UAE CT: Tax on IP Businesses in Free Zones
Mahar Afzal
Chief Executive Officer, and Founder at Kress Cooper | Entrepreneur | Angel Investor | Expert in Compliance (Corporate Tax, VAT, etc. ) | Writer | Educator | Trainer | Risk-Taker | Education Enthusiast
When a Qualifying Free Zone Person (QFZP) is involved in the Research and Development (R&D) of Intellectual Property asset, there is a possibility that certain portion of income generated from Qualifying Intellectual Property (QIP) asset can attract zero percent corporate tax, while any non-qualifying income from QIP asset and income from non-QIP asset are subject to a flat nine percent tax rate; and such income that is subject to nine percent tax will not be considered while applying the de-minimus test.
A QFZP can generate qualifying income from QIP asset if there is a direct link between the income generated from the QIP asset and the eligible R&D expenses that have contributed to that income. When a QFZP obtains QIP asset or contracts R&D services to a related party located outside the UAE, the income portion linked to the acquisition cost or outsourced R&D does not qualify as qualifying income.
Intellectual property refers to intangible assets that are owned and officially registered in person’s name, such as patents, copyrights, copyrighted software, formulas, trademarks, brands, and technical know-how. These intangible assets can be categorized as either QIP asset or non-QIP asset
The QIP asset encompasses intangible assets that have been registered according to the laws governing intangible assets in the UAE or a relevant foreign jurisdiction but are not being utilized for commercial purposes. For instance, a trademark used solely for one's own business cannot be considered QIP asset, even if it is protected under applicable laws.
Income generated from QIP assets can potentially qualify as qualifying income based on a specific formula outlined in the Guide and relevant Ministerial Decision. This formula is as follows: Qualifying income equals the ratio of qualifying expenditures plus uplift expenditure to total expenditure, multiplied by overall income. The formula requires the overall numbers over the life of QIP asset.
Qualifying expenditures refer to expenses incurred to support R&D initiatives, whether carried out by the QFZP itself or outsourced to a third party in the UAE or abroad who is not a related party, while the overall expenditure includes the qualifying expenditures, plus acquisition cost and outsourcing to the related party out of the UAE for the creation, invention or significant development of the QIP asset. Uplift Expenditures refer to qualifying expenditures that have been increased by 30%. However, this increase applies only if the qualifying expenditures, after the uplift, remain less than or equal to the overall expenditures. While the overall income means the separately identifiable income generated from the QIP asset.
Expenditures must be directly linked to the creation, invention, or significant development of the QIP asset, such as R&D personnel salaries and wages. For expenses like administrative costs that cannot be directly attributed to the QIP asset, they should be proportionately allocated. Additionally, qualifying expenses should be recognized when incurred, irrespective of their accounting and tax treatment.?
The formula mentioned above necessitates the inclusion of qualifying expenditures, overall expenditure, and overall income, requiring the QFZP to meticulously track all figures with a robust tracking system in place, organized by product or product families as appropriate. Tracking becomes straightforward when the QFZP has a single QIP asset and no outsourcing. However, when the QFZP manages multiple QIP assets, in-house R&D, and outsourced R&D, meticulous tracking is crucial for precise numerical outcomes.
The nexus approach involves tracking qualifying expenditures and overall expenditures for QIP assets. A QFZP can derive qualifying income from such assets developed before the corporate tax law but needs to track historic expenditures. A system for tracking historic expenditures may be challenging post-law implementation, especially for multiple assets. A transitional ratio method based on a three-year rolling average is permitted initially, shifting to a cumulative ratio later for the fourth and subsequent tax periods.
To establish the connection between qualifying expenditures and income from each QIP asset, a QFZP must maintain detailed records demonstrating ownership rights, expenditures, income, and the relationship between expenditures and income for each asset. Expenditures for general R&D must be linked to specific assets or explained for proportional allocation. In cases of acquiring assets from related parties, documentation verifying arm's length pricing and the transferor's expenditures is necessary.
Without proper tracking, a QFZP can't show qualifying income from QIP, missing the 0% tax rate benefit. Yet, it can exclude QIP revenue from total revenue and non-qualifying revenue while applying de minimis rules.
The writer, Mahar Afzal, is a managing partner at Kress Cooper Management Consultants. The above is not an official but his personal opinion. For any queries/clarifications, please feel free to contact him at?[email protected] .