The release of Cabinet Decision No. 55 of 2023 on 'Determining Qualifying Income' and Ministerial Decision No. 139 of 2023 on Qualifying Activities and Excluded Activities provide some clarity on the nature of a Free Zone Person's income that will be taxed at 0%, as well as the income that would disqualify the Free Zone Person (completely) from claiming the 0% tax rate.
The definition of Qualifying Activity captures a large number of domestic business activities and the provision of services to entities that are located outside of a Free Zone, as well as preserves a beneficial tax regime for the UAE headquarters functions (with headquarters and treasury services falling within this definition).
For Free Zone entities that earn income from individuals (such as earnings from e-commerce sales to individuals, retail businesses, restaurants, hotels, and to an extent professional service/consultancy firms) and UAE businesses that hold or exploit intellectual property (e.g., royalty and license fees from copyrights, trademarks), these income streams are included in the definition of Excluded Activity income. This will result in the businesses needing to assess if this income falls within the De Minimis exclusion (being the lower of (i) 5% of total revenue or (ii) AED 5 million).
The regulations suggest that if the level of the Excluded Activity income falls outside the De Minimis threshold, then the entity affected would not be eligible to be treated as a Qualifying Free Zone Person (QFZP) and all of its income would be subject to tax at 9% (under the UAE mainland tax regime). Furthermore, such a business would also be excluded from seeking to be treated as QFZP (i.e., claiming the 0% rate) for the following four (4) tax years.
It is, therefore, critical that a Free Zone Person assess whether and the extent to which their income streams can be viewed as Qualifying Activity income (i.e., including if their Excluded Activity income falls within the De Minimis exclusion).
Free Zone businesses should ensure that they satisfy all of the requirements of Article 18 of the UAE corporate tax law (which also includes the preparation of audited financial statements) to ensure that they continue to satisfy the conditions to be viewed as a QFZP.
In more detail - Qualifying Income definition
On 1 June 2023, the UAE Ministry of Finance released two decisions (Cabinet Decision No. 55 of 2023 on 'Determining Qualifying Income' and Ministerial Decision No. 139 of 2023 on Qualifying Activities and Excluded Activities). These two decisions seek to clarify the application of the UAE corporate tax framework to UAE Free Zone businesses, and whether a taxable person qualifies to be treated as a Qualifying Free Zone Person (QFZP) under Article 18 of the UAE corporate tax law.
Where a taxpayer is classified as a QFZP, Article 3 of the UAE corporate tax law states that the QFZP would be subject to tax at 0% on its Qualifying Income, and at a 9% rate on non-Qualifying Income that it receives.
Cabinet Decision No. 55 states that Qualifying Income includes income streams that are derived from:
- Other Free Zone Persons
- Domestic and foreign-sourced income which is derived from conducting any of the Qualifying Activities
- Any other income (i.e., Excluded Activity) provided that it is below the De Minimis threshold.
Income from Free Zone Persons
In considering goods transactions that are provided to another Free Zone Person, the Free Zone Person recipient must be the beneficial owner of those goods (and not merely pass on these goods to another party).
Ministerial Decision No. 139 states that 'Qualifying Activities' have been defined to include the following types of income (Article 2(a)):
- Manufacturing of goods or materials
- Processing of goods or materials
- Holding of shares and other securities
- Ownership, management and operation of ships
- Reinsurance services that are subject to regulatory oversight of the competent authority in the UAE
- Fund management services that are subject to regulatory oversight of the competent authority in the UAE
- Wealth and investment management services that are subject to regulatory oversight of the competent authority in the UAE
- Headquarter services to related parties
- Treasury and financing services to related parties
- Financing and leasing of aircraft, including engines and rotable components
- 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 the purposes of sale or resale
- Logistics services
- Any activities that are ancillary to the activities listed above
In addition to the definition of Qualifying Activities, Excluded Activities are defined under Article 3 of Ministerial Decision No. 139.
Where income falls within Excluded Activities this will not be treated as Qualifying Income (irrespective of where this income is derived from). Excluded Activities include the following:
- Any transaction with a natural person (i.e., individual) except for those transactions (d), (f), (g) and (j) listed in Qualifying Activities
- Banking activities, insurance activities and finance and leasing activities that are subject to regulatory oversight in the UAE unless they are specifically permitted as a Qualifying Activity under Article 2(a)
- Ownership or exploitation of immovable property, other than commercial property that is located in a Free Zone where the transaction is with other Free Zone Persons
- Ownership or exploitation of intellectual property assets
- Any activities that are ancillary to the activities listed above
De Minimis threshold
A QFZP can earn income from (i) Excluded Activities or (ii) activities that are non-Qualifying Activities where the other party is a Non-Free Zone Person provided that this does not exceed the De Minimis threshold, being the lower of either (i) 5% of total revenue or (ii) AED 5 million.
For the purposes of determining this, income that is attributable to a domestic permanent establishment (e.g., a UAE mainland branch) or a foreign permanent establishment is not included in the calculation.
Where this De Minimis threshold is breached or the QFZP does not satisfy the eligibility conditions of Article 18 of the UAE corporate tax law, then the Free Zone Person will not be eligible to be treated as a QFZP for the current tax year and then the subsequent four (4) tax years.
The implication of this is that all of the Taxable Income of the Free Zone Person would be subject to 9% (on the Taxable Income that exceeds AED 375,000).
Requirement to maintain adequate substance
Article 18 of the UAE corporate tax law requires that, in order to be treated as a QFZP, the Free Zone Person has adequate substance in the UAE.
Article 7 of Cabinet Decision No. 55 states that a QFZP is required to perform its core income-generating activities in a Free Zone having regard to the activities carried out, have adequate assets and an adequate number of qualifying employees, and incur an adequate amount of operating expenditure.
It is possible for this substance requirement to be outsourced to a related party in a Free Zone or a third party in a Free Zone, provided that there is adequate supervision of the outsourced activity. Therefore, by definition, it would not be possible for these activities to be outsourced to a UAE mainland party.
This requirement is in line with the existing UAE economic substance regulations.
Audited financial statements
Article 5 of Ministerial Decision No. 139 confirms the requirement that if a Free Zone Person is seeking to be treated as a QFZP it is required to prepare audited financial statements for the tax year.
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