04.06.2023
News
UAE Ministry of finance has published clarifications on the qualification of income of legal entities registered in free zones for income tax purposes

On June 1, 2023, the UAE Ministry of Finance issued 2 clarifications[1] regarding the application of corporate tax (hereinafter referred to as “corporate tax“) to the income of legal entities registered in UAE free zones, which clarified the conditions for applying a 0% tax rate to the income of these entities.

1. General provisions on corporate tax

On October 3, 2022, Federal Law No. 47 on the Taxation of Companies and Businesses (hereinafter referred to as “Law No. 47”) was enacted to apply the corporate tax to income earned by the following persons in tax periods beginning on June 1, 2023:

▪ legal entities registered in the UAE, including free zones;

▪ legal entities incorporated in other jurisdictions but managed from the UAE;

▪ individuals conducting business activities in the UAE.

If a person is not a UAE resident, he or she is considered a taxpayer if he or she has a permanent establishment in the UAE, including free zones (e.g., the person owns an office or business), or receives income from the UAE[2].

The object of taxation for residents is all profits derived by them from both UAE and non-UAE sources[3], while non-residents are required to pay tax solely on profits derived from UAE sources[4]. According to the Law No. 47, such profits are subject to tax at the following rates[5]:

▪ profits less than AED 375,000 are taxed at 0% rate;

▪ profits above AED 375,000 (~USD 102,000[6]) are taxed at the rate of 9%.

At the same time, a preferential tax regime is provided for legal entities and branches of non-residents registered in free zones, if they meet the following conditions:

▪ the person maintains a significant presence in the UAE (has sufficient assets, a sufficient number of qualifying employees and incurs sufficient operating expenses in conducting its business);

▪ the person receives qualifying income as specified in a resolution adopted by the Cabinet;

▪ the person has not voluntarily elected to be taxed by the corporate tax;

▪ the entity meets the requirements for related party transactions and complies with the reporting obligation.

If all the above requirements are met, a person registered in the free zone is entitled to apply the following rates of taxation to his income[7]:

▪ profits from qualifying income are taxed at a 0% rate;

▪ profits that do not fall under the criteria established for taxation at the 0% rate is taxed at the rate of 9%.

However, Law No. 47 did not establish criteria for classifying the income of persons registered in free zones as qualified income – the procedure for determining such income was introduced by recent clarifications issued by the UAE Cabinet of Ministers and Ministry of Finance.

 

2. Classification of income of persons registered in free zones for corporate tax purposes

According to the clarifications issued, qualifying income of persons registered in free zones which is subject to taxation at a 0% rate includes income:

▪ from transactions with other persons registered in free zones, except for income from non-qualifying activities. For example, if a resident of Meydan receives income from a resident of the Rakez free zone for providing logistics services, such income will be taxed at 0%. It should also be taken into account that residents of not all UAE free zones may apply the 0% tax rate, this issue is subject to clarification with the competent authority of the respective free zone;

▪ from transactions with persons registered outside free zones, provided that the income is derived from qualifying activities[8];

▪ any other income, subject to restrictions on the maximum amount of the share of income that does not meet the above criteria for applying the 0% rate in the total income of a person registered in the free zone. Currently, the amount of income not falling under the preferential treatment cannot exceed 5% of a person’s total income or AED 5,000,000 (~ USD 1,360,000[9]), whichever is less.

For the purposes of the provisions described above, the UAE Ministry of Finance has introduced the following distinction between qualifying and non-qualifying activities[10]:

 

Qualifying activitiesNon-qualifying activities
1.       Production and processing of goods or materials;

2.       Ownership of shares and other securities;

3.       Ownership, management and operation of vessels;

4.       Financial services (reinsurance services; fund management; capital and investment management);

5.       Logistics services;

6.       Aircraft financing and leasing; etc.

1.         Transactions with individuals (with exceptions, explicitly provided for in the clarifications);

2.         Banking activities;

3.         Insurance and leasing activities (with exceptions);

4.         Possession or use of intellectual property; etc.

 

It should be borne in mind that the clarifications of the Cabinet of Ministers and the UAE Ministry of Finance also provide for a number of general exemptions by virtue of which the special tax regime does not apply in particular:

▪ to the income from transactions in real estate located in the free zone in: (i) transactions with non-resident persons of the free zone (in respect of commercial real estate) and (ii) transactions with any person (in respect of non-commercial real estate) – such gain is taxed at a rate of 9%;

▪ income from permanent establishments in the UAE outside the free zone or outside the UAE – such income is also taxed at the rate of 9%;

▪ to the income of a person registered in the free zone as a whole, if the income that does not belong to the categories of income subject to taxation at 0% rate exceeds 5% of the total income of the person registered in the free zone or AED 5,000,000 (~ USD 1,360,000[11]), whichever is less. In such a case, the person loses the right to apply the rate of 0% in the tax period in which the above thresholds were exceeded, as well as in the 4 following tax periods, and during such period its profits are subject to corporate tax under the general procedure.

 

This material is for reference only and does not constitute advice or legal opinion. If you have any questions regarding this communication, please contact us at partners@whitesquarepartners.com.

[1] Cabinet Decision No. 55 of 2023 on the Definition of Qualifying Income for a Qualifying Person of a Free Zone, Ministry of Finance Order No. 139 of 2023 on Qualifying Activities and Non-Qualifying Activities.
[2] Part 4 of art. 11 of Law No. 47.
[3] Part 1 of art.12 of Law No. 47.
[4] Part 3 of art. 12 of Law No. 47.
[5] Part 1 of art. 3 of Law No. 47.
[6] At the exchange rate of the Central Bank of the UAE on June 2, 2023.
[7] Part 1 of art. 3 of Law No. 47.
[8] Art. 2 of Order No. 139 of the UAE Ministry of Finance.
[9] At the exchange rate of the Central Bank of the UAE on June 2, 2023.
[10] The full list of activities is given in art. 2 – 3 of the Order of the Ministry of Finance No. 139.
[11] At the exchange rate of the Central Bank of the UAE on June 2, 2023.