Is corporate tax not applicable to free zone businesses?

Keeping in view the importance of the free zones, special rules have been introduced in the corporate tax law of the UAE

Free Zones are a crucial part of the UAE economy and have a key role in attracting foreign investment that plays a pivotal role in the country’s development. Keeping in view the importance of the free zones, special rules have been introduced in the corporate tax law (the law) of the UAE.

According to article 3 of the law, zero per cent corporate tax (CT) is applicable on the qualifying income of the qualifying free zone person. All other income of the qualifying free zone person is subject to tax at nine per cent unless the income is exempt or out of the scope.

From the above requirement of the law, it is very clear that CT is applicable to the free zone persons, and the tax rate can be zero per cent or nine per cent based on the nature of the income. Since the free zone persons are taxable, so they are liable to comply with the CT law. They are legally responsible for registering for CT, calculating taxable income, submitting the annual return, making the tax payment, and complying with other provisions of the CT law. For clarification purposes, there is no threshold to register the business for corporate tax. If the business is in losses, having zero income in the last year and expecting no income in the next year, still, they need to apply for CT registration.

To apply the CT properly on businesses registered in the free zones, it is important to understand the terms free zone, free zone persons, qualifying free zone persons and qualifying income.

The law states that a free zone person is; “A juridical person incorporated, established or otherwise registered in a Free Zone, including a branch of a Non-Resident Person registered in a Free Zone”. From this definition, it is clear that a natural person who conducts business in the UAE and a juridical person not established in the free zone cannot be classified as a free zone person. The free zone persons can be juridical persons like limited liability companies, partnerships where the liability of any of the partners is not unlimited means limited liability partnership, funds structured as a legal entity, public shareholding companies, public joint stock companies, branches of a nonresident juridical person etc. established and incorporated in the free zone.

The term “qualifying free zone person” is even more important than the two mentioned above. Article 18 of the law describes that any free zone person which (i) maintains adequate substance in the UAE, (ii) derives qualifying income as specified in the cabinet decision, (ii) complies with prevailing transfer pricing rules and regulations and (iv) has not elected to be subject to CT, qualifies as a qualifying free zone person. If the taxable person does not meet any of these four conditions, the person will cease to be a qualifying free zone person. I believe the term “adequate substance” used above will be as per Economic Substance Regulations (ESR) law already prevailing in the UAE, which requires that relevant persons must have adequate physical assets, operating expenses, and employees in the UAE to comply with the ESR law. The term “qualifying income” means any income derived by a qualifying free zone person that is subject to CT at zero per cent, and such income will be specified in the cabinet decision. Therefore, we need to wait for the cabinet decision to understand the qualifying income thoroughly.

From the above, it is evident that the income of the free zone person can be classified into qualifying income and non-qualifying income. Qualifying income is the same income essential for the free zone person to qualify as a qualifying free zone person, and it will be subject to tax at zero per cent. If the qualifying free zone persons have only qualifying income, they will still be liable to submit the return by applying zero per cent CT on their qualifying income. However, a qualifying free zone person can elect to be taxed at nine per cent, as given in article 19(1) of the law.

The qualifying free zone persons have certain limitations as given in the law. For example, qualifying free zone persons cannot be part of the qualifying group where the law permits qualifying group members to transfer their assets and liabilities at the book value. Moreover, qualifying free zone persons cannot join the tax group where intragroup transactions are not subject to CT, and the group is required to submit a single return. In addition, qualifying free zone persons cannot enjoy the restructuring relief where the law allows no gain or loss should be booked upon the transfer of full business or independent part of the business to another taxable or potential taxable person. Finally, qualifying free zone persons can not transfer their losses to another taxable person where the law allows transferring the losses to another resident juridical person upon fulfilment of other conditions.

As mentioned above, the qualifying free zone can elect to be taxed at nine per cent. Once the qualifying free zone person opts to be taxed at nine per cent, will the above limitations be applicable? I believe, the above limitations will not be applicable, but we need to wait for clarification and guidance from FTA.

In a nutshell, almost all free zone businesses are subject to CT, and free zone companies should also work for the smooth implementation of CT to avoid any complexities in the future.