Compliance Essentials for Free Zone Companies Handling Corporate Tax in UAE

The corporate tax framework in the UAE for free zone entities has been structured to foster economic growth, providing businesses with a favourable tax environment. Companies operating within specific free zones significantly benefit from a 0% tax rate on qualifying income. However, it’s imperative for organizations to understand the essentials regarding qualifying and non-qualifying activities and know the clauses that the tax regime presents to them.

Forward-thinking companies look out for professional assistance for business set up in Dubai. In this edition, let’s have a look at the prime conditions businesses should fulfil to qualify for the Free Zone Person (QFZP) Status.

Conditions to Meet to Qualify as a Free Zone Person

Here are certain conditions entities in the UAE must meet to qualify as a QFZP. Accordingly, they need to address their corporate tax filings.

• Juridical person: The entity must be incorporated, established, or registered within a free zone.
• Adequate assets: The entity must maintain adequate assets, full-time employees, and operating expenditures within the free zone.
• Qualifying income: The income of the business should be derived from transactions with other free zone persons, activities classified as qualifying, or the ownership/exploitation of qualifying intellectual property.
• Arm’s Length principle: Transactions with related parties must comply with this principle to ensure fair market value.
• Transfer pricing documentation: Proper documentation must be maintained for transfer pricing.
• Audited financial statements: The entity must prepare and maintain audited financial statements.
• De Minimis requirements: Non-qualifying revenue should not exceed the lower of AED 5 million or 5% of total revenue.

Identifying Qualifying Activities

Businesses, in order to take advantage of the 0% corporate tax rate, must engage in certain qualifying activities. These include:

Production of goods within the free zone

• Trading in minerals, energy, raw metals, and agricultural commodities
• Owning, managing, and operating ships
• Fund and wealth management services
• Treasury and financing services
• Distributing goods from designated zones
• Logistics services

Non-Qualifying Activities

Certain activities are categorized as non-qualifying. These include:

• Transactions with natural persons
• Insurance and banking activities
• Leasing and financing
• Ownership or exploitation of immovable property outside the free zone

De Minimis Requirements

The de minimis rule allows for a small amount of non-qualifying income without losing QFZP status. For example, if a free zone entity earns AED 10 million, with AED 600,000 from non-qualifying sources, the non-qualifying revenue constitutes 6% of the total. This exceeds the permissible limit, resulting in the loss of QFZP status for the current and subsequent four taxable years.

Dealing with Real Estate

If an income is derived from an immovable property which is situated outside a free zone, it is considered to be non-qualifying. However, income generated from commercial property transactions within a free zone with other entities in the same area can qualify for the 0% corporate tax rate. Proper classification and compliance are essential to maintain this favorable tax treatment.

General Anti-Avoidance Rule (GAAR) Provisions

The GAAR is an essential aspect of the tax framework in the UAE. It has been developed to prevent tax evasion and ensure that businesses don’t reap tax benefits through abusive arrangements. The Federal Tax Authority (FTA) can disregard or re-characterize transactions lacking commercial substance or those primarily designed to gain a tax advantage. Therefore, companies must have robust tax planning strategies in place. These strategies must be commercially driven and compliant with GAAR to avoid penalties.

Compliance Strategies Recommended by Tax Experts

Here are a few compliance strategies that tax experts recommend businesses.

• Maintaining adequate substance: Companies must ensure they have sufficient assets, employees, and operational expenditures within the free zone to retain their QFZP status.
• Proper transfer pricing: Businesses need to comply with the arm’s length principle and maintain comprehensive transfer pricing documentation. This ensures that transactions with related parties reflect fair values and are ready for scrutiny from tax authorities.
• Fulfilling de minimis requirements: Organizations must monitor the sources of their revenue regularly to ensure compliance with de minimis requirements. In case they exceed the threshold, they may lose their QFZP status as well as the associated tax benefits.
• Complying with GAAR: For businesses, it’s important to assess their tax arrangements and make sure that they remain commercially substantive, and aren’t designed only for tax benefits. A proactive stance regarding GAAR provisions significantly mitigates the risk of adverse tax assessments and penalties.

Businesses operating in the free zones in the UAE must adhere to the strict tax regulations and comply with the established norms. With evolving tax regulations, most organizations reach out to established tax consultants to know how to calculate the corporate tax in UAE. Top consultants like the IMC Group can assist rapidly expanding organizations with professional advice, ensuring their compliance with GAAR. With seasoned experts on the side, businesses can secure their favourable tax status within the free zones in the UAE.