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Latest Updates on UAE Corporate Tax for Free Zone Entities

What is Corporate Tax in UAE?

A type of direct tax known as corporate tax (CT) is imposed on the net income or profit that corporations and other entities make from their operations. In certain countries, corporate tax is also known as "business profits tax" or "corporate income tax (CIT)."

With its ideal location, booming economy, and business-friendly laws the United Arab Emirates has become a global hub for businesses and investments.  However, for both domestic and foreign businesses, comprehending and managing corporate tax in the UAE is essential.

When it comes to corporate tax in the United Arab Emirates (UAE), there are both benefits and drawbacks for businesses. However, the new corporate tax measures for free zones are a big step towards making the nation more appealing to investors and business travellers. So, let’s explore what are free zone entities so we can comprehend the amendments made by the Ministry of Finance. 

What is a Free Zone Entity?

In the United Arab Emirates, free zones play a significant role in attracting foreign investment and fostering economic growth. So, what exactly is a free zone entity? Put simply, it refers to a company or business that operates within one of the designated free zones in the UAE.

Free zones are specific areas where businesses can enjoy various incentives and benefits. These include 100% ownership for foreigners, tax exemptions, repatriation of profits, and streamlined processes for setting up companies. This makes them an attractive option for both local and international entrepreneurs looking to establish their presence in the UAE market.

Operating as a free zone entity allows businesses to take advantage of numerous opportunities across different sectors such as logistics, technology, finance, healthcare, media production, and more. These entities often have access to state-of-the-art infrastructure and facilities designed specifically to support their operations.

By establishing themselves as free zone entities, businesses can tap into the thriving economy of the UAE while enjoying certain advantages not available outside these designated areas. However, it's important for these entities to stay informed about any changes in corporate tax laws that may affect their operations.

Changes in UAE Corporate Tax Laws for Free Zone Entities

The UAE has recently made significant changes to its corporate tax laws that impact free zone entities. These changes aim to streamline the taxation system and make it more aligned with international standards. 

The UAE Ministry of Finance released Cabinet Decision No. (100) of 2023 and Ministerial Decision No. (265) of 2023 about the tax system that applies to enterprises operating in free zones during the final week of October 2023. The Ministerial Decision No. (139) of 2023 and the Cabinet Decision No. (55) of 2023, both published on June 1, 2023, the revised Decisions involve significant changes to the Free Zone Tax Regime as well as additional explanation on it.

Previously, most free zone entities enjoyed a full exemption from corporate tax. However, under the new regulations, only companies engaged in specified activities will be eligible for this exemption. The criteria for these activities are yet to be fully defined by each respective free zone authority.

The new decisions apply to Qualifying Free Zone Persons (QFZPs), who are Free Zone enterprises that wish to take advantage of the 0% CIT rate under the CIT regime, as long as all requirements are met. The new changes are described as follow: 

Qualifying Intellectual Property

According to the Cabinet Decision, income from the ownership or use of qualifying intellectual property is now considered qualifying income. This feature is intended to support QFZPs that derive revenue from intellectual property (IP) assets, including patents, copyrighted software, and any other right that serves as a functional equivalent of a patent. Trademarks and other IP assets connected to marketing are expressly prohibited. For QFZPs possessing the necessary IP assets, the recent Ministerial Decision is a great relief since it eliminates IP operations from the list of Excluded operations. Additionally, the amount of 0% taxed Qualifying Income is determined by a recently adopted formula that is closely related to the investments made in Research and Development (R&D) activities by the QFZP.

Trading of Qualifying Commodities

Trading of Qualifying Commodities is a new activity that has been added to the list of qualifying activities. This activity includes trading qualifying commodities both directly and through derivatives. Metals, minerals, energy, and agricultural commodities are all considered qualifying commodities as long as they are traded on an approved commodities exchange market.

Maintaining Adequate Substance

The substance requirements for QFZPs have been expanded upon and changed by the new Decisions. With Cabinet Decision No. 100 of 2023, the notion of core income-generating activities is now more precisely defined. It highlights that these shouldn't just be support duties, but rather important roles that create value for the company. Since not all operations are regarded as key revenue-generating activities, this clarification aids organisations in understanding and adhering to content criteria.

In accordance with the earlier rulings, QFZPs have to carry out their primary revenue-generating operations inside a Free Zone, with sufficient resources, qualified personnel, and operational costs. Under the requirement that the QFZP have sufficient oversight, outsourcing was permitted to either a Related Party or a third party operating inside the same Free Zone. According to the new judgement, fundamental income-generating activities have to take place in either a designated zone or a free zone, depending on where they have to be done. This, in our opinion, restricts the geographic area in which some activities can be carried out.

For instance, since a Qualifying Distribution activity must be carried out inside a Designated Zone, a QFZP is not permitted to contract with an outsourced company based in a Free Zone.

The particular clause about outsourcing activities pertaining to qualifying intellectual property is a noteworthy innovation. These can now be outsourced to anybody in the United Arab Emirates (UAE), including connected parties, or to unrelated parties outside the country, as long as the QFZP is sufficiently monitoring the outsourced work. This greatly increases the amount of IP-related activities that can be outsourced.

The recent changes in the corporate tax laws in the UAE have brought about significant shifts in how free zone entities are taxed and regulated. While these changes present challenges, they also offer opportunities for greater transparency and alignment with international standards.