Impact of corporate tax on free zone entities

Understanding the proper substance definition is of utmost importance.

Generally, all free zone entities will pay a nine per cent tax on profits of Dh375,000. However, if the free zone person is a qualifying free zone person who earns qualifying income and meets the De Minimis conditions, then the free zone person can claim the zero corporate tax benefit for hundred.

Conditions to be a qualified free zone person: The free zone entity maintains the appropriate substance; earn qualified income; not opting for the normal corporate tax rate; meet de minimis requirements; maintain audited financial statements and; who complies with the transfer pricing rules will be considered a qualified free zone person.

Understanding the proper substance definition is of utmost importance. In article 7 of Cabinet Decision no. 55/2023 establishes that basic income-generating activities have adequate substance; adequate assets; adequate number of qualified employees and adequate operating expenses in that free zone.

However, a qualifying free zone person will lose the following benefits; the free zone entity cannot avail certain benefits that are extended to normal entities, i.e. business restructuring relief; be a member of a classification group; tax loss carryforwards; and take advantage of the benefits of relief for small businesses.

Qualifying individuals in the free zone who earn qualifying income will be eligible to receive a zero percent corporate tax. ‘Qualified income’ includes three categories of income according to Cabinet Decision No 55 of 2023namely:

to) income derived from transactions with a non-free zone person, but only in respect of qualifying activities that are not excluded activities;

b) income derived from transactions with other free zone persons, provided that they are not excluded activities (income derived from transactions with a free zone person will be considered when that freezing person is the beneficial owner of the relevant goods or services);

C) any other income, as long as the qualified person from the free zone meets the de minimis requirement.

Qualified activities include: Manufacturing/processing of goods or materials; logistics services; holding shares or securities; fund management, wealth management and investment management services subject to regulatory supervision; headquarters, treasury and financing services; ownership, management and operation of vessels; distribution of goods/materials in or from a designated free zone for subsequent sale/resale; aircraft financing or leasing, and reinsurance services subject to regulatory oversight.

Excluded activities include: banking activities; financial leasing activities except those carried out to related parties; insurance activities except reinsurance activities; certain transactions with natural persons; ownership or exploitation of intellectual property rights and; ownership or exploitation of real estate other than commercial property located in free zones.

The hottest debate in the free zone business community was over the distribution of goods or materials being shipped directly from foreign country A to foreign country B from a designated free zone entity and the taxation of such transactions. However, according to the recent corporate tax consultation document of the UAE Ministry of Finance, qualified activities point 3.11 Article 2 (1) (k), illustration of distribution of goods or materials, it seems that the ministry has clarified that the transaction related to goods being shipped directly from foreign country A to foreign country B from a designated free zone entity will be covered by the scope of qualified activities and therefore any income obtained from such activity will also be considered qualified income and will be subject to a zero percent corporate tax rate. .

It would be important to note that not all qualifying free zone people will get the benefit of the distribution of goods/materials. Therefore, trade in goods/materials from non-designated free zones will be subject to a 9 percent corporate tax. However, only designated persons in the free zone will get the benefit of 0 per cent tax rate for the distribution of goods/materials, as clarified by the UAE Ministry of Finance’s Consultation Paper on Corporate Taxes.

Entities registered in free zones that provide export of services (i.e. technology services, marketing services, consulting services, etc.) to entities outside free zones will be subject to a 9 percent corporate tax.

Normally, free zone entities that own property in the UAE mainland will be subject to a 9 per cent tax rate. The only exception is with respect to income from commercial properties held by qualified free zone entities located in free zones, which will qualify for zero percent tax rates.

Additionally, all qualifying free zone entities will have to apply for corporate tax registration and will have to mandatorily audit their books of accounts, regardless of the applicable tax rates, whether zero percent or nine percent.

News Source: Khaleej Times