The United Arab Emirates (UAE) has made significant strides in its tax regime by introducing corporate tax. Under this new framework, Qualifying Free Zone Persons (QFZP) has garnered considerable attention. These entities enjoy a remarkable tax advantage: a 0% corporate tax rate. By implementing a 0% corporate tax for certain free zone entities, the United Arab Emirates is implementing a compromise to balance the historically guaranteed tax exemption on the one hand and the economic development on the other.
The Special Status of Qualifying Free Zone Persons
One of the most anticipated aspects of this legislative evolution is the treatment of Qualifying Free Zone Persons (QFZP) under the corporate tax regime. QFZPs are a unique category of businesses operating within the UAE Free Zones that automatically benefit from a 0% corporate tax rate. This advantage is contingent on fulfilling specific criteria and maintaining adequate substance within a UAE Free Zone by conducting core income-generating activities.
Advantages and Limitations of QFZP Status
While QFZP status offers a highly attractive tax benefit, it has certain restrictions. QFZPs cannot form part of a tax group, transfer tax losses, or access corporate tax rollover relief.
Qualifying Income: The Key to 0% Corporate Tax
The “qualifying income” concept is pivotal for QFZPs seeking the 0% corporate tax rate. Qualifying income can be broadly categorized into three groups:
Income Derived from Transactions with Other Free Zone Persons:
As long as these transactions do not involve excluded activities, they qualify for the 0% corporate tax rate. Importantly, the FZP receiving the goods or services is considered the beneficial recipient.
Income Derived from Transactions with Other Free Zone Persons:
This applies specifically to qualifying activities that are not excluded activities.
Other Income:
This category encompasses any income that meets the de minimis requirement.
It’s essential to note that exceptions apply when this income is attributable to a domestic (UAE mainland) or foreign Permanent Establishment (PE) of the QFZP or to the ownership or exploitation of specific immovable property within a Free Zone. In such cases, the income is subject to the standard nine percent corporate tax rate.
Road to the QFZP Status
To be recognized as a QFZP and enjoy the 0% corporate tax rate, the entity must meet several key criteria, including:
Maintaining Adequate Substance in the UAE:
This requirement mandates that the entity conducts its core income-generating activities within a UAE Free Zone and maintains adequate assets, a sufficient number of qualified employees, and a requisite level of operating expenditure within the Free Zone. Outsourcing activities within the Free Zone is permitted if proper supervision is provided.
Deriving Qualifying Income:
Deriving Qualifying IncomeQFZPs must earn what’s termed “qualifying income.” This type of income is crucial for enjoying the 0% corporate tax rate.:
Staying within De Minimis Thresholds:
QFZPs must ensure that their non-qualifying revenue does not exceed the de minimis threshold.
The QFZP may not opt to be subject to CT:
Adhering to Transfer Pricing Documentation:
QFZPs must comply with transfer pricing documentation requirements specified in the CT Law.
Financial Transparency:
If a QFZP fails to meet the de minimis requirements or no longer satisfies any of the other qualifying conditions, they will be disqualified from the Free Zone Corporate Tax regime for a minimum of five years. During this period, they will be treated as regular taxable persons and subject to Corporate Tax at the rate of 9% on their Taxable Income above AED 375,000.
De Minimis Threshold: Maintaining Compliance
To preserve QFZP status, non-qualifying revenue must not exceed the de minimis threshold. The de minimis requirement is met when non-qualifying revenue in a tax period does not exceed five percent of the total revenue of the QFZP in that tax period or AED 5 million, whichever is lower. Non-qualifying revenue includes revenue derived from excluded activities and activities not categorized as qualifying activities when the counterparty is a non-Free Zone Person.
Qualifying Activities: The Foundation of Qualifying Income
- Manufacturing of goods or materials.
- Processing of goods or materials.
- Holding of shares and other securities.
- Ownership, management, and operation of ships.
- Reinsurance services are subject to regulatory oversight.
- Fund management services are subject to regulatory oversight.
- Wealth and investment management services are subject to regulatory oversight.
- Headquarters services to related parties.
- Treasury and financing services to related parties.
- Financing and leasing of aircraft, including engines and components.
- Distribution of goods or materials within or from a designated zone.
- Logistics services.
- Ancillary activities are related to the activities listed above.
Income derived from transactions with individuals in the UAE mainland or foreign countries can only enjoy the 0% rate if the activities align with these categories. Income from other activities falls outside the qualifying income bracket.
Excluded Activities: The Limitations
- Transactions with natural persons, except for specific qualifying activities.
- Banking activities under regulatory oversight.
- Insurance activities are under regulatory oversight, with specific exceptions for reinsurance services.
- Finance and leasing activities under regulatory oversight, with exclusions for financing and leasing of aircraft.
- Ownership or exploitation of immovable property, except for specific commercial property transactions within Free Zones.
- Ownership or exploitation of intellectual property assets.
- Ancillary activities related to the above-listed activities.
- Income Attributable to Immovable Property and Permanent Establishments
Income related to immovable property within a Free Zone may be subject to corporate tax, except when it involves commercial property transactions with other Free Zone Persons. Commercial property, in this context, refers to immovable property exclusively used for business or commercial activities, not for residential purposes.
Additionally, income attributable to a domestic or foreign Permanent Establishment (PE) of the QFZP is considered taxable income. The income is calculated as if the PE were a separate entity related to the QFZP.
How TME Legal Consultants can support your business
For businesses operating as QFZPs, understanding the criteria for qualifying income and navigating the nuances of Free Zone taxation is essential. These entities enjoy the unique advantage of a 0% corporate tax rate, provided they meet the stipulated conditions and derive qualifying income. On the other hand there are certain tax limitations for a QFZP.
TME Legal Consultants 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.
