#TaxmannPPT | Taxation of Freezones under UAE Corporate Tax

Free Zone Introduction and Implications

under Corporate Tax

Table of Contents 01

Overview of Recent Developments on Free Zones

05

Determination of Qualifying Income for Free Zone Persons

02

Conditions for Free Zone Persons

06

Income derived from Immovable Property

07 07

Decisive Strategies and Practical challenges

03 03

Meaning of Adequate Substance

04 04

Core Income Generating Activity and its outsourcing

Overview of Recent Developments on Free Zones 01 June 2023

09 December 2022 Corporate Tax Law issued

Ministerial Decision No.139 of 2023Qualifying Activities and Excluded Activities Cabinet Decision no.55 of 2023Determination of Qualifying Income

03 November 2023

19 July 2023 Public Consultation Paper on Free Zones

Ministerial Decision No.265 of 2023 Qualifying Activities and Excluded Activities Cabinet Decision no.100 of 2023-

FREE ZONE PERSON Article No. 18 of Corporate Tax (CT) Law

Public Consultation on Free Zone

Cabinet Decision No. 100 of 2023

Ministerial Decision No. 265 of 2023

Definition as per CT law

Free Zone

 Free Zone is a designated and defined geographic area within the UAE that is specified in a decision issued by the Cabinet at the suggestion of the Minister.

Free Zone Person(FZP)  The definition of a Free Zone Person under the UAE CT Law refers to juridical person incorporated , established or otherwise registered in a Free zone including branch of a NonResident Person registered in a Free Zone and branch of mainland entity in a free zone.

CT Rate for Qualifying Free Zone Person

Corporate Tax shall be imposed on a Qualifying Free Zone Person at the following rates:-

0% on Qualifying Income

9% on Taxable Income that is not Qualifying Income

Conditions as specified in Article 18 of CT Law for Free Zone Persons Maintain adequate substance in UAE

Deriving Qualifying Income

Has not elected to be subject to Corporate Tax

Complies with documentation

Arm

length

principle

and

transfer

pricing

Meets any other conditions as may be prescribed by the Minister.

Tax Impact if a FZP is not a Qualifying Free Zone Person(QFZP) A FZP will NOT be considered as a QFZP for 5 years .

If any one of the 4 conditions are NOT met in any particular year

If ELECTS to be subject to general rate of Corporate Tax in any particular year

Entire Profit Taxable @9%

Profit Taxable @9%

Additional Condition for Free Zone Persons

Ministerial Decision No. 265 of 2023 specified two additional conditions that Free Zone has to complied :  Non –qualifying revenues do not exceed the de-minimis requirements.  Prepares Audited Financial Statements in accordance with the Law.

Failure to meet any of the above requirements shall cease taxpayer’s status of a Qualifying Free Zone Person from the beginning of the relevant Tax Period and for the subsequent four Tax Periods.

Meaning of Adequate Substance China

 Maintain adequate substance in UAE  Deriving Qualifying Income  Has not elected to be subject to Corporate Tax  Complies with Arm length principle and transfer pricing documentation  Meets any other conditions as may be prescribed by the Minister.

Adequate assets in Free Zone

Adequate Substance

Adequacy Test

Core Income Generating Activities in Free Zone

Adequate qualified full time employees in Free Zone

Adequate operating expenses in Free Zone

Illustration-1

Free Zone Person

X Ltd is a free zone person in UAE having Flexi Desk in Free Zone

X ltd may not be considered a Qualifying Free Zone Person because of absence of proper office premises in Free Zone.

Illustration-2

Free Zone Person

X Ltd is a free zone person with no employees

in UAE

X ltd would not be considered a Qualifying Free Zone Person because of absence of employees in Free Zone.

Illustration-3

Offshore Free Zone Person Z Ltd is JAFZA of UAE

offshore entity

Z ltd an offshore entity would not be considered a Qualifying Free Zone Person because of absence of physical premises and employees in offshore.

Outsourcing of Core income-generating activities(CIGA) As per Cabinet Decision No.100

 A Qualifying Free Zone Person shall undertake its core income-generating activities in a Free Zone or a Designated Zone, depending on where such activities are required to be conducted, and having regard to the level of the activities carried out, have adequate assets, an adequate number of qualified full-time employees in a Free Zone or a Designated Zone depending on where such activities are required to be conducted, and incur an adequate amount of operating expenditures, in relation to each activity .  Core income-generating activities can be outsourced to another Person in a Free Zone or a Designated Zone depending on where such activities are required to be conducted, provided the Qualifying Free Zone Person has adequate supervision of the outsourced activity.  Core income-generating activities in respect of Qualifying Intellectual Property can be outsourced to any other Person in the UAE and to any other Person who is not a Related Party outside the UAE, provided the Qualifying Free Zone Person has adequate supervision of the outsourced activity.  Core income-generating activities may vary according to the specific activity but mainly consist of those significant functions that drive the business value for each activity carried out by a Qualifying Free Zone Person and are not exclusively or mostly support activities.

Illustration-CIGA  CIGA undertaken in a Free Zone or in a Designated Zone (e.g., for Distribution Activity)

Distribution Co-JAFZA

Outsourcing with Supervision

 Full -time employment  Outsourcing with an adequate supervision to a person in a Free Zone or in a Designated Zone (e.g., for Distribution Activity)

Outsourcing Co-Fujairah Free Zone

Distribution Co-JAFZA

DMCC Branch

Logistics, Quality Control

Sales , Marketing, procurement , top-management

Determination of Qualifying Income for Free Zone Persons As per Cabinet Decision 100, Qualifying Income of the Qualifying Free Zone Person shall include the below categories of incomeIncome derived from transactions with a Free Zone Person, except for income derived from Excluded Activities UAE Residents will be taxable on their worldwide income.

Income derived from transactions with a Non-Free Zone Person, but only in respect of Qualifying Activities that are not Excluded Activities.

However, for a natural person, the scope Qualifyi to the income earned ngscope will be limited Income derived from the ownership or exploitation of Qualifying Intellectual Property income earned from their business or Income or business activity (to be specified in the

Anydecision) other income provided that the Qualifying Free Zone Person satisfies the de minimis specified in the Cabinet requirements

List of Qualifying Activities Qualifying Activities In respect of Goods are follows :-

In respect of Services are as follows:-

1. Ownership, management & operation of Ships.

1. Manufacturing of goods or materials 2. Reinsurance services, if subject to 2. Processing of goods or materials regulatory oversight 3. Trading of Qualifying Commodities 3. Fund management services, if subject to 4. Distribution of goods or material in regulatory oversight or from a Designated Zones (Designated 4. Wealth and investment management Zones is as defined in VAT law) to a services, if subject to regulatory customer that resells such goods or oversight materials, or parts thereof or 5. Headquarter services to Related processes or alters such goods or Parties. materials or parts thereof for the 6. Treasury and financing services to purposes of sale or resale.

Related Parties.

7. Financing and leasing of Aircraft, Others :including engines and rotable 1. Holding of shares and other securities components. for investment purposes * Any activity that are ancillary to the above activities 8. Logistics services.

List of Excluded Activities Income from certain regulated financial service activities : Banking activities  Insurance activities except • Reinsurance services • Headquarter services to Related Parties  Finance and leasing activities except :• Treasury and financing services to Related Parties • Ownership, management and operation of Ships • Financing and leasing of Aircraft

Any activities that are ancillary to the Excluded Activities

Ownership or exploitation of Immovable property except transaction in respect of Commercial property located in Free Zone with other Free Zone Person.

Excluded Activities

Any transaction with natural persons, except transactions in relation to :• Ownership, managements and operation of Ships • Fund Management services • Wealth and investment management services • Financing and leasing of Aircraft

Determination of Qualifying Income from Free-Zones Person Free Zone Y Income earned from transactions with Free Zone will be treated as Qualifying Income except income in relation to Excluded Activities

Free Zone X

Natural Person Income earned from Natural Person will be treated as Non Qualifying Income except in relation to some specific Qualifying Activities.

Determination of Qualifying Income from Non Free-Zones Person UAE Mainland

Free Zone X

Qualifying Income if income derived from Qualifying Activity and not an Excluded Activity.

Foreign Company

Illustration Distribution Activity in a Free Zone will be Qualifying Activity if the said activities of distributing of goods or material is in or from a Designated Zones to customers that resells or processes or alters and sells such goods or material and the said goods/materials entering the State must be imported through Designated Zones I.

Free Zone Person Qualifying Income irrespective whether distribution activity is from designated zone or not.

IV. Foreign Entity Qualifying Income subject to the above condition

Distribution Activity undertaken in and from a Designated Free Zone Person

III. Natural Person Non Qualifying Income as it is covered under “Excluded Activity”

II. Mainland Person Qualifying Income subject to the above condition

Illustration

Service Activity I. Free Zone Person Qualifying Income (i.e. consultancy , logistics etc.) except if it is from “Excluded Activity”

Service Activity undertaken

by Free Zone Person

II. Mainland Person & Foreign Entity Non Qualifying Income except if it is from Qualifying Activity other than “Excluded Activities” III. Natural Person Non-Qualifying Income except in respect of following Qualifying Activities:1. Fund management services 2. Wealth and investment management services 3. Aircraft, including engines and rotable components 4. Ownership, management and operation of Ships

DE MINIMIS REQUIREMENTS • Non Qualifying Revenue derived by the Qualifying Free Zone Person in a Tax Period does not exceed the below limit :-

5% OF TOTAL REVENUE

DE MINIMIS THRESHOLD

NON QUALIFYING REVENUE

OR AED 5 MILLION

WHICHEVER IS LOWER

Non-Qualifying Revenue Non Qualifying Revenue is revenue derived in a Tax Period from any of the followings :-

•Excluded Activities •Activities other than “Qualifying activities”, where other party to the transaction is Non Free Zones person.

•Transaction with a Free Zone Person where such Free Zone Person is not the beneficial Recipient of the relevant Services or Goods.

Additional Condition for Free Zone Persons

Ministerial Decision No. 265 of 2023 specified two additional conditions that Free Zone has to complied :  Non –qualifying revenues do not exceed the de-minimis requirements.  Prepares Audited Financial Statements in accordance with the Law.

Failure to meet any of the above requirements shall cease taxpayer’s status of a Qualifying Free Zone Person from the beginning of the relevant Tax Period and for the subsequent four Tax Periods.

Illustration Particulars

Example 1

Example 2

Revenue

100,000,000

80,000,000

Non – Qualifying Revenue

4,000,000

6,000,000

Total Revenue

104,000,000

86,000,000

(a) 5% of Total Revenue

5,200,000

4,300,000

(b) Fixed amount

5,000,000

5,000,000

De minimis (Lower of (a) & (b)

5,000,000

4,300,000

Qualifying Income (0%)

104,000,000

--

Taxable Income (9%)

--

86,000,000

Calculation for De Minimis

2

1 Revenue attributable to immovable property located in Free Zone derived from : Transaction with Non – Free Persons in respect of Commercial Property  Transaction with any person in respect of immovable property that is not commercial property

Not to consider for Non – Qualifying Revenue and Total Revenue :-



Revenue attributable to Domestic or a Foreign Permanent Establishment of the Qualifying Free Zone Person.



Revenue Derived from the ownership or exploitation of intellectual property, except for the Qualifying Income calculated in accordance with the decision issued by the Minister

Domestic or Foreign Permanent Establishment Domestic Permanent Establishment (PE) :A place of business or other form of presence of a Qualifying Free Zone Person outside the Free Zone in the UAE.

Free Zone

 Free Zone person deriving income from Domestic or Foreign PE would be “Non Qualifying Income”.  Free Zone Person has to pay Corporate Tax @9% on such income.

Domestic PE (i.e.

Mainland Branch)

Foreign PE

 Free Zone person will not be allowed to avail basic exemption threshold limit of AED 375,000

Income deriving from Immovable Property Income attributable to immovable property located in a Free Zone that is derived from the below transactions shall be considered as Taxable Income and taxed @ 9% without availing the benefit of basic threshold limit of AED 375,000 : In respect of Commercial Property, income derived from Non Free Zone Persons.  In respect of Non- Commercial Property, income derived from any Persons.

Commercial Property As per Article 1 of Cabinet Decision No. 55 of 2023 ,

Immovable Property or part thereof : Used exclusively for a Business or Business Activity.  Not used as a place of residence or accommodation including hotels, motels, bed and breakfast establishments, serviced apartments and the like

Illustrat ion Situated in Free Zone

Situated in Free Zone

Income from transaction with other Free Zone Persons

Commercial Property

Income from transaction with any Persons

Non Commercial Property

Business Center / Warehouse / office

Hotel/ residence , etc

Qualifying Income Tax @ 0%

Non Qualifying Income Tax @ 9 %

Amendments in new Free Zone Decisions Updated list of Qualifying Activities and Excluded Activities

Description of Qualifying Activities and Excluded Activities

Clarifications on Free Zone substance requirements

De minimis threshold calculations

Incidental income is removed from Qualifying Income list, but ancillary activities definition is changed

Competent authorities are defined

Additions

Clarifications

Others

Introduction of new decision on Free Zone Persons On 3rd November, 2023, UAE Ministry of Finance has issued new Cabinet Decision (CD) No. 100 of 2023 on Determining Qualifying Income, as well as Ministerial Decision (MD)

No. 265 of 2023 on Qualifying Activities and Excluded Activities. These decisions are applicable

retrospectively

from

1st

June,

2023

and

has

replaced

previous Cabinet

Decision No. 55 of 2023 and Ministerial Decision No.139 of 2023 decisions.

2 new activities are included in the list of Qualifying activities

Trading of Qualified Commodities

Ownership or exploitation of Qualifying Intellectual Property

Trading of Qualified Commodities

Trading of Qualified Commodities Qualifying Activity

Income earned from physical trading of metals, minerals, energy and agricultural commodities in raw form that are traded on a recognized stock exchange, as well as the associated derivative trading income used to hedge against, the risk of such trading activities, shall be considered as Qualifying Income.

Qualifying Commodities Qualified Commodities:-As per Ministerial decision no-265 of 2023-Metals, minerals, energy and agriculture commodities that are traded on a Recognized Commodities Market in Raw Form shall be considered as Qualified Commodities.

Examples Commodities:-

of

Gold Bars Natural Gas

Qualifying

Silver Bars

Coal

Platinum bars

Crude Oil

Ownership or exploitation of Qualifying Intellectual Property

Ownership or exploitation of Qualifying Intellectual Property Qualifying Activity

Qualifying Intellectual Property has been defined in Cabinet Decision No. 100 of 2023, as patents, copyrighted software and any right functionally equivalent to a patent but does not include marketing related intellectual property assets, such as trademarks.

Calculation of Qualifying Income derived from Qualifying Intellectual Property Qualifying Income shall be determined by using the below formulae:-

Qualifying Income

Qualifying Expenditure

Expenditure

+

Up-lift Overall Income

Overall Expenditure ‘Uplift Expenditures” means the Qualifying Expenditure increased by 30% (thirty percent),

Change in definition of Ancillary Income

Ancillary Activities-as per new Cabinet Decision no-265 of 2023

An activity shall be considered ancillary where it is necessary for the performance of the main activity or where it makes a minor contribution to it and is so closely related to the main activity that it should not be regarded as a separate activity.

Ancillary Activities-as per old Cabinet Decision no-139 of 2023

An activity shall be considered ancillary where it serves no independent function but is necessary for the performance of the main Qualifying Activity.

Holding of shares and other securities  Ministerial Decision 265 has renamed the Qualifying activity “Holding of shares and other securities” to “Holding of shares and other securities for investment purpose”.  One critical condition has been included in new Ministerial Decision No.265 of 2023, which states that the shares and other securities shall be deemed to be held for investment purposes if it is held for uninterrupted 12 months period.  Hence, solely active trading of shares and other securities cannot not be regarded as a Qualifying activity.  There is no other condition that needs to be satisfied in case of holding of other securities (which was earlier mentioned in the PCD).

Distribution of Goods or Material in or from Designated Zone  Distribution of goods or materials in or from a Designated Zone, includes the buying and selling of goods, materials, component parts or any other items that are tangible or movable and may include the importation, storage, inventory management, handling, transportation and exportation of those goods or materials 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, provided such activities are conducted in or from a Designated Zone and the goods or materials entering the State are imported through the Designated Zone.

List of Designated Zones

• • • • •

•

•

Jebel Ali FZ(North-South) Dubai Cars and Automotive Zone.

DAFZA Industrial Park FZ - Al Qusais Dubai Aviation City Dubai Airport FZ International Humanitarian City – Jebel Ali Dubai CommerCity

Ras Al Khaimah

Abu Dhabi

Dubai

• • • • •

Free Trade Zone of Khalifa Port Abu Dhabi Airport FZ Khalifa Industrial Zone Al Ain International Airport FZ Al Butain International Airport FZ

• •

• •

•

RAK Port FZ RAK Maritime City FZ Al Hamra Industrial Zone – FZ Al Ghail Industrial Zone- FZ Al Hulaila Industrial Zone - FZ

Others

Sharjah Hamriyah FZ Sharjah Airport International FZ Fujairah • Fujairah FZ • Fujairah Oil Industry Zone Umm Al Quwain • Umm Al Quwain Free Trade Zone in Ahmed Bin Rashid Port • Umm Al Quwain Free Trade Zone on Sheikh Mohammed Bin Zayed Road Ajman • Ajman FZ • •

High Sea Sales /Third Port Shipment-Case Study Goods do not enter UAE

A Co. JAFZA (Designated Zones) Goods do not enter UAE

Will High Sea Sales (Third port shipment) be considered as a Qualifying Activity?

B Co. China

C Co. KSA

The new decision has not clarified the tax position with respect to High-sea sales(Third Port Shipment).

In various awareness sessions, it was mentioned by FTA that High Seas Sales (Third Port Shipment) if undertaken from Designated Zones shall be covered under Qualifying Activities.

Distribution activity as per Public Consultation Paper on Free Zones Article 2(1)(k) – Distribution of goods or materials Illustrations (1) Distribution of goods or materials outside of the UAE – Designated Free Zone Person (Distributor Co) buys goods from a manufacturer in Country A, and sells these goods to a retailer in Country B. Distributor Co earns a profit / margin on the goods sold to the retailer in Country B. The goods are shipped directly from the Manufacturer in Country A to the Retailer in Country B.

Manufacturing of Goods or materials-Case Study PCD on Free Zone  As per Public Consultation document on freezone persons, income derived from the manufacturing of goods or material by manufacturing company would be considered as Qualifying Income, irrespective of whether the manufactured products or material are manufactured for sale to mainland or foreign juridical person.  The income that is attributable to the distribution (sale) of the manufactured products or material would not be considered Qualifying Income from manufacturing, unless the distribution meets the conditions to be treated to be treated as a Qualifying distribution activity.

Cabinet Decision No. 100 of 2023  Manufacturing of goods or materials includes the production, improvement or assembly of products and materials from raw materials or components.

DISTRIBUTION CONDITIONS TO BE MET

Flowchart for Determination of Qualifying Income

Steps in Determining taxability for Free Zone Persons Step 1

• Are you a free zone Peron?

Step 2

• Are you a qualifying Free zone person?

Step 3

• Do you derive income from Qualifying Activity or from a free zone person?

Step • Does your Non-Qualifying Revenue exceed de-minimis threshold?

4 Step • Whether you are subject to 0% CT 5

or taxable @9% CT?

Contact Us CA Nirav Shah Director Advisory DMCC

:

FAME

Email-id nirav@fame.com

:

Website www.fame.ae

:

Contact No. 502771511

:

+971-

Disclaimer Please note that our views mentioned above are based on current prevailing regulatory regime in UAE and refers specifically to Federal Decree Law No. 47 of 2022. Our views or advise does not cover implications under any other laws or regulations that may govern the situation and are limited to the taxability consequences in UAE alone. For any other implications, we would recommend to obtain specific advice in that connection.

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