From 1 June 2023, the Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses has been enacted in the United Arab Emirates. The Law introduces corporate profit tax for most UAE companies and applies to tax periods beginning on or after 1 June 2023. It affects both companies established in the UAE mainland and companies incorporated in free zones.
The highlights of the corporate tax in the UAE
The corporate tax applies to both UAE residents and non-residents. Resident taxpayers include:
- legal entities incorporated in the UAE, including the UAE free zone companies;
- foreign legal entities managed and controlled in the UAE;
- individuals doing business in the Emirates.
The tax base of legal entities that are residents of the UAE is their worldwide income, which means the income received within the UAE together with the foreign-sourced income. A taxpayer can deduct the expenses incurred for its business purposes.
The UAE companies are now required to submit a tax return within nine months after the end of their tax period or at other times as the tax authority may prescribe. The tax authority may request a company to provide its financial statements based on which the taxable income was determined and any other documents or information.
Corporate tax rate in the UAE
Generally, the following corporate tax rates will apply in the UAE:
- 0% – on the portion of the taxable income that does not exceed AED 375 000 (according to Cabinet Decision No. 116 of 2022);
- 9% – on the amount of the taxable income that exceeds the threshold mentioned above.
The qualifying free zone persons, which we consider below, will use similar tax rates but on different conditions (without the exemption limit):
- 0% – on qualifying income;
- 9% – on non-qualifying income.
It means that the qualifying free zone companies in the UAE receiving qualifying income will be able to apply a zero tax rate in respect of that income.
At the same time, a qualifying free zone company may elect the usual way of corporate taxation (the first of the mentioned above).
The UAE mainland companies and non-qualifying free zone companies that use standard taxation can benefit from small business relief (Article 21 of the Law). A company is treated as not having received any taxable income if its revenue for the current and previous tax periods has stayed within the established threshold and the company meets other requirements. Under Ministerial Decision No. 73 of 2023, this threshold is AED 3,000,000 (around USD 816,000), and the exemption applies to tax periods ending on or before 31 December 2026.
Tax exemption for free zone companies
One of the first questions arising from introducing the corporate tax is whether the tax exemption for companies incorporated in the UAE free zones will continue. To resolve it, the Law uses the “qualifying free zone person” category.
A free zone person is considered “Qualifying” if it meets all of the following conditions:
- maintains adequate substance in the UAE;
- receives qualifying income (as determined by the Cabinet);
- has not elected to use standard taxation (9% rate on the amount exceeding the exemption limit);
- complies with Article 34 (arm’s length principle in related party transactions) and Article 55 of the Law (transfer pricing documentation which a tax authority may request);
- fulfils any other conditions that may be prescribed.
If a free zone company ceases to meet any of the above conditions during a tax period, it is not considered “qualifying” from the beginning of that period and for subsequent four tax periods (par. 2 art. 5. of the Decision No. 139). In this case, the company will be subject to taxation under the same rules as companies in the UAE mainland.
Since the Law contains many general terms and rules, it is subject to clarification by the UAE competent authorities. Here are the most important explanatory documents published to date:
- Explanatory Guide on Federal Decree-Law No. 47 of 2022, published on 12 May 2023 (“Explanatory Guide”);
- Cabinet Decision No. 55 of 2023 on Determining Qualifying Income, published on 30 May 2023 (Decision No. 55);
- Ministerial Decision No. 139 of 2023 Regarding Qualifying Activities and Excluded Activities, published on 1 June 2023 (Decision No. 139).
Below, we outline the tax exemption conditions for free zone companies based on the available guidance.
Adequate substance in the UAE free zone
Article 7 of Decision No. 55 states that a qualifying free zone company must conduct its core income-generating activities in a free zone plus, depending the level of activities, –
- have adequate assets,
- have an adequate number of qualified personnel and
- incur adequate operating expenses.
A qualifying free zone company can outsource its activities to a related party or a third party in a free zone, provided it adequately supervises the outsourced activity.
Other details of the “adequate substance” requirements in a free zone for tax purposes are still unavailable. As far as can be judged, the existing economic substance legislation is not currently applicable to these issues.
Qualifying activities of free zone companies
Article 2 of Decision No. 139 classifies the following activities of a free zone company as “qualifying”:
- Production of goods or materials.
- Processing of goods or materials.
- Holding shares and other securities.
- Ownership, management and operation of ships.
- Reinsurance services supervised by the UAE competent authority.
- Fund management services supervised by the UAE competent authority.
- Wealth and investment management services supervised by the UAE competent authority.
- Headquarter services provided to related parties.
- Treasury and financing services to related parties.
- Financing and leasing aircraft, including engines and rotables.
- 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 sale or resale.
- Logistics services.
- Any activities that are ancillary to the activities listed in paragraphs (a) to (l).
“Excluded activities” are the activities the income from which is not exempt from tax. According to article 3 of the Decision No. 139, such activities include:
- Any transactions with individuals (except transactions related to such qualifying activities as ownership, management and operation of ships, fund management services, wealth and investment management services and financing and leasing of aircraft).
- Banking activities supervised by the UAE competent authority.
- Insurance activities supervised by the UAE competent authority (except reinsurance).
- Finance and leasing activities supervised by the UAE competent authority (except financing of related parties and leasing of aircraft).
- Ownership or exploitation of immovable property other than commercial property located in a free zone where the transaction is made with other free zone persons.
- Ownership or exploitation of intellectual property assets.
- Any activities that are ancillary to the activities listed above.
Qualifying income of the UAE free zone companies
Qualifying income as defined in Article 3 of Decision No. 55 includes:
- Income derived from transactions with other free zone persons, except for income from excluded activities (see the list above).
- Income derived from transactions with non-free zone persons, but only in respect of qualifying activities that are not excluded activities.
- Any other income provided that the qualifying free zone person satisfies de minimis requirements under Article 4 of Decision No. 55.
“De minimis requirements” mean the allowable amount of non-qualifying revenue against a company’s overall revenue in a tax period. If the amount of non-qualifying revenue does not exceed the allowable threshold, the entire income remains qualifying and, therefore, eligible for the 0% rate.
Article 4 of Decision No. 139 specifies that a qualifying free zone company meets de minimis requirements if its non-qualifying revenue received in a tax period does not exceed 5% of the total revenue in that tax period or AED 5,000,000 (whichever is lower).
A company can receive non-qualifying revenue from:
- excluded activities;
- activity that is not qualifying where the other party to the transaction is a non-free zone person.
According to par. 3 of Article 4 of Decision No. 55, the following revenue is not included in the non-qualifying revenue (as well as in the total revenue):
- Revenue from transactions in respect of commercial immovable property located in a free zone, with non-free zone persons;
- Revenue from transactions in respect of immovable property that is not commercial with any persons;
- Revenue of a free zone person’s permanent establishment located in the UAE mainland or abroad.
“Commercial property” is immovable property or part thereof used exclusively for business and not used as a place of residence or accommodation like hotels or similar facilities.
- On 1 June 2023, the UAE switched to moderate corporate taxation. The tax rate (0% or 9%) is one of the lowest in the world among countries with a profit tax.
- Both UAE mainland and free zone companies are now subject to taxation.
- A zero-tax option for the UAE free zone companies remains available if they are “qualifying free zone persons”.
- A qualifying free zone company must have adequate substance in the free zone, receive qualifying income, and observe transfer pricing rules and other requirements.
- A free zone company may only use a 0% rate regarding its qualifying income. Non-qualifying income will be taxed at a 9% rate.
- A free zone company can retain the right to a 0% tax rate even if it receives a certain portion of non-qualifying income. Such income must not exceed the established threshold (de minimis) in the company’s total revenue. The current threshold is the lowest of the following amounts: 5% of total revenue or AED 5,000,000.
- The limited number of qualifying activities and the increased complexity of the requirements for applying a zero rate will likely decrease the number of free zone companies eligible for tax exemption.
- Instead of using the 0% rate on qualifying income, a free zone company may choose the regular taxation regime of 0% on non-taxable income and 9% on the excess.
- Free zone companies wishing to apply the 0% rate should match their business to the lists of qualified and excluded activities and understand the proportion of qualifying and non-qualifying income. Using the standard taxation may be more convenient than maintaining the status of a qualifying free zone person, as the case may be.