UAE Corporate Tax Law: What Constitutes Qualifying Income for Free Zone Persons?

Background

The UAE enacted its Corporate Tax Law (the “CTL”) in December 2022 (Federal Decree-Law No. (47) of 2022 on the Taxation of Corporations and Businesses). The CTL came into force on 1 June 2023. The main corporate tax rate of 9% applies on income exceeding AED 375,000 (roughly USD 102,000). The CLT provides that the rate of corporate tax which applies to “Qualifying Free Zone Persons” (“QFZP”) is 0% with respect to qualifying income (“Qualifying Income”) and 9% on non-qualifying revenue (“Non-Qualifying Revenue”).

After much anticipation, the UAE Ministry of Finance released Cabinet Decision No. 55 of 2023 on “Determining Qualifying Income for the Qualifying Free Zone Person” and Ministerial Decision No. 139 of 2023 on “Qualifying Activities and Excluded Activities” on 1 June 2023. These two decisions address the application of the CTL to Free Zone Persons. In particular, these decisions provide clarity on when a Free Zone Person qualifies to be taxed as a QFZP.

Qualifying Income

For the purposes of the application of Article 18 of the CTL, the following will be treated as Qualifying Income of a QFZP:

• income derived from transactions with other Free Zone Persons, except for income derived from “excluded activities” (“Excluded Activities”);
• income derived from transactions with a Non-Free Zone Person, but only in respect of “qualifying activities” (“Qualifying Activities”) that are not Excluded Activities; and
• any other income provided that the QFZP satisfies the specified de minimis requirements (the “De Minimis Requirements”).

Qualifying Activities

The following activities conducted by a QFZP shall be considered Qualifying Activities:

1. manufacturing of goods or materials;
2. processing of goods or materials;
3. holding of shares and other securities;
4. ownership, management and operation of ships;
5. reinsurance services that are subject to the regulatory oversight of the competent authority in the UAE;
6. fund management services that are subject to the regulatory oversight of the competent authority in the UAE;
7. wealth and investment management services that are subject to the regulatory oversight of the competent authority in the UAE;
8. headquarter services to related parties;
9. treasury and financing services to related parties;
10. financing and leasing of aircraft, including engines and rotable components;
11. 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;
12. logistics services; and
13. any activities that are ancillary to the activities listed in paragraphs (a) to (l) of the above.

Excluded Activities

The following activities shall be considered Excluded Activities:

1. any transactions with natural persons, except transactions in relation to the Qualifying Activities specified under paragraphs (d), (f), (g) and (j) of the above section;
2. banking activities that are subject to the regulatory oversight of the competent authority in the UAE;
3. insurance activities that are subject to the regulatory oversight of the competent authority in the UAE, other than the activity specified under paragraph (e) of the above section;
4. finance and leasing activities that are subject to the regulatory oversight of the competent authority in the UAE, other than those specified under paragraphs (i) and (j) of the above section;
5. ownership or exploitation of immovable property, other than commercial property located in a Free Zone where the transaction in respect of such commercial property is conducted with other Free Zone Persons;
6. ownership or exploitation of intellectual property assets; and
7. any activities that are ancillary to the activities listed in paragraphs (a) to (f) above.

De Minimis Requirements

Non-Qualifying Revenue is revenue derived in a tax period from any of the following:

1. Excluded Activities; or
2. activities that are not Qualifying Activities where the other party to the transaction is a Non-Free Zone Person.

The De Minimis Requirements shall be considered satisfied where:

• the Non-Qualifying Revenue derived by the QFZP in a tax period does not exceed 5% (five percent) of the total revenue of the QFZP in that tax period; or
• AED 5,000,000 (approximately USD 1.4 million),

whichever is lower.

Where:

• the De Minimis Requirements threshold is exceeded;
• the QFZP does not satisfy the eligibility conditions of Article 18 of the CTL; or
• the QFZP does not satisfy any other conditions prescribed by the Minister,

then the Free Zone Person will not be eligible to be treated as a QFZP from the beginning of the relevant tax period and the subsequent four tax periods.

Other Requirements

A QFZP must also meet the following conditions:

1. undertakes its core income-generating activities in a Free Zone and, having regard to the level of the activities carried out, have adequate assets, an adequate number of qualified employees, and incur an adequate amount of operating expenditures; and
2. prepares audited financial statements in accordance with any decision issued by the Minister on the requirements to prepare and maintain audited financial statements for the purposes of the CTL.

Next Steps

Free Zone Persons should now review whether the above criteria can be met in order to be treated as QFZP for the purposes of the CTL.