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Ensuring Tax Security in UAE Free Zones: A Recent Supreme Court Ruling

Ensuring Tax Security in UAE Free Zones: A Recent Supreme Court Ruling


In the United Arab Emirates (UAE), numerous free zones have a long history with enticing tax advantages and other incentives. These free zones often feature an appealing zero percent corporate tax rate for a specified period, potentially extendable. However, the introduction of a new corporate tax framework in the UAE has cast a shadow of uncertainty over the interplay between federal tax laws and such local exemptions.


To shed light on this matter, the Federal Supreme Court issued a landmark judgment in October 2023, which serves as a precedent for the application of tax laws in free zones. In this article, we will delve into the key aspects of the ruling, the exemption provisions for free zone entities under the UAE corporate tax law, and the wider implications of this court decision.


The Federal Supreme Court’s Judgment


The Federal Supreme Court’s judgment in October 2023 is a pivotal development, clarifying the relationship between federal and emirate-specific tax laws. This legal battle primarily concerned whether domestic tax laws would override federal tax legislation, particularly regarding tax exemptions.


Previously, the Federal Primary Court and the Federal Appeals Court had concluded that local tax laws held no sway over federal tax regulations. In contrast, the Supreme Court adopted a different perspective.


The Supreme Court’s ruling emphasized, “The local law does not restrict or specify the federal law issued by the federal authorities; rather, they operate within a framework of legislative integration and synergy. The petitioner is considered subject to tax, as what it practices in the activity in question … aims for profit. The [tax] exemption of the petitioner does not change the foregoing.”


The petitioner, in this case, sought recourse to the Supreme Court after facing a series of ministerial decrees within their respective emirate that granted tax exemptions. They aimed to challenge the lower federal courts’ findings.


The Federal Primary Court had previously argued that the FTA is responsible for the assessment, collection, and enforcement of the federal Corporate Tax. It is also responsible for imposing fines in the event of non-compliance. Emirate-related or free zone-related tax incentives do not supersede the nationally applicable corporate income tax regulations.


Similarly, the Federal Appeals Court concurred, stating, “The exemptions issued under local legislations have no impact on the application of the tax imposed under federal tax legislations.”


The lower federal courts had primarily scrutinized whether the exemptions granted to the petitioner within their respective emirate aligned with federal tax legislation. Their rationale was that emirate-specific tax exemptions benefited the taxpayer within the given emirate but did not have federal implications.


However, the Supreme Court’s stance was that the focus should be on whether an entity engages in profit-making activities rather than its location and whether federal tax legislation incorporates emirate-specific tax exemptions. This judgment underscored that domestic tax laws are indeed applicable but must be harmonized with federal tax laws. This departure from the reasoning of the lower federal courts offers much-needed assurance for free zone entities.


Existing Federal Exemption Provisions for Free Zone Entities (QFZP)


The UAE introduced a new corporate tax law in 2022, outlining tax obligations for all entities, including those in free zones. To qualify for tax exemptions, a free zone entity must meet specific criteria, including maintaining a substantial presence in the UAE, generating qualifying income, and adhering to specific auditing and pricing regulations. If these conditions are met, the entity is recognized as a “Qualifying Free Zone Person” (QFZP) and can enjoy tax exemptions. This framework aims to ensure compliance with international tax standards while providing a structured framework for tax obligations and exemptions.


Implications of the Supreme Court Judgment


The Supreme Court’s ruling is of paramount importance as it clarifies that profit-generating entities fall within the federal tax framework, irrespective of emirate-specific tax exemptions. This reaffirms that profit-making entities in free zones are subject to federal tax laws, like entities outside free zones. The judgment enhances our understanding of the interaction between federal and local tax laws, ensuring that businesses in free zones contribute to the country’s tax revenue when engaged in profit-generating activities. It aligns the tax treatment of free zone entities with the broader tax framework of the UAE, promoting equity and adherence to the new corporate tax regime.


It is noteworthy that the Supreme Court recognizes the existence and validity of domestic tax exemptions, such as those in free zones, without disregarding them. Instead, the Supreme Court emphasizes the need for emirate-specific exemptions to harmonize with federal tax laws. This principle underscores the importance of alignment between federal and local tax frameworks, acknowledging local exemptions if they conform to federal tax laws.


How TME Services Can Support Your Business


One promising avenue for harmonizing local free zone tax incentives and federal corporate tax law could involve a structured dialogue between government bodies and businesses operating within free zones. This dialogue could lead to developing guidelines or mechanisms that ensure the seamless coexistence of local and federal tax frameworks, promoting both economic growth and tax compliance in a balanced manner. Such an approach can enhance collaboration between local and federal authorities, creating a more secure and attractive environment for businesses in free zones to maximize their tax benefits while contributing to the UAE’s financial stability.


TME Services is a team of 45 professionals in legal-, tax-, accounting, and compliance with over 18 years of experience. We advised a significant number of SMEs in the context of the implementation of the tax framework in the UAE and KSA over the last decade to make sure that our clients are well-oriented in the new and fast-evolving tax landscape and to reduce the legal liability of managers which may arise in connection with non-compliance.

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