The United Arab Emirates (UAE) will impose a 9% corporate tax on companies operating within its borders beginning on June 1 of 2023. Companies with profits over AED 375,000 are the target of this tax. While Free Zone companies are initially exempt from this tax, certain conditions must be met to maintain this exemption. However, it is crucial for Free Zone entities to thoroughly understand the fine print of these conditions, as corporate tax may potentially apply to them, and the scope and effective tax rate might exceed the 9% threshold due to various factors such as domestic conditions on supplies, cross-border taxation, transfer pricing, and adherence to OECD guidelines.
Free Zones, Significant Aspect of the UAE Economy:-
Having a vital role in the UAE economy, Free Zones are driving worldwide business activities by offering a range of encouragement such as foreign ownership with hundred percent rights, customs duty free, exemptions on qualifying income and VAT exemptions, repatriation of profits and capital, And many more incentives. The introduction of corporate taxation aligns with the UAE Government’s economic reform agenda, as tax exemptions provided to Free Zones act as a multiplier for economic growth, subject to meeting certain conditions.
Conditions for Tax Exemption in Free Zones:-
To enjoy tax exemptions, Free Zone entities must adhere to specific criteria such as Mandatory maintenance of a satisfactory monetary substance, compliance with regulatory prerequisites of the specific jurisdiction in which Free Zones fall by ensuring valid audit of their financial books/records, and last but not the least to refrain from acquiring earnings from Mainland bodies or to get service earnings from other Free Zones.
Withholding Tax Implications on Permanent Establishment
Zero percent withholding is imposed on the transactions between a Permanent Establishment of Free Zones while doing business through Mainland incorporated bodies. The factor, in the opinion of experts, will significantly affect how business operates in the UAE. “A company’s fixed location where it conducts all or some of its business operations in the United Arab Emirates is known as a Permanent Establishment”.With the introduction of corporate taxation, Free Zones need to be cautious about the potential establishment of such a presence, as it may subject them to taxes beyond the 9% threshold.The imposition of a zero percent withholding tax on payments has significant importance for businesses operating between Mainland entities and Free Zones entities. It allows for seamless financial transactions and encourages business growth. However, it is essential to note that any changes to these regulations in the future could impact the overall tax implications for Free Zone entities.
Economic Substance Regulations
With regard to the Economic Substance Regulations (ESR), in particular, the requirements for tax exemption in free zones may be in conflict with other existing laws. The ESR was instituted by the UAE to stop multinational corporations from artificially shifting profits to countries with low or no income taxes, without there being a significant amount of economic activity in those countries. If corporate taxes are implemented, it is still unknown if the ESR of the UAE will change.
- Economic Substance In the UAE:- The ESR requires entities to demonstrate an adequate level of economic substance in the UAE by conducting core income-generating activities. This requirement ensures that businesses have a genuine presence and economic activity in the UAE rather than using the country as a mere tax haven.
- Application on branches and Freezone gain:- The ESR might still be applicable to UAE branches and entities that gain from free zone incentive programs. The ESR, however, might phase out for those entities over time as they become subject to the 9% corporate tax. In order to avoid paying Mainland company taxes, Free Zone operations may need to change how they generate revenue, grant employee visas, and use their assets.
Restructuring and Anti-Abuse Provisions:
The timing, manner, and extent of restructuring efforts, in conjunction with the antiman abuse provisions outlined in the proposed tax law, will determine the feasibility and impact of corporate taxes and other compliance requirements. Free Zone entities that want to give up their corporate tax exemption can choose to join a tax group and be subject to regular corporate taxation in exchange for the possibility of offsetting group-company losses and more simplified management of tax compliance.
It is important for Free Zone entities to seek professional advice from tax experts and consultants who have a deep understanding of the local tax regulations and their implications. These professionals can assist in developing a comprehensive restructuring plan that aligns with the business goals and objectives while ensuring compliance with the tax laws.
In conclusion, the UAE’s Free Zones now levy corporate taxes, signaling a significant change in corporate tax legislation. While Free Zone entities initially enjoy tax exemptions, they must be vigilant in understanding the conditions and potential implications of corporate tax. The interplay between tax regulations, such as the Economic Substance Regulations, and the available restructuring options should be carefully navigated to ensure ongoing compliance and minimize the tax burden. By proactively assessing their operations, revenue streams, employee visas, and asset utilization, Free Zone entities can adapt to the changing tax environment and continue to thrive in the UAE’s dynamic business ecosystem.
- “Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations ….” https://mof.gov.ae/wp-content/uploads/2022/12/Federal-Decree-Law-No.-47-of-2022-EN.pdf. Accessed 2 July. 2023.
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