabinet Decision No. 55 of 2023 and Ministerial Decision No. 139 of 2023 have provided much-needed clarity to the UAE Corporate Tax framework, particularly for FZ Persons. These decisions have brought forth specific definitions for Qualifying Income, Qualifying Activities, and Excluded Activities, thereby setting clear parameters for tax obligations for businesses operating within one of the more than 40 multidisciplinary UAE FZs. It is also worth mentioning that the guidelines concerning the so-called De Minimis Requirements for maintaining adequate substance have been detailed.

The scope of the 0% UAE CT rate appears to be narrower than initially anticipated, potentially reducing the UAE’s attractiveness as a tax-friendly business jurisdiction. Moreover, the Qualifying Activities do not seem to encompass all the activities businesses may undertake with third countries, potentially limiting the scope of the 0% rate. Financial services, which are traditionally exempt from tax in many FZ jurisdictions when “exported”, are also included in the list of “Excluded Activities”. This could have substantial implications for the financial sector and potentially discourage financial institutions from operating in UAE FZs.

The rationale behind excluding certain activities from the Qualifying Activities list is unclear and could benefit from further clarification. The original purpose of establishing FZ’s was to facilitate export-related income; however, it is important to note that not all activities conducted with third countries fall under this category. Certain services, such as professional consultancy, legal, tax, administrative, along with software development and leasing of non-aircraft assets, are notably excluded from the scope of Free Zone activities focused on export.

Furthermore, businesses and stakeholders must keep an eye on future developments and changes to these laws and regulations as the UAE government continues refining its corporate tax framework. It will be crucial for businesses to monitor these changes closely to ensure that they remain compliant and can effectively manage their tax obligations in the UAE. It is likely that the Ministry of Finance and the FTA’s position on some of the matters might evolve or be clarified.

If you wish to understand the UAE Corporate Tax on Qualifying Free Zone Persons easily, we have simplified the essential information under this topic through this informative animated video.

Free Zones

UAE Free Zones – How Tax Exempt Are They?

UAE Free Zones – How Tax Exempt Are They?

Freezone benefits under the CIT law and the Designated Zone benefits under the VAT law in the UAE. How to do they compare and how will they impact your business?

With the Corporate Income Tax (CIT) regime planned to be introduced in the United Arab Emirates (UAE) next year (2023), many businesses are examining the impact of the reforms on their existing business structures. 

Free Zones have played a large part in the economic development of the UAE, attracting foreign businesses with relaxed requirements and tax benefits. The tax regime applicable to Free Zone businesses has evolved greatly in the last years, with the introduction of VAT in 2018 and CIT planned to be introduced in 2023 respectively.

What is the applicable regime? We provide you with a recap in this article.

Highlights of the proposed UAE CIT system

The CIT system will be implemented with effect from June 2023. The headline rate will be 9% for taxable income earned in an year exceeding AED 375,000 (slightly above $100,000). This is globally a very competitive rate, and even within the Gulf states, it is the lowest among states that have a CIT regime. 

The Public Consultation Document issued by the Ministry of Finance states that the CIT regime will apply to the following persons

  • UAE companies and other legal persons incorporated in the UAE.
  • Foreign legal entities that have a Permanent Establishment (PE) in the UAE. 
  • Individuals (natural persons) engaged in a business or a commercial activity in the UAE. 

The calculation of taxable income would be aligned with the international accounting standards. Like most tax systems, the taxpayer would be able to deduct most expenses that are incurred in the process of generating revenue, subject to expense deduction limitations. Likewise, losses can also be generally carried forward from one year to the next and setoff against future profits. 

UAE resident companies will generally be subject to CIT on their worldwide income, including capital gains. There are certain exceptions to this rule. 

To retain and further develop the UAE’s status as an international financial and regional hub, the UAE has proposed many reliefs intending to reduce the effective tax rate or simplify matters administratively for businesses.

Amongst others, it has envisaged adopting a so-called ‘participation exemption’ which is relatively common. Here, a UAE Corporate shareholder would generally be exempt from CIT on dividends received and capital gains earned from the sale of shares of a subsidiary company, subject to fulfillment of both of the following two conditions:

  • The UAE Corporate shareholder owns at least 5% of the shares in the subsidiary company.
  • The (foreign) subsidiary is subject to CIT at least 9%. 

Finally, we come to grouping options available under the proposed regime. Such grouping may reduce the effective tax rate of a group containing several businesses. The objectives of providing the grouping facility are:

  • To allow one group member’s loss to be setoff against another group member’s profits.  
  • To treat the whole tax group as a single taxable person, with the parent company responsible for the administration and payment of CIT on behalf of the tax group. 
  • To ignore the transactions between the members of the tax group. 

A UAE resident group of companies can elect to form a tax group if the parent company holds at least 95% of the share capital and voting rights of the subsidiaries. 

Where the parent company does not meet the 95% criteria and instead holds 75% of the ownership of the subsidiaries, it can still seek to transfer losses from a loss-making group company to a profit-making group company, as long as both the following conditions are met:

  • The company transferring losses is neither exempt nor benefits from the 0% Free Zone regime. 
  • The total tax loss offset ought not to exceed 75% of the taxable income of the company receiving the tax losses for the relevant period. 

In addition to the above-mentioned facilities, the proposed UAE CT regime will also allow for an exemption or deferral of CT in respect of the transfer of assets or liabilities between members of a group, to avoid triggering an unnecessary tax charge when businesses reorganize themselves. The CT regime would also allow some corporate reorganization transactions (e.g., mergers) to be undertaken on a tax-neutral basis.  

What about the Free Zone tax exemption and Corporate Income Tax?

Companies and branches that are registered in a Free Zone (Free Zone Persons) are within the scope of the CIT regime and subject to filing requirements. 

The UAE Government has committed, however, that the tax exemptions will continue to apply to Free Zone Persons provided they (i) maintain adequate substance, (ii) comply with all other regulatory requirements, and (iii) income is earned from transactions with businesses located outside the UAE, or from trading businesses located in the (same or any other) Free Zone.

The complications start when Free Zone businesses interact with businesses located in Mainland UAE (Mainland Persons). Let’s consider a few scenarios here:

  • A Free Zone business (that does not have a branch in the Mainland) transacting with a Mainland business: 

– If the income is passive (like interest, royalties, dividends, and capital gains from owning shares in Mainland Persons) – 0% CIT.

  • A Free Zone business (that has a branch in the mainland): 

– Taxed on the Mainland Sourced income. 

– Not taxed on its other income. 

  • A Free Zone business transacting with a (group company) Mainland business: 

– 0% CIT, but 

– Payments made by the Mainland business to its group company in Free Zone will not be deductible. 

  • A Free Zone business located in a Designated Zone for VAT purposes earning income from the sale of goods to a Mainland business: 

– 0% CIT, if 

– The Free Zone business is the importer of record of those goods. 

  • A Free Zone business earning income by transacting with a Mainland Person (not covered in any of the above four scenarios): 

– Such Free Zone Person will have its 0% CIT privilege disqualified for all of its Income

Fair to say, that there are a number of complexities involving Free Zones. 


VAT was introduced in the UAE on 1 January 2018 at a standard rate of 5% on the supply of goods and services. 

VAT is a broad-based consumption tax levied on almost all supplies of goods and services in the UAE, including deemed supplies, as well as the importation of goods into the UAE.

Like most VAT systems, VAT in the UAE avoids a cascading effect on tax (tax on tax) by allowing the Input tax to be subtracted from the output tax liability. Generally, Input tax can be recovered (subtracted from output tax) when goods or services are (intended to be) used for making taxable supplies in the UAE or supplies outside the UAE. 

The term ‘goods’ here refers to all types of physical property. Any supply that does not constitute a supply of goods, is a supply of services.   

The provisions relating to place of supply and valuation of supply are mostly in line with international standards. Some benefits are offered to supplies made in certain Free Zones (referred to as Designated Zones) discussed in the next headline. 

UAE VAT and Free Zones 

When the UAE Government introduced the concept of Free Zones, it did not envisage the requirement of a VAT system at that time. Accordingly, to ensure that the UAE continues to remain a competitive trading and investment destination even after the introduction of the VAT law, some relief is available for the sale of goods. For the supply of services, however, there are no exceptions made to the regular VAT system, except for the shipping of goods from a Designated Zone, if supplied by the same supplier of the goods.

Some businesses in some Free Zones benefit from an exception. These Zones are referred to as ‘Designated Zones’. The list of Designated Zones that are effective as of date is provided in Appendix 1. 

Designated Zones are defined as a specific fenced geographic area and has security measures and Customs controls in place to monitor entry and exit of individuals and movement of goods to and from the area

Designated Zones are treated as being outside the State for VAT purposes for certain supplies of goods. This means that a supply of goods within a Designated Zone is treated as made outside the UAE, and therefore, outside the scope of VAT in the UAE. 

Even though Designated Zones are considered to be outside the State, a sale from Mainland UAE to the Designated Zone is taxable at the standard rate of 5%.  

The situations involving a Designated Zone where VAT liability generally become due (treated to be imported into the UAE) are either of the following:

  • Goods are consumed within the Designated Zone.
  • Goods are rendered unaccounted for. 
  • Goods are taken out of a Designated Zone and into Mainland UAE (including Free Zones not considered as Designated Zones). 

In short, the VAT implications of transactions with entities in the Designated Zones can be summarized below: 

  • Domestic sale from the UAE to a Designated Zone – 5%.
  • Domestic sale from Designated Zones to the UAE Mainland – Import taxable at 5%.
  • Domestic sales from Designated Zones to Designated Zones – VAT is not applicable.
  • Domestic sales within the same Designated Zone – VAT is not applicable (except for retail sales).
  • Export from Designated Zones to GCC countries/non-GCC countries – VAT is not applicable (outside the scope of VAT).


List of Designated Zones in the UAE

Abu Dhabi

  • Free Trade Zone of Khalifa Port
  • Abu Dhabi Airport Free Zone
  • Khalifa Industrial Zone
  • Al Ain International Airport Free Zone 
  • Al Butain International Airport Free Zone


  • Jebel Ali Free Zone (North-South)
  • Dubai Cars and Automotive Zone (DUCAMZ)
  • DAFZA Industrial Park Free Zone – Al Qusais
  • Dubai Aviation City
  • Dubai Airport Free Zone
  • International Humanitarian City – Jebel Ali
  • Dubai CommerCity


  • Hamriyah Free Zone
  • Sharjah Airport International Free Zone

Umm Al Quwain

  • Umm Al Quwain Free Trade Zone in Ahmed Bin Rashid Port 
  • Umm Al Quwain Free Trade Zone on Sheikh Mohammed Bin Zayed Road

Ras Al Khaimah

  • Ras Al Khaimah Port Free Zone
  • RAK Maritime City Free Zone
  • Al Hamra Industrial Zone – Free Zone
  • Al Ghail Industrial Zone – Free Zone
  • Al Hulaila Industrial Zone – Free Zone


  • Fujairah Free Zone
  • FOIZ (Fujairah Oil Industry Zone)

Designated Zones – Ajman

  • Ajman Free Zone

Free Zones UAE Corporate Income Tax

Free Zones and UAE Corporate Income Tax – a complicated harmony

Free Zones and UAE Corporate Income Tax – a complicated harmony

In the text of the public consultation, published by the UAE Ministry of Finance, it discusses its proposed regime for Free Zone Companies.

While the Corporate Income Tax concepts are thus far fairly straightforward, they are much less so for Free Zones.

Contrary to perhaps more simple exemptions for Free Zone companies in the Philippines or India, the UAE is implementing a fairly complex regime, trying to balance a number of interests.

Free Zones have been one of the success stories of the UAE, but incorporating there comes with limitations too, as e.g. the prohibition to trade with the mainland. In mainland, foreign businesses needed a local sponsor or shareholder.

In recent times, those lines have blurred, with more legal possibilities for foreign businesses to fully own a mainland businesses. In addition, free zones businesses were sometimes awarded a “dual license”, allowing them to operate in the mainland, and sometimes were even awarded importer codes.

The principle under the Corporate Income Tax Law which will be implemented with effect from June 2023, is that the UAE will honour the tax incentives currently being offered to Free Zone businesses that maintain adequate substance and comply with all regulatory requirements.

Presumably the reference to substance is a reference to the Economic Substance Regulations introduced in 2019 by way of Cabinet Decision No. 57 of 2020. It would be helpful if it is clarified whether for example a free zone business with a mainland branch can count its mainland substance towards the substance required for ESR purposes.

In addition, it is assumed that when a Free Zone business loses its tax exemption, the substance requirements are no longer applicable.

The CT exemption only continues to apply if the business solely transacts with other Free zone businesses (in the same free zone or another) or with third countries. This offers substantial possibilities, as JAFZA alone, according to its own claims, in 2019 contributed 23.8% to Dubai’s GDP (1).

There are some interesting considerations as regarding what constitutes transacting with the mainland. If a Free Zone business does so, without having incorporated a branch subject to CT, then the income of the Free Zone business is fully subject to CT. In other words, there is no more blanket exemption available.

What constitutes transacting with the mainland is interesting to note, as:

  • Free zone businesses in a Designated Zone for VAT purposes are not considered transacting with the mainland, if the buyer is the importer of record.
  • Conversely, assumed, though not made explicit, services rendered to the mainland are considered, and therefore such FZ businesses involved in these services will loose their tax exemption.

As regarding goods, there are a number of situations to be considered:

  • Free Zone businesses do not control the status of the Free Zone as a Designated Zone. Such a status needs to be applied for by the Free Zone Authority, and is subject to approval. Moreover, Free Zones can loose or gain Designated Zone status with retroactive effect. This has an adverse impact on legal certainty in regard to the application of the tax exemption.
  • There is a stark contrast with traders in a free zone (e.g. commodity traders), who may buy in mainland to sell in mainland, or to bring those goods into a free zone. Those seem to be excluded from the tax exemption, whereas they are conducting the same trade, just in the opposite direction.
  • Retail sales in the Designated Zone look to be at an advantage. For VAT purposes, they are subject to VAT, but when conducted by a Free Zone business with mainland and free zone branches, the mainland branches’ income is subject to CT, and the free zone branches in a designated zone are not.

Certain transactions are further allowed to be conducted with the mainland, such as situations where a free zone business earns passive income, i.e. interest, royalties, dividends and capital gains from mainland companies. This is good news for holding companies in free zones.

Transactions from a Free zone to a group company in mainland are also allowed without losing the benefit of the 0% CT. However, payments made to a Free zone business will not constitute a deductible expense for CT purposes.

So far, we have not identified an anti-abuse rule preventing a free zone company to make the charge to a business abroad, for that business to subsequently charge the mainland business, this nonetheless creating a deductible expense.

Group Treasury Centres or HQs often established in Free Zones may considered the non-deductibility on a group level a disadvantage. This may tempt groups to reconsider their structure, and put their regional headquarter in a different country with a low level of taxation (e.g. Bahrain or a gree zone abroad), and where payments would nonetheless be deductible. Additionally, the non deductibility looks limited to UAE Free Zones.

A business who relocates their Group Treasury Centre for example to a KSA Free zone, or a HQ, may continue to benefit from tax exempt income on the one hand, and deductibility on the other hand.

From a policy perspective, the UAE may consider an anti-abuse rule considering this situation, which may for example consist of defining a Free Zone in a broad enough manner in order for it to encompass foreign free zones as well, as no or only nominal tax jurisdictions in which activities may be relocated.

It is fair to say that due to the complexities, compliance will need to be closely monitored.

(1), consulted on 4 May 2022.

Free Zones GCC Tax

KSA’s First Free Zone

Free Zones UAE VAT

UAE publishes long awaited Cabinet Decisions on Free Zones and Medical Supplies

UAE publishes long awaited Cabinet Decisions on Free Zones and Medical Supplies

The Designated Zones are special zones for VAT purposes which are generally considered outside of the UAE for VAT purposes. While VAT applies throughout the UAE, in the Designated Zones VAT generally does not apply. Only fenced free zones with special controls on goods and services going in and out could benefit from this status. As expected, important free zones such as JAFZA, DAFZA and KIZAD are on the list.

The wait for these decisions has caused a lot of confusion with importers, exporters, clearing agents and forwarders. It is good that clarity has been brought.

The other long awaited cabinet decision is on medical supplies. Certain supplies of medication and medical equipment which are registered with the Ministry of Health can benefit from a zero rate. This however does not extend to services related to medical equipment although hospitals often rent equipment. The practical issues with registering goods with MoH shall now also have a tax impact.

Both decisions work retroactively back to 1 January 2018. This means that quite a number of invoices need to be corrected, as VAT will have been applied on certain imports and sales in the DZ’s and on medical supplies. Unduly invoiced VAT is not deductible.