Zero Tax for UAE Free Zone Companies: The Updated Guide

Zero tax for free zone companies 

The Federal Law on the Taxation of Corporations No. 47 of 2022 came into force in the United Arab Emirates in 2023. It introduced the corporate tax, which applies to tax periods beginning on or after 1 June 2023. The tax rate is 9% on the amounts exceeding the threshold of 375,000 AED.

The corporate tax applies to both UAE mainland and free zone companies. However, free zone companies can enjoy a zero rate. For this purpose, the company must be a “qualifying free zone person”. 

Below, we will review the conditions for free zone companies to apply a zero rate based on the latest clarifications from the UAE Cabinet and the Ministry of Finance.  

Updated regulations on taxation in free zones

In October 2023, the UAE issued:

• Cabinet Decision No. 100 of 2023 on Determining Qualifying Income for the Qualifying Free Zone Person and
• Ministerial Decision No. 265 of 2023 Regarding Qualifying Activities and Excluded Activities.

Both documents are valid retrospectively, starting from 1 June 2023. Previously existing decisions on the same matters (No. 55 and No. 139, respectively) were repealed. 

The main changes in the new Decisions compared to the previous ones: 

• Trading has been added to the list of qualifying activities, but only for certain commodities (mainly raw materials).
• Activities related to intellectual property (IP) have been removed from the list of excluded activities. 
• Income derived from qualifying IP (patents and copyrighted software) is now classified as qualifying income. 
• Income derived from transactions with free zone persons is considered “qualifying” only if such persons are beneficial recipients of the relevant goods or services.

Qualifying Free Zone Person

A free zone company is considered a “Qualifying Free Zone Person” if it meets all the following requirements: 

1. maintains adequate substance in the UAE;
2. derives “qualifying Income” (that is, income from “qualifying activities”), and 
3. its non-qualifying revenue does not exceed the “de minimis” requirements; 
4. has not elected to pay corporate tax under standard rules (9% on the amount exceeding the threshold of 375,000 AED);
5. complies with the “arm’s length principle” (transfer pricing rules in related-party transactions);
6. maintains transfer pricing documentation (which the tax authority may request);
7. prepares audited financial statements;
8. meets any other conditions as may be prescribed by the Minister of Finance.   

If a company fails to meet any of these conditions during a tax period, it ceases to be a qualifying free zone person from the beginning of that tax period and for the subsequent four tax periods. In other words, the company loses its right to a zero rate for five years and pays corporate tax under the standard rules. 

Qualifying and excluded activities

“Qualifying” are activities from which a free zone company derives qualifying income.

“Excluded” are activities that generate non-qualifying income to which the zero rate cannot be applied. 

Decision No. 256 provides a list of qualifying and excluded activities and details of each activity. 

Qualifying activities

Excluded activities

Manufacturing of goods or materials. Processing of goods or materials. Trading of qualifying commodities. Holding of shares and other securities for investment purposes. Ownership, management and operation of ships. Reinsurance services. Fund management services. Wealth and investment management services. Headquarter services to related parties. Treasury and financing services to related parties. Financing and leasing of aircrafts. Distribution of goods or materials in or from a designated zone (the include some free zones designated for VAT purposes). Logistics services. Any activities that are ancillary to the qualifying activities specified above.

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. Insurance activities (except reinsurance and headquarters services to related parties). Finance and leasing activities (except ownership, management and operation of ships, treasury and financing services to related parties and financing and leasing of aircrafts). 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 a free zone person. Any activities that are ancillary to the excluded activities specified above.

New to this list is the trading of qualifying commodities. It means the physical trading of qualifying commodities and associated derivative trading used to hedge against risks involved in such activities. Qualifying commodities include metals, minerals, energy, and agriculture commodities traded in raw form on a recognised commodities exchange market.  

Qualifying and non-qualifying income

The 0% rate applies only to a company’s qualifying income. Non-qualifying income is taxed at a 9% rate.

Qualifying income

Non-qualifying income

Income derived from transactions with a free zone person, except for income derived from excluded activities (as listed above). Income derived from transactions with a non-free zone person, but only in respect of qualifying activities that are not excluded activities. Income derived from the ownership or exploitation of qualifying IP.  Any other income provided that the qualifying free zone person satisfies the de minimis requirements.

Income from excluded activities. Income from activities that are not qualifying activities where the other party to the transaction is a non-free zone person. Income from transactions with a free zone person where such person is not the beneficial recipient of the relevant goods or services.

An important restriction has been introduced regarding transactions with free zone persons. The income from transactions with a free zone person will be considered qualifying if that person is a beneficial recipient of the relevant goods or services. The beneficial recipient is a person who has the right to use and enjoy the goods or services and has no contractual or legal obligation to supply such goods or services to other persons.

The following categories do not count towards non-qualifying revenue (as well as total revenue): 

1. Revenue derived from the following transactions with immovable property located in a free zone:
   • ransactions with a non-free zone person in respect of commercial property;
   • transactions with any person in respect of non-commercial immovable property;
2. Revenue attributable to a domestic or foreign permanent establishment of the qualifying free zone person.
3. Revenue derived from the ownership or exploitation of intellectual property other than “qualifying” intellectual property.

Commercial property is immovable property used exclusively for business and not as a place of residence or accommodation like hotels or similar facilities.

De minimis requirements

“De minimis requirements” mean the allowable amount of non-qualifying revenue against a company’s total 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.

De minimis requirements are considered satisfied if a portion of non-qualifying revenue of the qualifying free zone person in a tax period does not exceed the lowest of the following:

• 5% of the total revenue in that tax period or
• 5,000,000 AED (approx. 1,360,000 USD). 

Income from intellectual property

According to the latest decisions, qualifying income now includes income derived from the ownership or exploitation of “qualifying” IP. 

Qualifying IP includes:

• patents;
• copyrighted software;
• any rights functionally equivalent to a patent. They may include utility models, IP assets that grant protection to genetic material, orphan drug designations and others.

IP assets related to marketing, in particular trademarks, cannot be treated as qualifying IP. 

Decision No. 265 provides a formula for calculating income from qualifying IP, which is subject to a zero corporate tax rate:

Qualifying income = ((Qualifying expenditures + Qualifying expenditures increased by 30%) / Overall expenditures) × Overall income

Qualifying expenditures mean expenditures incurred to fund research and development (R&D) activities, conducted either by the qualifying free zone person or outsourced to any person in the UAE or any unrelated party outside the UAE. Such expenditures must be directly connected with the creation or development of the qualifying IP.

Overall expenditures mean total expenditures incurred to fund R&D activities, conducted either by the qualifying free zone person or outsourced to any person, directly connected with the creation or development of the qualifying IP, including acquisition costs of the qualifying IP.

Overall income means royalties or any other income derived from qualifying IP as determined according to the provisions of the Corporate Tax Law.

Qualifying expenditure increased by 30% may not exceed or be equal to overall expenditures.

Adequate substance in the UAE and outsourcing 

Adequate substance in the UAE is one of the conditions of being a qualifying free zone person. To maintain adequate substance in the UAE, a company must:

• undertake its core income-generating activities (CIGA) 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, 
• have an adequate number of qualified full-time employees in a free zone or a designated zone and
• incur adequate operating expenditures. 

CIGA consist of those significant functions that drive the business value for each activity carried out by a qualifying free zone person. 

CIGA can be outsourced to another person in a free zone, provided the qualifying free zone person has adequate supervision of the outsourced activity.

СIGA, in respect of qualifying IP, can be outsourced to any other person in the UAE and any unrelated party outside the UAE, provided the qualifying free zone person adequately supervises the outsourced activity. 

Zero corporate tax in free zones: summary

• A free zone company can enjoy a zero tax if it is a “qualifying free zone person”.
• To benefit from the 0% rate, a free zone company must simultaneously meet all the criteria for a qualifying free zone person, including qualifying income, adequate substance in the UAE, mandatory financial statements audit, observance of transfer pricing rules, and other requirements. 
• 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 specified threshold (de minimis) in the company’s total revenue.
• The updated regulations issued by the UAE financial authorities generally repeat the previous ones, maintaining numerous and fairly strict conditions for applying the zero rate. However, this opportunity has now appeared for companies that receive income from certain IP assets or trading in commodities.
• To understand whether your UAE free zone company is eligible for applying the 0% rate, you should match its business to the list of qualifying and excluded activities and understand the proportion of its qualifying and non-qualifying income.