UAE CT Update: Cabinet Decision (read with Ministerial Decision) providing clarification on Taxation of Free Zone Business in the UAE

The Cabinet of Ministers has issued Cabinet Decision No. 55 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’). Further, the Ministry of Finance has issued Ministerial Decision No. 139 of 2023 (effective from 1 June 2023) defining the terms “Qualifying Activities” and “Excluded Activities” for the purpose of the CT Law supplementing the said Cabinet Decision.

• Who will be a Qualifying Free Zone Person (‘QFZP’) under the CT Law

As per Article 18 of the CT Law, a Qualifying Free Zone Person is a Free Zone Person that meets all of the following conditions:

1. Maintains Adequate Substance in the UAE
2. Derives Qualifying Income
3. Has not specifically elected to be subject to Corporate Tax under the CT Law
4. Complies with Transfer Pricing regulations
5. Maintains audited financial statements as per IFRS / IFRS for SMEs
6. The Non-Qualifying Revenue of a Free Zone person does not exceed the lower of (termed as De Minimis requirement in decisions) in a Tax Period:
   1. 5% of the Total Revenue of a Free Zone Person; or
   2. AED 5 million (specified in the subject Ministerial Decision)

In case a QFZP fails to meet any of the above-listed conditions at any particular time in a Tax Period, it shall cease to be a QFZP from the beginning of the relevant Tax Period and for the subsequent 4 (four) Tax Periods. It, therefore, implies that a free zone person will be treated as a Taxable Person chargeable to corporate income tax @ 9% for a minimum term of 5 (five) years.

• Maintaining an Adequate Substance by a Free Zone Person

  The said Cabinet Decision states that a QFZP which undertakes its core income-generating activities in a Free Zone and has adequate assets, an adequate number of qualified employees, and incurs an adequate amount of operating expenditure having regard to the level of activities in the Free Zone, shall be said to have an Adequate Substance therein.

  It has been further clarified that the activities can be outsourced to a Related Party or to a Third-party in a Free Zone, provided, the QFZP has adequate supervision of the outsourced activity.

• 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:

*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.

1. Domestic Permanent Establishment

   A Domestic PE has been defined to mean a place of business or another 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.

2. Income attributable to a Domestic PE or a Foreign PE

   Income is 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.

3. Income attributable to Immovable Property located in a Free Zone

   Income attributable to an 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):

   1. Transactions with Non-Free Zone Persons in respect of Commercial Property;
   2. Transactions with any Person in respect of an Immovable Property that is not a Commercial Property.

   Commercial Property has been defined to mean an immovable property or part thereof:

   1. Used exclusively for a Business or Business Activity
   2. Not used as a place of residence or accommodation including hotels, motels, bed and breakfast establishments, serviced apartments, and the like.

4. Excluded Activities

   These activities include the following:

   1. Transactions with natural persons (subject to certain exceptions under Qualifying Activities related to shipping and aircraft plus fund, wealth, and investment management);
   2. Banking, finance, leasing, and insurance activities are subjected to regulatory oversight;
   3. Ownership or exploitation of immovable property, except for transactions with Free Zone Persons in relation to commercial property located in a Free Zone;
   4. Ownership or exploitation of intellectual property assets; and
   5. Any ancillary activities in relation to the above activities.

5. Qualifying Activities

   These activities include the following:

   1. Manufacturing and processing of goods or materials;
   2. Holding of shares and other securities;
   3. Ownership and operation of ships;
   4. Reinsurance and fund /wealth and investment management subject to regulatory oversight;
   5. Headquarters, treasury, and financing services to related parties;
   6. Financing and leasing of aircraft;
   7. Logistics; and
   8. The distribution of goods in or from a designated zone (as defined in VAT Law) is subject to certain conditions.

6. 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:

   1. Excluded activities;
   2. Activities that are not Non-Qualifying activities where the other party to the transaction is a Non-Free Zone Person.

   Total Revenue is all the Revenue derived by a QFZP in a Tax Period.

   The following Revenue will not be included in the calculation of Non-Qualifying Revenue and Total Revenue:

   1. Revenue is attributable to a domestic PE or a Foreign PE.
   2. Revenue is attributable to immovable property located in a Free Zone.

Separate Ministerial Decisions shall be issued to implement the provisions of Cabinet Decision No. 55.

MBG View

• One of the requisite conditions for a Free Zone Person to qualify as a QFZP is to have an “Adequate Substance” in the UAE. While the same gets complied if the QFZP undertakes core income generating activities having adequate assets, number of qualified employees, and incurring of an adequate amount of operating expenditures, it is pertinent to note that as of now there are no defined thresholds or standards for satisfying these criteria.
• 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.

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Also Check:- Corporate Tax in UAE