INTRODUCTION
UAE Corporate Tax Law specifies the conditions for Qualifying Income (“QI”) of Qualifying Free Zone Person (“QFZP”) which is exempted from taxation. Firstly, a Free Zone is a geographic area which is defined and decided by the Cabinet. A Free Zone Person is any legal person that is incorporated, established or registered in the Free Zone.
QUALIFYING FREE ZONE PERSON
A Free Zone Person is considered a Qualifying Free Zone Person after fulfilling certain conditions under Article 18 of the UAE Corporate Tax Law which are as follows:
- Adequate Substance: The person maintains adequate substance in the Free Zone area which involves having adequate staff, assets, etc.
- Qualifying Income: The person derives Qualifying Income as specified in the Cabinet Decision.
- No Election: The person is has not elected to be subjected to the corporate taxes under UAE Corporate Tax Law.
- Arm’s Length Principle: The person must follow the arm’s length principle mentioned under Article 34 related to transfer pricing.
- Transfer Pricing Documentation: The person must also maintain and comply with the transfer pricing documentation requirements as specified under Article 55 of the law.
- Ancillary Conditions: Any other condition may be specified by the decisions of the Cabinet. These are:
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- Non-Qualifying Revenue shouldn’t exceed the de minimis requirement;
- Maintenance and preparation of Audited Financial Statements.
The status of Qualifying Free Zone Person can be removed at any point of time when there is failure to meet any of the conditions specified above. The removal of status shall be considered from the beginning of the taxation period.
QUALIFYING INCOME – CABINET DECISION NO. 100 OF 2023
Conditions to be fulfilled for an income to be considered as Qualifying Income are defined in the Article 3 of Cabinet decision on determining Qualifying Income for the Qualifying Free Zone Person which is as below:
1. Transaction with Free Zone Person: The income generated from transactions except from Excluded Activities, between the Qualifying Free Zone Person and Free Zone Person, who is a Beneficial Recipient of services or goods.
Who is a Beneficial Recipient?
A Beneficial Recipient is a person who has the:
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- Right to use the services or goods.
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- Right to enjoy the services or goods.
This is without any legal or contractual obligation to supply them to another person.
Goods: Further, ‘goods’ can be a tangible or intangible property (including movable and
immovable property) which has economic value.
2. Transaction with Non-Free Zone Person: The income generated from transactions only from Qualifying Activities and not Excluded Activities, between the Qualifying Free Zone Person and a Non-Free Zone Person (“NFZP”).
3. Ownership or Exploitation of Qualifying Intellectual Property: Income derived from exploitation or ownership of Qualifying Intellectual Property (“QIP”) calculated as per Article 7 of the Cabinet Decision.
What is Qualifying Intellectual Property?
As defined in the Cabinet Decision, Qualifying Intellectual Property includes patents,
copyrighted software and any other right functionally identical to such patent like:
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- Utility Models,
- IP Assets granting protection to plant and genetic material,
- Orphan Drug Designations,
- Extension of Patent Protection.
However, this does not include marketing IP assets like trademarks.
4. De Minimis Requirement: Any income of the Qualifying Free Zone Person, if such person qualifies the De Minimis Requirement as stated under Article 4 of the Cabinet decision.
Exclusions for Qualifying Income:
If the income is derived from the following, then it will not be considered as Qualifying Income:
- Attributed to Domestic Permanent Establishment (Article 5),
- Attributed to Foreign Permanent Establishment (Article 5),
- Derived from ownership and exploitation of Immovable Property (Article 6),
- Considered Taxable Income under Article 7.
What is the De Minimis Requirements?
This condition is tested in respect of Non-Qualifying Revenue (“NQR”) derived by the Qualifying Free Zone Person. According to Article 4 of the Cabinet decision and Article 3 of the Ministerial Decision No.265 of 2023, the De Minimis condition will be met when the NQR derived by the QFZP in a Tax Period doesn’t exceed (lower of the two):
- 5% of Total Revenue (TR) earned by the Qualifying Free Zone Person in the taxation period; or –
- AED 5 million.
What is Non-Qualifying Revenue (NQR)?
For the purpose of De Minimis requirement, NQR includes revenue from (any of the three):
- Excluded Activities;
- Revenue earned from Non-Qualifying Activities involving Non-Free Zone persons;
- FZP where FZP is not Beneficial Recipient of goods or services.
What is Total Revenue (“TQ”)?
Total Revenue tis that revenue which is derived by QFZP in a Tax Period.
Exclusions while calculating NQR and TQ
The total revenue and revenue from Non-Qualifying activities does not include:
- Income attributable to Domestic & Foreign Permanent Establishment. However, Domestic and Foreign PE will be considered as separated and independent, i.e. Related Party of QFZP;
- Income from ownership or exploitation of IP (except under Article 7 of the Cabinet Decision.
- Income generated from the immovable property in Free Zone on transaction with:
- Non-Free Zone Person, related to commercial property;
- Any person related to immovable property which is a non-commercial property.
INCOME ATTRIBUTED TO DOMESTIC OR FOREIGN PERMANENT ESTABLISHMENT
Article 5 states that if the income is attributable to Domestic PE (location of business outside the Free Zone area but within UAE) & Foreign PE (place of business outside UAE) carrying out the relevant transaction, then, it will be considered as Taxable Income and taxed under Article 3 (2) (b) of UAE Corporate Tax Law.
Further, the income will be calculated as if it is a separate and independent person, i.e. Related Party of Qualifying Free Zone Person.
INCOME FROM IMMOVABLE PROPERY IN FREE ZONE
Article 6 states the condition for any income generated from immovable property in the Free Zone area. It will be considered as Taxable Income and taxed under Article 3 (2) (b) of UAE Corporate Tax Law.
Taxable Income: The Taxable Income from the immovable property will include transaction with:
- Non-Free Zone Person, related to commercial property;
- Any person, related to immovable property which is a non-commercial property.
INCOME DERIVED FROM QIP – QUALIFYING INTELLECTUAL PROPRTY
Article 7 of the Decision specifies that the income from exploitation and ownership of IP shall be considered as Qualifying Income. The process to calculate such Qualifying Income is specified by the decision of the Minister.
However, these incomes will be considered as Taxable Income and taxed under Article 3 (2) (b) of UAE Corporate Tax Law:
- Any income from ownership or exploitation of IP which is not Qualifying IP;
- Income that exceeds the Qualifying Income calculated by the above method.
ADEQUATE SUBSTANCE IN FZ AND OUTSOURCING IN FZ
According to Article 8, Core Income Generating Activities means those functions that drive business value for every activity performed by QFZP and is not mere support activity.
What is meant by Maintaining Adequate Substance?
For Maintaining Adequate Substance in a Free Zone, QFZP shall conduct its Core Income Generating Activity in that Free Zone or Designated Zone and according maintain the following:
- Adequate Assets;
- Adequate number of qualified full-time employees in the Free Zone;
- Adequate operating expenditure shall be incurred
When can QFZP Outsource Core Income Generating Activities?
A Core Income Generating Activity can be outsourced to following people when such activity is in supervision of concerned QFZP:
- General Core Income Generating Activity can be outsourced to another person in Free Zone or Designated Zone Persons.
- Core Income Generating Activity in respect of Qualifying IP can be outsourced to any person in UAE or any person outside UAE who is not Related Party.
TAX ON INCOME OF QUALIFYING FREE ZONE PERSON
According to Article 3 of the UAE Corporate Tax Law, the tax rates of income of Qualifying Free Zone person are as follows:
- Qualifying Income: Any income earned by a Qualifying Free Zone person which is a Qualifying Income shall have 0% tax liability
- Non-Qualifying Income: Any income gained by a Qualifying Free Zone person which is not a Qualifying Income shall have 9% tax liability.
CONCLUSION
In conclusion, the UAE Corporate Tax Law provides a comprehensive framework for Qualifying Free Zone Persons (QFZP), outlining stringent conditions for Qualifying Income (QI) exemption. QFZPs must meet criteria such as maintaining adequate substance, adherence to the arm’s length principle, and transfer pricing documentation. Cabinet Decision No. 100 of 2023 defines QI conditions, emphasizing transactions with Free Zone Persons, Qualifying Activities with Non-Free Zone Persons, and ownership of Qualifying Intellectual Property. Notably, a 0% tax liability applies to QI, incentivizing compliance, while Non-Qualifying Income incurs a 9% tax liability. Adequate substance maintenance and outsourcing regulations further enhance the integrity of the tax regime.
FAQs
1. What types of income are considered as Qualifying Income for a Qualifying Free Zone Person?
The following types of income are included in qualifying income for a Qualifying Free Zone Person:
- Income from transaction with other Free Zone Person, excluding Excluded Activities.
- Revenue from dealings with Non-Free Zone Persons, but only in connection with qualifying activities that are not excluded activities.
- Any additional income, as long as the Qualifying Free Zone Person satisfies the de minimis criteria.
2. Does revenue from dealings with other Free Zone Persons count as Qualifying Income?
Yes, with the exception of revenue obtained from Excluded Activities, Qualifying Income does include transactions with other Free Zone Persons.
3. Can Qualifying Income be derived from transactions with Non-Free Zone Persons? If so, are there any conditions or restrictions?
Income derived through dealings with Non-Free Zone Persons may be regarded as Qualifying Income, provided that it satisfies the requirements of being connected to Qualifying Activities and not being an Excluded Activity.
4. What does “Beneficial Recipient” mean in terms of business dealings with people from Free Zones?
A person who has the right to utilize and enjoy the services or goods obtained in a transaction with a Free Zone Person is referred to as a “Beneficial Recipient”. Legally or contractually, the Beneficial Recipient is not required to transfer the received goods or services to another party.
5. What do the de minimis standards define as non-qualifying Revenue?
Non-qualifying Revenue is income generated during a tax period through Excluded Activities or non-qualifying activities, particularly when a Non-Free Zone Person is the other party to the transaction.
6. How are the de minimis criteria applied to total revenue?
Total Revenue is the sum of all revenue that a Qualifying Free Zone Person receives during a Tax Period from all sources combined.
7. How are the Qualifying Free Zone Person and its Domestic Permanent Establishment or Foreign Permanent Establishment treated under the de minimis requirements?
The Qualifying Free Zone Person and its Domestic Permanent Establishment or Foreign Permanent Establishment are treated as if they were separate and independent entities, resembling a Related Party relationship with the Qualifying Free Zone Person.
8. What happens to income attributable to a Domestic Permanent Establishment or a Foreign Permanent Establishment of a Qualifying Free Zone Person?
Income attributable to a Domestic Permanent Establishment or a Foreign Permanent Establishment of a Qualifying Free Zone Person is considered Taxable Income and is subject to taxation Article 3(2)(b) of the UAE Corporate Tax Law.
