Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (‘CT Law’) provides, for Free Zone Persons (‘FZP’) that are Qualifying Free Zone Persons (‘QFZP’), a Corporate Tax rate of 0% on ‘Qualifying Income’ and 9% on ‘Taxable Income’ that is not ‘Qualifying Income’.
To provide further clarity with regard to items/issues that were subject to further Guidance as per the CT Law provisions, Cabinet Decision No. 100 of 2023 and Ministerial Decision No. 265 of 2023 were issued. These two Decisions dealt with topics such as ‘Qualifying Activities’, ‘Excluded Activities’, ‘De-minimis’ requirement test, preparation of audited financial statements etc.
While these Decisions provided additional guidance on the applicability of the Free Zone regime, various topics still needed more clarity and guidance as they were open/subject to interpretation. Now, the Federal Tax Authority (‘FTA’) has released a much-awaited Corporate Tax Guide – CTGFZP1 on Free Zone Persons (‘FZP Guide’ or ‘the Guide’) to provide general guidance on the application of CT Law to QFZP.
High-level summary of the FZP Guide
In the FZP Guide, the FTA, by way of multiple examples, has clarified the following matters:
- Substance-related requirements: To maintain adequate substance in a Free Zone/Designated Zone, the FZP is required to undertake its core income-generating activities for that business in the Free Zone/Designated Zone. In addition, it is required that the QFZP maintains adequate assets and qualified full-time employees and incurs an adequate amount of operating expenditure. In this regard, it should be noted that this has been illustrated in the FZP Guide with the help of examples. It is also specified that an evaluation needs to be conducted on a case-to-case basis for each situation, taking into account all facts and circumstances.
- Requirements to be a QFZP: The prescribed conditions such as being the ‘Beneficial recipient’, how to segregate revenue to determine what is considered as ‘Non-qualifying Revenue’ for the ‘De-minimis’ requirements, or the status during the startup phase, are discussed and clarified in detail.
- Permanent Establishment (‘PE’): The FZP Guide also deals with segregation/separation of the Domestic PE and Foreign PE from the QFZP regarding the separation of activities, output transferred to Domestic PE etc. along with the conditions in which a QFZP creates a PE.
- Immovable property: The FZP Guide covers detailed examples of mixed-use immovable property located in the Free Zone for computing ‘Qualifying Income’ and ‘Taxable Income’.
- Qualifying Intellectual Property: To benefit from the 0% Corporate Tax Rate on the ‘Qualifying Income’ obtained from the exploitation or ownership of ‘Qualifying Intellectual Property’, a QFZP must be able to demonstrate a nexus between ‘Qualifying Expenditures’ and the income from ‘Qualifying Intellectual Property’. The FZP Guide provides the tracking systems to demonstrate nexus. In addition, clarity is provided on the calculation of ‘Qualifying Income’ from Intellectual Property with examples on uplift expenditures and the ‘Qualifying Intellectual Property’ formula.
- Qualifying Activities:
- The Guide has elaborated on the scope of each of the ‘Qualifying Activities’ and ‘Excluded Activities’ as listed in the Ministerial Decision No. 265 of 2023 with detailed examples of each of the Activities.
- Major clarifications have been provided in connection to the physical entry of goods into the Designated Zones for Distribution activities. The requirement for distributed goods to enter a Designated Zone only applies to the distribution of foreign goods to customers located in the UAE and outside a Designated Zone. Further, it is clarified that the ‘high-sea sales model’ is also considered as meeting the conditions to be a distribution activity (for ‘Qualifying Activity’ purposes) even if the goods are not introduced into the UAE and are directly shipped from an overseas supplier to a client (reseller/distributor) that is also based in another jurisdiction.
- The scope of ‘Ancillary’ activities is defined in detail to cover activities that are there to support the core-income generating activity or it is an activity that makes a minor contribution to the main activity but is so closely related to the main one.
- Losing status of QFZP: In case the conditions are not fulfilled—or cease to be fulfilled during any relevant tax period, the QFZP person shall be considered as a QFZP that has failed to meet the criteria to benefit from the QFZP regime. It would cease to be a QFZP from the beginning of the relevant tax period in which the conditions are not cumulatively met and for the later four tax periods.
- Election period: The Guide provides clarity and comments for the effects of an election to be subject to standard Corporate Tax rules as the rest of Taxable Persons that are subject to the headline rate by an FZP that might qualify as a QFZP.
- Computation mechanism: Further, the Guide also provides clarity for the computation mechanism in order to determine the ‘Taxable Income’ and tax liability of a QFZP. Compliance requirements to be met by a QFZP are noted in the FZP Guide.
It is important to note that this FZP Guide is not a legally binding document but is intended to assist in the understanding of the tax implications arising from the CT regime applicable to a QFZP.
A detailed Tax Flash will be released in due course covering major clarifications and will provide further insight .
Next steps
All FZPs should now ascertain in light of the additional guidance provided in the FZP Guide whether they can claim the benefit of the QFZP regime. This might require revisiting the existing positions adopted based on the Cabinet and Ministerial Decisions issued. In case of doubts or ambiguity regarding the business model or other activities performed, the FZP should identify potential measures that can be adopted to utilize the benefit of the FZP regime.
KPMG has a dedicated team to help your business understand the impact of CT in the UAE.