The UAE recently introduced a Corporate Tax regime, effective June 1, 2023. Under this regime, Free Zone companies have the opportunity to be exempt from Corporate Tax if they meet specific conditions and earn Qualifying Income. This new tax system applies to all businesses and commercial activities in the UAE, with exceptions for personal income from employment, investment, and real estate. Free Zone corporate tax regime enables the legal entities i.e. corporations/companies and branches, incorporated within a designed free zone, including non-branch residents to avail the corporate tax relief at zero percent preferential rate on income from transactions and qualifying activities.

Recently, Ministerial Decisions No. 55 and 139 of 2023 shed light on the concept of “Qualified Income” for Free Zone Persons, offering clarity on which income will be subject to a favorable tax rate of 0%, and which income may disqualify them from claiming this tax benefit. The key aspects of this corporate tax regime for such entities are outlined by the ministerial decisions and are mentioned as follows:

• Qualifying Income: A zero percent corporate tax rate applies to the qualifying income of a qualifying free zone person. Qualifying income refers to the income necessary for a free zone person to be eligible as a qualifying free zone person, and it is taxed at zero percent.
• Non-Qualifying Income: All other income earned by a qualifying free zone person is subject to a nine percent tax unless the income is exempt or falls outside the scope of taxation.
• Qualifying Free Zone Person: The free zone qualifying person is a legal entity registered with the designated Free Zone areas by satisfying the criteria which are mandatory to avail the benefits of the Free Zone Corporate Tax regime.
• Qualifying Activities: The Free Zone Corporate Tax regime applies exclusively to income derived from activities performed within a Free Zone. Income from activities conducted outside the Free Zone is not eligible for the zero percent tax rate.
• Electing Taxation: A qualifying free zone person has the option to elect for taxation at the nine percent rate. However, once this election is made, they cannot revert to the zero percent tax rate for their qualifying income.

Eligibility Criteria For Qualifying Free Zone Person:- 

To qualify as a Free Zone Person in the UAE, a business entity must fulfill the following eligibility criteria:

• Maintain Sufficient Substance in the UAE: The business entity must establish a physical presence in the UAE, such as an office or warehouse, and conduct its business activities from within the country.
• Earning Qualifying Income: The business must generate qualifying income to be eligible for the 0% tax rate.
• Opting-In to Free Zone Tax Regime: The entity should not have elected to opt out of the free zone tax regime.
• Compliance with Transfer Pricing Rules and Documentation: The business should adhere to transfer pricing rules and maintain appropriate documentation.

Advantages of Free Zone Corporate Tax system For Qualifying Business:-

For businesses to benefit from the tax exemption, they must determine their tax status, whether they qualify as an exempt entity, a qualifying free zone person, or are subject to the standard Corporate Tax. Qualifying Free Zone Persons can enjoy a favorable 0% Corporate Tax rate but are required to maintain a substantial presence in the UAE, generate Qualifying Income, refrain from electing standard tax rates, and adhere to transfer pricing requirements.

Here are the key benefits:

• Zero Percent Corporate Tax: Qualifying free zone companies enjoy a zero percent corporate tax rate on income generated from transactions with individuals or entities. This means that their qualifying income remains tax-free.
• Tax Exemption: Businesses operating in free zones are exempt from the standard corporate tax rate of nine percent on their qualifying income. This exemption provides a significant cost advantage, fostering a favorable business environment.
• Attractiveness for Foreign Investors: With 100% foreign ownership and full exemption from import/export taxes within the free zone area, free zones become highly appealing to foreign investors. The Free Zone Corporate Tax regime further enhances this attractiveness by offering additional tax benefits.
• Flexibility in Business Operations: Free zone businesses enjoy the flexibility to conduct operations within the same or other free zones and outside of the UAE through agents or distributors. This flexibility empowers businesses to expand their reach and explore new markets.
• Ease of Compliance: The Free Zone Corporate Tax regime provides clear and comprehensive guidelines on the tax treatment of free zone businesses. 

What are the Effects of Non-compliance:- 

To maintain their status as a Qualifying Free Zone Person in the UAE and benefit from the 0% preferential Corporate Tax rate on their Qualifying Income, businesses must meet the specific eligibility requirements. If they fail to meet these conditions, they will lose their tax benefits and become subject to the standard Corporate Tax rate of 9% on all income, including their Qualifying Income. It is essential for businesses to ensure ongoing compliance with the qualifying criteria to retain their privileged tax status and enjoy the tax advantages offered by the Free Zone Corporate Tax regime.

Free Zone Corporate Tax regime is a new taxation framework that offers Corporate tax at 0% to qualifying free zone persons in the UAE while the free zones offer businesses attractive incentives, including 100% foreign ownership and exemption from corporate taxes on qualifying income. To maintain this preferential tax status, businesses must meet specific conditions. If they fail to meet the criteria or opt for the standard tax regime, they will be subject to the regular corporate tax rates.

Hina N. Chaudhry

Hina Chaudhry is a law graduate with a deep understanding, knowledge and expertise of complex legal issues. She is providing exceptional legal services to clients, navigating intricate legal matters precision and clarity with deep interest in evolving laws and regulations. She is inspiring other women to pursue careers in law and break down barriers that hinder gender equality in the legal arena. She has keen attention to detail and strong analytical skills adapting at thoroughly researching and presenting persuasive arguments. She has experienced in providing sound legal advice and representing clients in various legal proceedings. She has a unique perspective and approach to the table. She is dedicated to advocating for justice, fairness, and equality. She is determined to use her legal knowledge to make a positive impact in the lives of her clients and within the legal community as a whole.