UAE Free Zone Companies: Who Can Enjoy the Zero Corporate Tax Regime?

 Introduction

Special Economic Zones (SEZs) play a pivotal role in a nation’s economic development. Take Shenzhen, for example. Once a small village in China with a population of just 30,000, it transformed into an economic powerhouse after being designated an SEZ in 1980. By 2019, its GDP per capita had skyrocketed by 33,479%! During the same period, China’s GDP increased more than 54 times. This transformation demonstrates the remarkable effect that SEZs can have on economic growth.

The UAE has been a trailblazer in establishing free zones, a type of SEZ, offering businesses numerous advantages. In fact, six of the world’s top ten free zones were located in the UAE in 2023. The Dubai Multi Commodities Centre (DMCC) even earned the title of “Global Free Zone of the Year” for nine consecutive years. These free zones have been key in positioning the UAE as a global investment hub.

To maintain their appeal, the UAE introduced a groundbreaking initiative: a 0% corporate tax rate for free zone companies that meet certain criteria. This blog delves into which companies can benefit from this tax advantage under the UAE’s Corporate Tax Law.


Who Can Benefit from the Zero Corporate Tax Regime?

In 2022, the UAE introduced corporate tax for the first time. According to the Corporate Tax Law, businesses with taxable income under AED 375,000 are eligible for the zero corporate tax rate, whether they are located in mainland or free zones. This blog will focus on the second category of businesses: the Qualifying Free Zone Persons (QFZPs).

Article 18 of the Corporate Tax Law outlines the requirements for free zone companies to qualify as QFZPs. To fully understand the conditions for the zero corporate tax benefit, it is essential to answer two key questions:

  1. Who qualifies as a Qualifying Free Zone Person (QFZP)?

  2. What are the Qualifying Activities?


Qualifying Free Zone Person (QFZP) and Qualifying Activities

A Free Zone Person refers to a legal entity, such as a corporation or partnership, that is established within a UAE free zone. As defined by the UAE’s Corporate Tax Guide for Free Zone Persons, this includes companies registered in a free zone, with either their headquarters or branch located there. For tax purposes, only the portion of the business based in the free zone is eligible for the zero corporate tax rate.

For a business to qualify, it must derive income from "Qualifying Activities," which are defined by the UAE’s tax regulations. These activities could include manufacturing, logistics services, wealth management, and investment services, along with related ancillary operations. The UAE has also specified which activities are excluded from the qualifying list.

Additionally, the income generated from Qualifying Intellectual Property, such as patents or copyrighted material, may also be considered qualifying income, provided it meets the necessary criteria.


Conditions to Be a Qualifying Free Zone Person

To qualify for the zero corporate tax regime, a Free Zone Person must meet several specific conditions, outlined as follows:

  1. Adequate Substance in the Free Zone: The business must operate its primary income-generating activities within the free zone. This includes maintaining adequate assets, employing full-time staff, and incurring sufficient operational expenses to support these activities.

  2. Generating Qualifying Income: The income must come from transactions with other free zone companies or activities that involve both free zone and non-free zone entities. Qualifying Income also includes earnings from Qualifying Intellectual Property. Importantly, non-qualifying income must not exceed the lesser of AED 5 million or 5% of the company’s total revenue.

  3. Choosing Not to Opt for Regular Corporate Tax: Free Zone Persons can opt to be subject to the regular corporate tax rate, in which case the 0% tax rate does not apply.

  4. Compliance with Transfer Pricing Rules: Companies must adhere to the Arm’s Length Principle when transacting with related parties. For example, transactions between a parent company in the free zone and its subsidiary outside the zone must comply with standard market pricing. Proper transfer pricing documentation must be maintained to demonstrate compliance.

  5. Audited Financial Statements: Free Zone Persons are required to prepare audited financial statements, regardless of their revenue size. These documents must be reviewed by an independent auditor to ensure transparency.

If a company fails to meet these conditions, it risks losing its QFZP status for the current and the next four tax periods. As a result, adhering to these requirements is critical for maintaining the zero corporate tax benefit.


The Importance of UAE’s Free Zones in Attracting Investments

UAE’s free zones have been instrumental in fostering the country’s economic growth. From 2015 to 2021, exports from free zones consistently represented over 60% of the UAE’s total exports, with free zones also contributing more than half of the country’s re-exports in 2020.

The UAE’s free zones have also played a significant role in attracting Foreign Direct Investment (FDI). According to a report by Middlesex University, Dubai, the UAE has consistently outperformed major global economies like the USA, China, and India in terms of FDI-to-GDP ratio. In 2022, the UAE attracted $22.7 billion (AED 83 billion) in FDI—10% more than in 2021. The country now leads the West Asia and MENA regions in FDI inflows.

In 2022, the UAE accounted for 47.1% of total FDI inflows in West Asia and 32.4% of the total FDI inflow in the MENA region.


Conclusion

The UAE’s tax policies, especially the zero corporate tax regime for qualifying free zone companies, have solidified the country’s position as a business-friendly hub. With the introduction of a 9% corporate tax rate on taxable income exceeding AED 375,000, the UAE offers a far more competitive corporate tax environment than many other nations.

However, businesses must carefully navigate the complexities of qualifying income and tax regulations. Transfer pricing documentation and maintaining audited financial statements can be a challenge, and failure to comply with the criteria for maintaining QFZP status may result in the loss of the zero corporate tax benefit for the current and subsequent four tax periods.

For free zone businesses, working with experts in corporate tax is crucial to understanding the requirements and ensuring full compliance with the UAE’s Corporate Tax Law. At AKW Consultants, our team is ready to help free zone companies maximize their benefits under this tax-friendly regime.

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