31 May 2024 - On 20 May 2024, the Federal Tax Authority (FTA) published a Corporate Tax (CT) Guide on Free Zone Persons (FZP) (referred to as the 'Guide') aiming to provide general guidance on the application of the Federal Decree Law No. 47 of 2022 on the Taxation of Corporations and Businesses (CT law) to Free Zones (FZ) as well as the FZPs.

The Guide provides an overview of the conditions required to be met for a FZP to be considered as a Qualifying Free Zone Person (QZFP) and benefit from the 0% CT rate. It also provides elaborate guidance on the activities considered as Qualifying Activities (QA) and Excluded Activities (EA), providing various examples to clarify and explain many issues which were not clear based on the CT law.

The Guide states that it is not a legally binding document but is intended to provide assistance in understanding the tax implications of the UAE CT regime for FZPs.

Background

To recognize the continued importance of FZs, the UAE CT rules enable FZ companies (including branches) that meet prescribed conditions to benefit from a 0% CT rate on specified incomes.

To support the intended implementation of the beneficial UAE CT regime for FZPs, the FTA has now issued the much-anticipated Guide to provide additional guidance and clarifications in this respect.

Key Clarifications

With the above background, we have highlighted below certain key clarifications and important takeaways from the Guide, for reference:

FZP / QFZP status

Taxpayers are required to check with the FZ authority to confirm its FZ status for CT purposes.

A FZP is deemed a QFZP unless any of the prescribed QFZP conditions are not met.

QFZP status would be lost for five tax periods where an election is made to be subject to CT at 9%.

A FZ branch of a UAE juridical person can also benefit from the UAE CT regime for FZPs.

A head office located outside the FZ would be considered a Domestic Permanent Establishment (PE) or a Foreign PE (as the case may be).

Qualifying Income

Reliance can be placed on a written statement/undertaking from the FZ purchaser (say, a contractual stipulation) for Beneficial Recipient criteria.

In the case of start-ups, even if no Qualifying Income (QI) is earned, the condition of 'Derives QI' would be considered as met.

Exempt income derived by an Exempt Person would be excluded from the de minimis calculation.

Tax Computation Mechanism

Election to be subject to a 9% CT rate can be made either during the tax period or after the end of the respective tax period but before the date of filing the relevant CT return.

The Guide provides specific insights on the following aspects:

Computation mechanism to determine the Taxable Income (TI) of FZP that is not a QI.

Indicative principles to determine the allocation of expenses between QI and TI.

For income derived from mixed use of a FZ property, allocation of revenue between commercial and non-commercial units (on an arm’s length basis).

Set-off/carry forward of tax losses on the TI component and QI component.

Further, it is clarified that income from Intellectual Property (IP) (other than QI from Qualifying Intellectual Property) can only be offset against tax losses from such IP.

Substance Requirements

Separate substance is required for each Core Income Generating Activity (CIGA).

Restrictions on double counting of employees for substance purposes.

Mechanisms/means required to be put in place to supervise outsourced CIGAs.

Qualifying Intellectual Property (QIP)

The sum of Qualifying Expenditures (QE) and Uplift Expenditures (UE) must be the lesser of 130% of QEs or Overall Expenditures (OE).

Special rules are prescribed for expenditures incurred prior to the first tax period.

QI calculation is required to be performed on a QIP-by-QIP basis (if not feasible, the nexus approach can be applied for the products and product families).

QFZP would be required to ensure tracking systems to demonstrate nexus.

Expenditures related to unsuccessful Research & Development (R&D) costs are required to be excluded.

Qualifying Activities

A solitary activity which does not naturally or integrally form part of a coherent Business of the FZP may not constitute a QA.

Ancillary activities will need to be determined on a case-by-case basis, taking into consideration the main QA.

Investment of surplus funds cannot be considered as an ancillary activity.

High seas sales/third port shipments would be covered under QA of Distribution.

Confirmation by way of a written undertaking/contract may be taken from customers to ensure fulfillment of the “resell/resale” criteria for QA of Distribution.

Guidance on the meaning of raw form for QA of Trading of Qualifying Commodities is now provided.

No threshold for the amount of loans to qualify under QA of Treasury and Finance Services to Related Parties. Further, interest on bank deposits may qualify as Treasury and Finance service to self, subject to conditions.

Negotiable or non-negotiable financial instruments under QA of Holding of shares and other securities for investment purposes include Cryptocurrency.

Trading of shares and securities on a Recognized Stock Exchange with a natural person is not considered an EA.

For details on the above guide, please refer our webinar on “Navigating the Free Zone Persons Corporate Tax guide” on the following link.

Key Takeaways

The Guide clarifies various key aspects in relation to the UAE CT regime for FZPs.

Considering the detailed guidance and clarity provided in the Guide, it becomes crucial for all taxpayers to revisit their activities and business structures for the FZ entities, with key attention on aspects such as QI, ancillary activities, and meeting the adequate substance test.

It is equally important for QFZPs to focus on maintaining proper records/documentation to demonstrate the calculation of QI (including specific records required in relation to QI from QIPs), proving adequate substance, evidencing compliance with transfer pricing requirements, etc.

Contacts

We have a dedicated Business Tax team based in the UAE who have in-depth experience and can support you throughout your readiness journey. Please get in touch with one of our tax experts listed on the following page.

You can also contact us and submit all your queries on this email cituae@deloitte.com.