Decree-Law clarifies tax treatment of free zone businesses

The UAE has more than 40 free zones spread across the seven Emirates. For many years the benefit of establishing a company with 100% foreign ownership made setting up a presence in one of the free zones the number one option for doing business in the UAE.

Businesses operating in the free zones are typically permitted to do business in the same or other free zones or outside of the UAE and within the mainland through an agent or a distributor. As such, the concept of the free zone is actually one of “doing business from the UAE” rather than “doing business in the UAE.” Among the benefits of operating in a free zone are the 100% foreign ownership and full exemption from import/export taxes for goods within the free zone area. Many free zones also offer guarantees of exemption from income and corporate taxes.

The regulatory restrictions on free zone businesses transacting with the UAE mainland appear to be mirrored in the new corporate tax (CT) regime. The initial announcements on CT and the subsequent consultation paper indicated there would be relief from CT for free zone entities provided income did not come from non-free zone sources (for prior coverage, see the article in the May 2022 issue and the article in the February 2022 issue of Corporate Tax News). The CT Decree–Law issued on 9 December 2022 provides greater detail on how this relief will be applied.

BDO insight

The CT Decree–Law confirms that free-zone entities will be subject to CT at the zero-rate subject to certain conditions, as follows:

Maintaining adequate substance in the UAE – More clarity on this concept is expected in Regulations/Cabinet Decisions. The guidance from the existing economic substance regulations might indicate what will be required but at this stage, we should not assume the tests will be the same.
Earning Qualifying Income – Unfortunately, the Decree-Law does not give details of what is meant by “qualifying income.” This will be addressed in a Cabinet Decision, which is yet to be published. However, taking a cue from the public consultation paper, qualified income could be limited to income sourced from the same or other free zones or from outside the UAE. If the free zone business has both qualifying and non-qualifying income, the non-qualifying profits will be potentially liable to the 9% CT, subject to the normal rules.
Electing to be liable to CT – Free zone relief appears to be optional. Thus, subject to the regulatory allowances, free zone businesses can opt to be taxable. For example, free zone companies might elect to be liable to the normal CT rates in order to be eligible to join a tax group (which may be established under the new regime).
Complying with the Decree-Law requirements for transfer pricing – Along with the condition of establishing substance in the UAE, it will be necessary to have a transfer pricing policy and documentation to establish that transactions with UAE-based free zone-related businesses are carried out on arm’s length terms.
Other conditions – In addition to the above, the Decree-Law provides that the Minister can prescribe additional conditions.

If a qualifying person ceases to satisfy conditions at any time, they will be treated as ceasing to be a qualifying person from the beginning of that tax period.

Cabinet Decisions are expected to iron out the nuances of applying for a CT exemption, but an area that remains open is the impact of the OECD Pillar 2.0 proposals on UAE CT. As yet, there is no indication of how and when the UAE will implement the Pillar 2.0 proposals, which may result in some multinational corporations operating in the UAE being liable to a higher rate of CT. Therefore, it will be interesting to see how UAE free zone business will be treated from an OECD Pillar 2.0 perspective.

Ashish Athavale
Brian Conn
Mufaddal Safdari