The introduction of Corporate tax was a significant step in the United Arab Emirates, marking a big shift in how businesses are taxed across the country. Companies with profits above AED 375,000 are taxed at 9%, and 0% on profits up to that amount. However, businesses based in Free zones can still benefit from a 0% tax rate if they meet the requirements of Qualifying Free Zone Persons.
When a Free Zone entity meets certain conditions, such as engaging in the right kind of activities, maintaining proper offices and operations in the UAE, and following appropriate rules while dealing with related companies, it qualifies as a Qualifying Free Zone Person in the UAE and hence, can benefit from zero corporate tax on its qualifying income. Nevertheless, it comes with strict compliance requirements. Entities that fail to meet these conditions can lose their tax benefits for the next five years.
Through this article, we will try and understand what Qualifying Free Zone Persons actually are, what types of income qualify under UAE corporate tax, and how to ensure that the business stays compliant and tax-efficient in the UAE.
Understanding the Mainland and Free Zone in the UAE
Entrepreneurs planning a business setup in the UAE can choose between the mainland and a free zone. However, the choice mainly depends on the nature of the business, the target market, and other specific business needs.
- Mainland: This region is overseen by the Department of Economic Development (DED), which allows businesses to trade freely across the UAE and internationally. With the recent amendments in Federal law in the UAE, foreign investors can now own up to 100% of their mainland company in specific sectors, with exceptions in regulated sectors like finance, banking, and insurance, that still require mandatory shareholding by Emirati partners. Mainland entities with taxable income exceeding AED 375,000 are legally required to pay a 9% tax and file tax returns regularly.
- Free Zones: These areas are also known as free trade zones, where businesses are registered with the respective Free Zone Authority. These zones offer 100% foreign ownership, with a key focus on specific industries like trading, logistics, manufacturing, technology, etc. Unlike the Mainland, Free zone companies are restricted from trading directly with the local market without a local distributor. However, they can trade within the designated zone and internationally. Qualifying free zone businesses are exempt from paying any kind of corporate tax.
Qualifying Free Zone Person: Explained
Article 18 of the Corporate Tax Law outlines the requirements that need to be fulfilled to qualify as a Qualifying Free Zone Person –
- Registration with a Free Zone Authority in the UAE: Businesses must establish a significant presence in the UAE and register with a Free Zone Authority to get recognized as a legitimate entity that is subject to the regulations and benefits of that particular zone.
- Participation in Qualifying Activities and Earning Qualifying Income: The company must be engaged in qualifying activities and earn qualifying income, as specified by the Corporate Tax law in the UAE.
- Compliance with the UAE’s Transfer Pricing Regulations: Businesses must adhere to the transfer pricing regulations in the UAE as specified in Articles 34 and 55 of the Federal Decree Law No. 47 of 2022, to ensure that transactions between related entities are conducted at fair market value and tax evasion is prevented.
Businesses that fail to meet any of the above conditions during the tax period will lose the special tax status from the beginning of the year. However, under certain exceptions, the Minister can decide the conditions under which the company can maintain its special status.
What is Qualifying Income?
Qualifying Free Zone Persons can benefit from a 0% corporate tax rate on their income earned from qualifying business activities conducted within the designated zone. Cabinet Decision No. 55 of 2023 specifies the criteria for the qualifying income:
- Transactions with Other Free Zone Persons: Income earned from transactions with other Free Zone entities, excluding any income from activities designated as ‘excluded activities.’
- Transactions with Non-Free Zone Persons: Income earned from transactions with mainland companies, only if the activities meet the rules and are not classified as excluded activities. There is a de minimis threshold, which is a minor portion of the overall earnings.
- De Minimis Requirements: The permitted level of income that the business can generate as a Qualifying Free Zone Person from non-qualifying activities. The specific thresholds and calculations are determined by the relevant authorities.
Qualifying Income for Permanent Establishments (PEs)
If a QFZP business has a significant operational presence outside the Free Zone, it will be considered a ‘permanent establishment’ (PE). Hence, income generated by the establishment would be subject to the 9% corporate tax.
Qualifying Income for Immovable Property located in a Free Zone
Income earned from renting out a commercial property located within the Free Zone will be considered qualifying income, except for the revenue earned from renting to non-Free Zone businesses for commercial purposes.
Qualifying vs Non-Qualifying activities in the UAE
Let’s have a quick look at the activities that are considered qualifying and the ones that are excluded under UAE law -
1. Qualifying Activities
Ministerial Decision No. 139 of 2023 classifies these activities and any direct ancillary activities as qualifying:
- Manufacturing or processing goods
- Holding shares or securities (for investment)
- Operating and managing ships in international transportation
- Financing/leasing aircraft engines and components
- Treasury and financing services to related parties
- Headquarters services provided to related parties
- Fund, wealth, and investment management
- Reinsurance services
- Logistics services
- Distribution of goods in or from a Designated Zone
- Ancillary activities like storage, packaging, or installation related to the above.
2. Non-Qualifying Activities
The following activities and any income derived from them are considered non-qualifying:
- Transactions with natural persons, unless part of allowed activities such as ship operation, aircraft leasing, or wealth management.
- Banking, insurance, finance/leasing services (unless specific exceptions apply)
- Ownership or use of immovable property, except commercial property within Free Zones, sold/leased to other FZPs
- Intellectual property income (unless qualifying)
- Ancillary services for excluded activities, such as the maintenance of property
Income derived from the mainland or foreign permanent establishment of Qualifying Free Zone Persons is not treated as qualifying income, and hence will be taxed separately at 9%.
Registration and filing requirements for Qualifying Free Zone Persons
Corporate tax registration is mandatory for all entities operating in the Free Zone, including QFZPs. Businesses must register via the EmaraTax portal and obtain a Tax Registration Number (TRN).
1. Deadline:
- Businesses incorporated after March 1, 2025: Register within 90 days of establishment
- Businesses incorporated before March 1, 2025: Varying deadlines, typically 3 months from the date of issuance of the license.
2. Tax Return & Disclosure Obligations:
Businesses must file annual returns within 9 months of the end of the financial year, even if no tax is payable. Additional requirements include:
- Separated qualifying vs non-qualifying income
- Statement of average full-time employees, operating expenses, economic substance, and outsourced activities
- Audited financial statements prepared under IFRS
- Transfer pricing documentation and disclosures
- All relevant records and supporting documents, such as financials, audits, TP files, and substance documentation, for a minimum of 7 years.
Failing to comply with the above requirements can cause loss of QFZP status in the UAE, leading the business to pay tax at 9% for the next 5 years.
Seek professional assistance from our tax experts
Being a qualifying free zone person gives businesses a big advantage. However, it comes with a specific set of rules. The process can get a bit tricky, especially with keeping proper records, filing tax returns, and following transfer pricing rules. Therefore, it is always better to seek expert help from our tax agents who can confirm whether you qualify as a QFZP and help you with corporate tax registration and tax return filing, thereby ensuring that your business stays fully compliant and avoids penalties.
If you need help managing tax rules, get in touch with our tax advisors today.
