Corporate Tax
The Cabinet of Ministers have recently issued Cabinet Decision No. 100 of 2023, (effective from 1 June 2023) for determining Qualifying Income for the Qualifying Free Zone Persons under the Federal Decree Law No. 47 of 2022 (’the CT Law’) repealing the earlier Cabinet Decision No. 55 of 2023 issued on 30 May 2023 (on determining Qualifying Income for the Qualifying Free Zone Persons). Further, the Ministry of Finance has issued Ministerial Decision No. 265 of 2023 (effective from 1 June 2023) defining the terms “Qualifying Activities” and “Excluded Activities” besides dealing with certain procedural conditions for the purpose of the CT Law supplementing the said Cabinet Decision and repealing the earlier Ministerial Decision 139 of 2023 issued on 1 June 2023.
UAE Corporate Tax Update: New tax move for Free Zone
November 09, 2023
- A. Who will be a Qualifying Free Zone Person (‘QFZP’) under the CT Law
- Maintains Adequate Substance in the UAE
- Derives Qualifying Income
- Has not specifically elected to be subject to Corporate Tax under the CT Law
- Complies with Transfer Pricing regulations
- Maintains audited financial statements as per IFRS / IFRS for SMEs
- The Non-Qualifying Revenue of a Free Zone person does not exceed the lower of (termed as De Minimis requirements in aforesaid decisions) in a Tax Period:
- 5% of the Total Revenue of a Free Zone Person; or
- AED 5 million (specified in the subject Ministerial Decision)
- B. Aspects which have been introduced by the above mentioned Decisions are as below:
- The concept of Qualifying Intellectual Property (“QIP”) has been introduced, wherein QIP refers to Patents, Copyrighted Software, and any right functionally equivalent to a Patent that is both legally protected and subject to a similar approval and registration process to a Patent, such as utility models, intellectual property assets that grant protection to plants and genetic material, orphan drug designations, and extensions of Patent protection, but not including any marketing related intellectual property assets, such as trademarks.
- The scope of Qualifying Income has been expanded to cover the income derived from the ownership or exploitation of Qualifying Intellectual Property, provided such income is not attributable to a Domestic PE or a Foreign PE, nor derived from ownership or exploitation of immovable property. The calculation of the same has been given as below:
This calculation follows the methodology outlined in the Organization for Economic Co-operation and Development's modified nexus approach.
- Documents to be maintained and furnished to the FTA upon request, with respect to the above issue of QIP:
- Ownership details and the right to exploit the Qualifying Intellectual Property;
- Qualifying Expenditures and Overall Expenditure incurred;
- Overall income derived from the Qualifying Intellectual Property;
- The link between Qualifying Expenditure and Overall Income derived
- Further, income derived from the ownership or exploitation of intellectual property that is not Qualifying Intellectual Property and income in excess of Qualifying income calculated with the prescribed formula, shall be considered taxable income and taxed in accordance with Clause 2 of Article 3 of the UAE CT Law i.e. would be taxable at 9% as per Article 3 of the CT Law.
- The Decisions have also stated that the revenue generated from the Trading of Commodities would be considered as Qualifying Income, wherein Qualifying Commodities refers to metals, minerals, energy and agricultural commodities that are traded on a recognized commodities exchange market in raw form;
- C. Expanded scope of Qualifying Activities:
- Manufacturing of goods or materials;
- Processing of goods or materials;
- Trading of Qualifying Commodities;
- Holding of shares and other securities for Investment Purpose (i.e. for an uninterrupted period of 12 months);
- Ownership and operation of ships;
- Reinsurance services;
- Fund management services;
- Headquarter, treasury and financing services to related parties;
- Financing and leasing of aircraft;
- Logistics; and
- The distribution of goods in or from a designated zone (as defined in VAT Law) subject to certain conditions.
- Any ancillary activities in relation to the above activities.
- D. Excluded activities have been given below:
- Transactions with natural persons (subject to certain exceptions under Qualifying Activities related to ownership, operation of ships, fund management services, wealth and investment management services and financing and leasing of aircrafts);
- Banking activities;
- Insurance activities, without prejudice to reinsurance services and headquarter services to related parties;
- Financing and leasing activities without prejudice to ownership, management and operation of ships, treasury and financing services to related parties and financing and leasing of aircrafts.
- Ownership or exploitation of immovable property, other than Commercial Property located in a Free Zone where the transaction in respect of such commercial property is conducted with a Free Zone Person;
- Any ancillary activities in relation to the above excluded activities.
- E. What is the Qualifying Income of a QFZP?
The categories of incomes excluded and included from the categorization of a “Qualifying Income” has been tabulated below:
Incomes excluded 1. Incomes attributable to a Domestic Permanent Establishment (‘PE’) or a Foreign PE 2. Incomes attributable to the ownership or exploitation of immovable property as specified in point 3 below 3. Incomes derived from any Person specified in the Excluded Activities 4. Incomes derived from a Non-Free Zone Person other than Qualifying Activities
*Beneficial Recipient has been defined as a Person who has the right to use and enjoy the service or the good and does not have a contractual or legal obligation to pass such service or good to another Person. Good has been defined to mean any tangible or intangible property that has economic value in dealing including moveable and immovable property.Incomes included 1. Any income derived from other Free Zone Persons (except those derived from Excluded Activities) provided that the other Free Zone Person is the Beneficial Recipient* of the relevant services or goods. 2. Income derived from ownership or exploitation of Qualifying Intellectual Property as calculated in accordance with the Decisions 3. Income derived from trading of Qualifying Commodities 4. Income derived from Qualifying Activities undertaken with a Non-Free Zone Person (provided not treated as Excluded Activities). 5. Any other income, subject to satisfaction of De Minimis requirement as per point 4 below.
- F. Domestic Permanent Establishment A Domestic PE has been defined to mean a place of business or other form of presence of a QFZP outside the Free Zone in the UAE.In this regard, a reference has been given to the provisions determining the PE of a Non-Resident Person under Article 14 of the CT Law for interpreting the definition of domestic PE of any Free Zone Person in the UAE. To illustrate, if a Free Zone Person has a branch in the mainland region, such a Branch shall be subject to tax @ 9% on its Taxable Income.
- G. Income attributable to a Domestic PE or a Foreign PE< Income attributable to a Domestic PE or a Foreign PE of the QFZP shall be considered as Taxable Income chargeable to corporate tax @ 9% (without the benefit of basic monetary threshold exemption of AED 375,000 of taxable income). Such Income shall be calculated as if the subject PE was a separate and independent Person that is a Related Party of the QFZP.
- H. Income derived from Immovable Property located in a Free Zone
Income derived from immovable property located in a Free Zone that is derived from the below transactions shall be considered as Taxable Income chargeable to corporate tax @ 9% (without the benefit of basic monetary threshold exemption of AED 375,000 of taxable income):
- Transactions with Non-Free Zone Persons in respect of Commercial Property;
- Transactions with any Person in respect of an Immovable Property that is not a Commercial Property.
- Used exclusively for a Business or Business Activity;
- Not used as a place of residence or accommodation including hotels, motels, bed and breakfast establishments, serviced apartments and the like.
- I. Non-Qualifying Revenue and Total Revenue (De Minimis requirement)
The Revenue derived by a Free Zone Person from any of the following activities in a Tax Period would qualify as Non-Qualifying Revenue:
- Excluded activities;
- Activities that are not Non Qualifying activities where the other party to the transaction is a Non-Free Zone Person.
- Transactions with a Free Zone Person where such Free Zone Person is not the Beneficial Recipient of the relevant services or Goods
- Revenue attributable to a domestic PE or a Foreign PE.
- Revenue attributable to immovable property located in a Free Zone.
- Revenue derived to non-qualifying income of Intellectual Property
- One of the requisite conditions for a Free Zone Person to qualify as a QFZP is to have an “Adequate Substance”. While the same gets complied if the QFZP undertakes core income generating activities in a Free Zone or a Designated Zone depending on where such activities are required to be conducted and having regard to the level of activities carried out, have adequate assets, adequate number of qualified employees in a Free Zone or a Designated Zone depending upon where such activities are required to be conducted, and incur an adequate amount of operating expenditures in relation to each activity, it is pertinent to note that as of now there are no defined thresholds or standards for satisfying these criterions.
- The core income generating activities can be outsourced to another person in a Free Zone or a Designated Zone depending on where such activities are required to be conducted, provided the QFZP has adequate supervision of the outsourced activity. The core income generating activities in respect of Qualifying intellectual property can be outsourced to any other person in the State and to any other person who is not a related party outside the State, provided the QFZP has adequate supervision of the outsourced activity. The core income-generating activities may vary according to the specific activity but mainly consist of those significant functions that derive the business value for each activity carried out by a QFZP and are not exclusively or mostly support activities.
- The De Minimis Rule under the subject Decisions requiring the Non-Qualifying Revenue earned by a Free Zone Person to not exceed the lower of 5% of the total revenue or AED 5 million in a Tax Period, becomes very important for a Free Zone entity to qualify as a QFZP and retain the status of an exempted business, as failure to comply with any of the eligibility conditions will result into disqualification of a Free Zone Person for being a QFZP for 5 years (current year and subsequent 4 years) and make it a taxable business.
- The subject Decisions have introduced the concept of a Domestic PE which would play a pivotal role in determining the taxation of Free Zone Persons especially where the QFZP also carries business outside the Free Zone.
- An activity shall be considered ancillary where it is necessary for the performance of the main activity or where it makes a minor contribution to it and is so closely related to the main activity that it should not be regarded as a separate activity.