Background
Article 18 of the Federal Decree-Law No. 47 of 2022 (the ‘UAE CT Law’) co-jointly read with the Cabinet Decision No. 100 of 2023 and Ministerial Decision No. 265 of 2023 issued by Ministry of Finance prescribed conditions to be satisfied for a Free Zone Person (‘FZP’) to be a Qualifying Free Zone Person (‘QFZP’). The status of QFZP allows FZP to enjoy 0% Corporate Tax (‘CT’) rate subject to meeting all the following conditions:
- FZP must maintain adequate substance within an FZ.
- FZP must derive Qualifying Income (‘QI’).
- FZP must not have elected to be subject to standard CT under the UAE CT Law.
- Compliance with the arm’s length principle as per Transfer Pricing (‘TP’) is required, along with related documentation must be maintained.
- Maintaining audited Financial Statements are necessary.
- Non-qualifying revenue must not breach the de-minimis threshold.
Publication of FZP CT Guide
The recently released CT Guide on FZP by the Federal Tax Authority (‘FTA’) provides valuable insights and in-depth explanations regarding the application of the UAE CT Law to FZPs operating in the UAE.It is pertinent to note that this CT Guide is not a legally binding document but is intended to be read with the UAE CT Law and Cabinet / Ministerial Decisions to aide in interpreting of the conditions and comparing with practical instances aptly referenced in this Guide.
Key Insights
- Adequate Substance
Adequate Substance requires the FZP to undertake the core income-generating activities for that business in the FZ (or DZ for the QA of distribution), and within the FZ (or DZ), have adequate assets and qualified full-time employees, and incur an adequate amount of operating expenses. The scale that resembles ‘adequate’ remains subjective and should be determined on a case-to-case basis.
As guidance, it has been clarified that an employee of an FZP cannot be double-counted while assessing whether the FZP has adequate employees to perform the core income-generating activities for all activities that derive QI.
For adequate supervision of outsourcing activity, an FZP needs to establish methods to monitor, evaluate, guide, and give instructions on the service provider's deliverables in terms of quality, quantity, and timeliness. The same should be documented in agreements and supported by the parties' actual actions.
- Qualifying Activity
- Manufacturing of goods or materials: Goods means tangible (and not intangible items), however, software embedded in hardware generally would be considered as goods. Manufacturing shall cover both full-fledged manufacturing and contract/ toll manufacturing (irrespective of the contractor’s location). However, manufacturing excludes repair services given that it is generally categorized as a form of service involving the restorationor fixing of already existing products to their original or functional condition, as opposed to the creation of a new product (manufacturing) or the significant alteration of a product's form or characteristics (processing). It has been clarified that goods manufactured in a Free Zone are not required to be tested for end-user conditions when sold. This exemption is essential for testing distribution as a standalone QA
- Processing of goods or materials: Processing is commonly positioned as the intermediary stage within the production process, although exceptions exist where it may serve as the final step. It is important to note that processing extends beyond manufacturing and can occur when an object undergoes a transformation without creating a new product. The term "processing" conveys the idea of consistent or ongoing actions carried out on a tangible item.
- Trading of Qualifying Commodities: The meaning of ‘raw form’ in relation to trading of Qualifying Commodities shall also include raw commodities that have undergone minimal processing like cleaning, sorting, grading, and minor refining to meet quality and uniformity standards for trading on commodity exchanges. Even though they are not in their original untouched state, they are still considered raw because they have not been turned into a different product or finished good.
- Holding of shares and other securities for investment purposes: Holding of shares and other securities for investment purposes shall also include cryptocurrency investment. For shares and other securities to be classified as held for investment purposes, they must be held for an uninterrupted period of at least 12 months, or there must be a clear intention to hold them, and the FZP must be able to demonstrate this intention. Also, it may be presumed that the transaction is not made with a natural person if the person trades shares and securities on a Recognized Stock Exchange, provided the 12-month ownership test is satisfied.
- Fund management vs Wealth and investment management services: Wealth and investment management is a comprehensive service that goes beyond fund management. It covers all aspects of a person's finances, including retirement planning, estate planning, tax planning, and budgeting. Wealth managers develop personalised plans to help clients achieve their short and long term financial objectives.
- Headquarter services to Related Parties: An FZP is considered to provide headquarters services if it offer specific services to Related Parties who are either residents or non-residents. A headquarters company can be responsible for the group’s overall success or an important aspect of the group's performance, while also ensuring corporate governance. To be seen as taking responsibility for a group’s success, an FZP may need to provide strategic services, senior management, take on material risks, or give substantive advice on managing risks.
- Treasury and financing services to Related Parties: Treasury and financing services to include cash pooling and centralised payment/cash collection activities for or on behalf of Related Parties [including Domestic Permanent Establishment (‘PE’) and self-investment]. Interest income will be treated as arising from the QA of treasury and financing services to Related Parties, provided the FZP maintains adequate substance in relation to the activity.
- Distribution of goods or materials in or from a DZ: Distribution of goods or materials outside of the UAE (high sea sales or third port trading) by a person based in DZ shall be considered QA. Also, the person involved in distributing goods or materials needs to perform due diligence (like 'know your client', seeking confirmation by way of an undertaking or a contract, etc.) to ensure that their customer is not the final user, to fall within the scope of the QA. Also, the sales agents or consultants who solely help purchase or sale of goods or materials without directly participating in the actual transaction are not considered part of the QA of distribution.
- Logistics services: An FZP conducts most of its logistics operations within an FZ for clients in the UAE or abroad while offering last mile delivery services outside of the FZ in the UAE or another country. Despite the delivery services being outside of the FZ, they are considered as part of the FZP’s logistics services QA.
- Transfer Pricing
Requirement to maintain documentation to demonstrate the arm’s length nature of the relevant transactions and prepare of a master file, local file, and disclosure form for the FZP if the relevant TP compliance thresholds are met.
- Other considerations
- De-minimis requirement: For the computation of de-minimis threshold requirements, the revenue attributable to a Domestic/ Foreign PE is determined by applying the arm’s length principle.
- Maintain Audited Financials: To be an QFZP, an FZP must have audited financial statements for CT purposes .It doesn’t need separate financial statements for its QI and its other income or for any of its branches, but it should have sufficient documentation to demonstrate the QI calculation.
- Registration: An FZP (including QFZP) must register for CT within the prescribed timelines. However, if a non-resident company has a branch in an FZ (but does not have a PE) and only earns the UAE sourced income, they are not obligated to register for CT.
- Obligation to Taxpayers: DZ listed for VAT purposes should be considered as DZ for CT purposes. But the Guide casts the obligation to verify with their relevant FZ Authority to ensure if they function in a Free Zone (FZ) or Designated Zone (DZ) for customs and tax purposes.
- Domestic / Foreign PE: Head office in the UAE / Branch of a Foreign company within a FZ would be generally considered a Domestic / Foreign PE. Also, there is guidance provided around constitution of Domestic / Foreign PE for the FZP.
- Satisfaction of beneficial recipient of goods or services: FZP selling goods or services to another FZP may rely on a written statement/ undertaking from the latter confirming that they are the intended recipient of the same and will utilise it for their FZ business unless there is a valid reason to doubt the accuracy of such representation.
- No Qualifying income in first Taxable Period: A FZP who has not generated any QI during a Tax Period due to not commencing revenue generation would be deemed to satisfy the QI criteria if it does not earn any non-qualifying revenue.
- Re-evaluating eligibility after the first Taxable Period: If a FZP person fails to meet the conditions of the QFZP in the first Taxable Period, then the same person can opt to be QFZP right after the end of the total 5-year period. Not meeting the conditions of QFZP for year 2 to year 5 does notaffect eligibility for re-qualification.
- Loss set-off: Tax Losses incurred as per the UAE CT Law in relation to the taxable income component is eligible to set-off and carry forward against QFZP taxable income. However, income from non- qualifying intellectual property can only be offset against tax losses from such intellectual property.
Way forward
This Guide provides useful guidance and clarity on various aspects. The instances covered in the guidance should be carefully compared to specific facts and the same can be used in interpreting conditions relevant for satisfying to be QFZP. To reiterate, it is essential that these conditions are evaluated with utmost diligence in the first year due to the legislative restriction of allowing to enjoy 0% CT rate for the next 4 years if eligibility of conditions are not met in the first year.
Our tax experts can help businesses evaluate whether they can meet the conditions for the 0% tax rate on Qualifying Income and can advise on any associated compliance matters. If you would like help with this or any other tax matter, please contact our tax team.