A free zone entity is a juridical person incorporated, established, or otherwise registered in a free zone, including a branch of a non-resident registered in a free zone. Approved companies are allowed to establish in one of the UAE’s free zones, which are typically designated by business sectors. The zones provide several benefits, but are restricted if a company established in such zones wants to operate anywhere in the UAE outside of the zone.
The main benefits of the free zones include:
- No foreign ownership restrictions;
- Reduced trade barriers, tariffs, and quotas;
- Exemption from taxes and duties levied on profits and production;
- Customs duty exemption;
- Commercial levies exemption;
- No restrictions on the repatriation of capital profits; and
- Depending on the Emirate, most free zones provide corporate tax exemption for 15 to 50 years.
Effective 1 June 2023, qualifying free zone entities are subject to corporate tax at the following rates:
- 0% on qualifying income; and
- 9% on income not meeting the qualifying income definition.
To be treated as a qualifying free zone entity, the entity must:
- Maintain adequate substance in the UAE;
- Derive qualifying income (as specified through a Cabinet Decision, see below);
- Comply with transfer pricing rules and maintain the relevant transfer pricing documentation; and
- Not have opted to be subject to corporate tax.
On 30 May 2023, the UAE Ministry of Finance issued Cabinet Decision No. 55 of 2023 providing guidelines for determining the qualifying income of a qualifying free zone entity. On 1 June 2023, the Ministry also issued a related decision, Ministerial Decision No. 139 of 2023, providing guidelines relating to qualifying activities, excluded activities, de minimis requirements, and substance requirements.
If at any point during a tax year, a qualifying free zone entity fails to meet any of the conditions specified in the federal corporate tax law or in the decisions, they are treated as a taxable person subject to the standard corporate tax rate from the beginning of that tax year and for the following 4 tax years.
Qualifying income include the following:
- Income from carrying out qualifying activities with non-free zone entities, provided the income is not derived from excluded activities (see below);
- Income from any transaction with other free zone entities, provided the income is not derived from excluded activities; and
- Any other income provided the qualifying free zone entity meets the de minimis requirements, i.e., if the non-qualifying revenue does not exceed 5% of the total revenue or AED 5 million, whichever is lower (see below).
However, the following do not constitute qualifying income:
- Income derived from a domestic or foreign permanent establishment of a qualifying free zone entity, as the permanent establishment is treated as a separate and independent entity which is distinct from the qualifying free zone entity; and
- Income derived from an immovable property situated in a free zone (non-commercial property and commercial property if the transactions are with non-free zone entities)
Income not forming part of qualifying income is subject to corporate tax at the standard corporate tax rate.
Note that the presence of a permanent establishment does not disqualify the free zone entity from benefiting from the 0% corporate tax rate on qualifying income or affect its eligibility for the de minimis requirements (see below).
A domestic permanent establishment for qualifying free zone entities is defined as a place of business or any other form of presence of such entities in mainland UAE if it meets the criteria specified in the federal corporate tax law regarding the establishment of a non-resident’s permanent establishment in the UAE (see Sec. 4.1.).
Qualifying activities include the following:
- Manufacturing and processing of goods or materials;
- Holding of shares and other securities;
- Ownership, management and operation of ships;
- Regulated reinsurance services;
- Regulated fund management, investment management and wealth management services;
- Headquarter services to related parties;
- Treasury and financing services to related parties;
- Financing and leasing of aircraft, including engines, and rotable components;
- Distribution of goods or materials in or from a designated zone to a customer that resells such goods or materials, or parts thereof, or processes or alters such goods or materials or parts thereof for the purposes of sale or resale;
- Logistics services; and
- Activities that are ancillary to the activities listed above.
Excluded activities include the following:
- Transactions with natural persons, other than the following qualifying activities:
- ownership, management, and operation of ships;
- regulated fund management, investment management and wealth management services; and
- financing and leasing of aircraft, including engines, and rotable components;
- Regulated banking activities;
- Regulated insurance activities other than regulated reinsurance services;
- Regulated finance and leasing activities other than the following qualifying activities:
- treasury and financing services to related parties; and
- financing and leasing of aircraft, including engines, and rotable components;
- Ownership or exploitation of immovable property, other than transactions with free zone entities in relation to commercial property located in a free zone;
- Ownership or exploitation of intellectual property assets; and
- Any activities that are ancillary to the activities listed above.
Qualifying income includes income earned by a qualifying free zone entity that meets the de minimis requirements. The de minimis requirements are considered met if the non-qualifying revenue in a tax year does not exceed 5% of the total revenue or AED 5 million, whichever is lower.
Non-qualifying revenue is defined as revenue from excluded activities or activities that are not qualifying activities if the transactions are with non-free zone entities.
Note that revenue derived from an immovable property situated in a free zone (non-commercial property and commercial property if the transactions are with non-free zone entities) and revenue derived from a domestic or foreign permanent establishment of the qualifying free zone entity are not considered for calculating non-qualifying revenue and total revenue.
A qualifying free zone entity is required to maintain adequate substance in a free zone. Adequate substance is deemed to be maintained if a qualifying free zone entity:
- Undertakes its core income-generating activities in a free zone; and
- Maintains adequate assets, employs adequate number of qualified employees, and incurs an adequate amount of operating expenditure, considering the level of activities undertaken in the free zone.
The activities can be outsourced to a related party or a third party under the supervision of the qualifying free zone entity.
Under the domestic law, the term “investment fund” refers to an arrangement or juridical person whose primary purpose and activity is to pool investor funds and invest such funds in accordance with a defined investment policy. Investments funds include real estate investment trusts, mutual funds, private equity funds, or other alternative investment funds.
An investment fund can apply to the tax authorities to be exempt from corporate tax as a qualifying investment fund.
To be granted an exemption from corporate tax, an investment fund is required to fulfill all the following general conditions:
- The investment fund or the investment fund’s manager is subject to the regulatory oversight of a competent authority in the UAE, or a recognized foreign competent authority;
- Interests in the investment fund are traded on a recognized stock exchange, or are marketed and made available sufficiently widely to investors;
- The main or principal purpose of the investment fund is not to avoid corporate tax; and
- Any other conditions that may be prescribed in a decision issued by the Cabinet.
On 29 July 2023, the UAE Ministry of Finance issued Cabinet Decision No. 81 of 2023, prescribing specific conditions to exempt real estate investment trusts (REITs) and investment funds other than REITs.
To be granted an exemption from corporate tax, in addition to the general conditions, a REIT is required to fulfill all the following specific conditions:
- The value of real estate assets, excluding land, under the management or ownership of the REIT exceeds AED 100 million;
- At least 20% of the share capital of the REIT is listed on a recognized stock exchange, or it is directly wholly owned by two or more institutional investors specified in the Decision (see below), provided that at least two of those institutional investors are not related parties; and
- The REIT has an average real estate asset percentage of at least 70% during the relevant calendar year, or the relevant twelve-month period for which the financial statements are prepared.
Institutional investors specified in the Decision include the following:
- The federal government;
- A local government;
- A government entity;
- A government-controlled entity;
- A foreign government, its institutions, and authorities, or the companies fully owned by any of them;
- International organizations;
- A bank;
- An insurance provider;
- A pension or social security fund;
- An investment entity licensed by a relevant competent authority or a similar regulatory authority in or outside of the UAE; and
- Any other juridical person determined by the tax authority.
To be granted an exemption from corporate tax, in addition to the general conditions, an investment fund other than a REIT is required to fulfill all the following specific conditions:
- The main business or business activities conducted by the investment fund are investment business activities, and any other business or business activities conducted by the investment fund are ancillary or incidental. Other business or business activities are considered as ancillary or incidental if the combined revenue of such business or business activities does not exceed 5% of the total revenue of the investment fund in the same financial year;
- A single investor and its related parties do not own more than:
- 30% of the ownership interests in the investment fund, where the investment fund has less than ten investors; or
- 50% of the ownership interests in the investment fund, where the investment fund has ten or more investors;
- The investment fund is managed or advised by an investment manager having a minimum of three investment professionals; and
- The investors do not have control over the day-to-day management of the investment fund.
Note that the investment fund is considered to have met the ownership interest condition of 30% or 50%, as the case may be, in the first two financial years of the fund’s establishment if there is sufficient evidence to demonstrate the investors’ intention to meet the condition after the first two financial years. However, if the ownership interest condition is not met after the first two financial years, the investment fund ceases to be treated as a qualifying investment fund from the beginning of the third financial year of its establishment.
The income and expenditure of a qualifying investment, as reflected in its financial statements, pass through to the investor of the fund in proportion to the investor’s ownership interest in the relevant tax year.
On 6 April 2023, the UAE introduced incentives for small businesses that are resident persons and fulfill the following conditions:
- Their revenue does not exceed AED 3 million in the relevant tax year or in any previous tax year; and
- They are not members of MNE Groups (groups of companies operating in multiple countries with consolidated group revenues exceeding AED 3.15 billion) or qualifying free zone entities.
In August 2023, the Federal Tax Authority (FTA) published detailed guidance on the application of the small business relief.
Persons eligible for the small business relief can elect to be treated as having no taxable income in the relevant tax year. Such persons are also eligible for the following simplified compliance requirements:
- Filing of a simplified corporate tax return rather than a full tax return;
- Exemption from computation of taxable income; and
- Exemption from maintaining transfer pricing documentation. However, transactions with related parties must comply with the arm’s length principle.
The small business relief applies to tax years starting on or after 1 June 2023 and ending on or before 31 December 2026. The revenue threshold of AED 3 million is required to be maintained during the relief period. If the revenue exceeds the threshold (i.e., 3 million) in a financial year, the relief would not be available for the remaining financial years even if the revenue for such subsequent years is less than the threshold. The revenue can be determined as per the accounting standards accepted in the UAE.
The election for the small business relief must be made in a corporate tax return, and therefore, persons seeking the relief are required to first register with the FTA for corporate tax and obtain a tax registration number (see Sec. 14.3.).
The tax losses (see Sec. 7.1.) and disallowed net interest expenditure (see Sec. 13.2.1.) of a tax year in which the small business relief is not claimed can be carried forward to subsequent tax years, provided the relief is not claimed in those subsequent years as well. However, the tax losses and disallowed net interest expenditure of a tax year in which the small business relief is claimed cannot be carried forward to subsequent tax years. Furthermore, the relief for transfers within a qualifying group (see Sec. 5.3.) and business restructuring relief (see Sec. 11.) cannot be claimed in the tax years in which the small business relief election is made.
If the tax authorities establish that a person has artificially separated their business into separate entities in order to keep the revenue threshold below AED 3 million for claiming the small business relief where in reality, the revenue of the entire business exceeds the threshold in any tax year, the person may be treated as having obtained a corporate tax advantage in violation of the general anti-abuse rules (see Sec. 13.1.). In such a case the tax authorities may deny the relief under the anti-abuse rules and impose penalties.
The UAE is a member of the Gulf Cooperation Council (GCC), which provides incentives relating to excise duty, customs duty (see Sec. 8.1.2.) and VAT (see Sec. 12.) for businesses established in the UAE.
Effective 1 June 2023, a new federal corporate tax regime is introduced in the UAE. Previously, the primary incentive for the UAE was essentially a tax-free economy, including no federal corporate tax, no income tax, no withholding tax on outward remittances, no capital gains tax, no value added tax, and no foreign exchange controls.
Until the introduction of a federal corporate tax, only oil and gas companies were taxed under the tax system of each of the 7 Emirates comprising the UAE (territorial tax system). As per the territorial tax system, the rate of tax is determined at the level of the individual emirates (generally 55%), but concessionary rates are usually provided by the Emirate in which the company is located. In addition, branches of foreign banks may be taxed, but the Emirates generally do not impose tax or may provide concessionary rates.
As a result of the introduction of a new federal corporate tax regime (see Sec. 8.1.), the UAE no longer remains a tax-free economy.