Insights · UAE Corporate Tax
Qualifying Free Zone Person: How to Keep the 0% UAE Tax Rate
The five conditions a UAE free-zone company must meet to keep 0% corporate tax, the de minimis limit, and what happens for five years if you fail one.
A Qualifying Free Zone Person pays 0% UAE corporate tax on qualifying income and 9% on everything else. The 0% rate does not come with the free-zone licence. It depends on meeting every condition, every year. Failing one costs the 0% rate for that tax period and the four that follow.
Key figures
- 0% on qualifying income; 9% on taxable income that is not qualifying (Federal Tax Authority guide)
- De minimis: non-qualifying revenue up to the lower of 5% of total revenue or AED 5 million
- Audited financial statements and transfer pricing documentation are required whatever the size
- Loss of status lasts five tax periods in total
- The AED 375,000 zero band does not apply to a Qualifying Free Zone Person
The conditions
- Be a juridical person incorporated or registered in a free zone, including a branch.
- Maintain adequate substance in a free zone.
- Derive qualifying income.
- Not have elected to be taxed at the standard rate.
- Comply with the arm’s length principle and keep transfer pricing documentation.
- Prepare audited financial statements.
- Keep non-qualifying revenue within the de minimis limit.
What counts as qualifying income
- income from transactions with other free-zone persons, where that person is the beneficial recipient, other than income from excluded activities
- income from qualifying activities, whoever the customer is, including mainland and foreign customers
- income from qualifying intellectual property, in the proportion allowed under the nexus approach
- other income, if within the de minimis limit
Qualifying activities
The list is set by ministerial decision and includes manufacturing and processing of goods, trading of qualifying commodities, holding shares and securities for investment, ship ownership and operation, reinsurance, fund management, wealth and investment management, headquarters services to related parties, treasury and financing services to related parties, financing and leasing of aircraft, logistics services, and distribution of goods in or from a designated zone to a customer that resells them or uses them in its business.
Excluded activities
Transactions with natural persons, with limited exceptions; regulated banking, insurance, finance and leasing, with exceptions for the items above; ownership or exploitation of UAE immovable property, other than commercial property in a free zone dealt with another free-zone person; and ownership or exploitation of intellectual property other than qualifying intellectual property.
The de minimis test, with numbers
A free-zone services company has revenue of AED 20 million. Of this, AED 19.2 million is consulting income from other free-zone companies and AED 0.8 million is from mainland clients. Consulting is not a qualifying activity, so the mainland income is non-qualifying. The limit is the lower of 5% of AED 20 million, which is AED 1 million, and AED 5 million. AED 0.8 million is within it, so the company keeps its status and the whole AED 20 million is taxed at 0%. If mainland income reaches AED 1.1 million, the company loses its status and pays 9% on all taxable income for five tax periods.
Revenue attributable to a mainland or foreign permanent establishment, and revenue from immovable property that is not qualifying, is left out of both sides of the calculation. It is simply taxed at 9%.
Substance
The core income-generating activities must be carried out in a free zone, with adequate assets, an adequate number of qualified full-time employees and adequate operating expenditure for the activity. Outsourcing is permitted to a related party or a third party in a free zone, provided the company supervises it adequately. A flexi-desk licence with no staff does not meet this test for an operating business. Holding companies are judged by the lighter standard appropriate to holding shares.
Where Indian-owned companies go wrong
- Services to the Indian group. Support, IT or marketing services billed to an Indian parent are not a qualifying activity unless they fall within headquarters or treasury services to related parties. The Indian parent is not a free-zone person, so this revenue is usually non-qualifying.
- Trading from a non-designated zone. Distribution qualifies only when it is carried out in or from a designated zone and the goods enter the UAE through it.
- Sales to individuals. E-commerce to consumers is an excluded activity.
- No audit. Many free zones do not require an audit for licence renewal. Corporate tax does.
- No transfer pricing file. See transfer pricing between India and the UAE.
Should you elect out?
A free-zone company can elect to be taxed under the standard regime. It then gets the AED 375,000 zero band, can use Small Business Relief while it lasts, and can join a tax group. For a small company whose income is mostly non-qualifying, the standard regime is often cheaper and much simpler. The election applies for that period and the four following.
Related reading: UAE corporate tax explained, UAE corporate tax for Indian businesses and free zone vs mainland. Our UAE corporate tax team runs the qualifying-income analysis before the year closes, while the revenue mix can still be managed.