1. Background
The Client is currently engaged in the business of trading and export of trading of products from India to international markets. The Client intends to relocate or expand its trading operations to the United Arab Emirates (UAE) by establishing a company within a UAE Free Zone.
The objective of this restructuring is to take advantage of the UAE Corporate Tax (CT) regime, particularly the 0% Corporate Tax rate available to Qualifying Free Zone Persons (QFZPs) on Qualifying Income, subject to the satisfaction of certain statutory conditions under the UAE Corporate Tax Law (Federal Decree-Law No. 47 of 2022) and related Cabinet Decisions.
It is important to note that merely establishing a company in a Free Zone does not automatically grant the 0% Corporate Tax benefit. The company must be structured and operated in compliance with the conditions applicable to a Qualifying Free Zone Person.
Eligibility in Corporate Tax Law to attract 0% Corporate tax
According to Corporate tax (CT) law of UAE, qualifying income of the qualifying free zones shall be subject to 0% CT, whereas non-qualifying income shall attract CT at a regular rate of 9%. Accordingly, the qualifying income of the Qualifying Free Zone Person shall be subject to 0% CT, whereas non- qualifying free zones person shall be subject to 9% CT.
Therefore, as per the above provisions, to attract 0% Corporate Tax, Client needs to ensure that he is a qualifying freezone person who earns Qualifying Income in Qualifying Freezone .
As you can understand, that 5 conditions need to be satisfied to attract 0% Corporate Tax in UAE:
- Client needs to ensure that he is a qualifying freezone person
- Client earns Qualifying Income
- Arm’s length Pricing & Transfer pricing Provisions
- Qualifying Free zone person does not opt for normal Corporate tax regime
- Other Conditions
Now, let’s analyse each condition in detail to understand how client can attract 0% Corporate Tax by qualifying above conditions. Please note that opening a Company in UAE does not automatically attract 0% CT.
Structuring of the Company has to be done in such a way that it qualifies to be qualifying freezone person.
1. Condition 1: Client needs to ensure that he is a qualifying freezone person.
Free Zone person shall qualify only if it has adequate substance in the Free zone.
Following 4 aspects need to be evaluated to have adequate substance in Freezone:
1) Core income-generating activity
It means a freezone person must undertake core income generating activity in Freezone only .In our case, we advised client to conduct all then activities in Freezone only.
2) Employees
Free zone should employee sufficient number of employees in the Freezone who are physically present in client’s office in Freezone. That means to undertake activities like admin, marketing, finance, they need to have sufficient employees.
3) Assets
To establish the substance, the client needs to have adequate physical assets in the Freezone are. In our case, since it is a trading business, clients needs to have laptops, telephones, warehouse etc to substantiate the assets in Freezone
4) Operating Expenditure-
Freezone person (client) needs to incur operating expenditure in Freezone to run business in Free zone. Expenses like payroll, sales commissions, rent, transportation, internet expenses etc needs to be incurred in Freezone to run the business.
As it can be analysed from above aspects, that the business should properly run from the freezone. Opening a Company in Freezone & running on the paper won’t work to qualify as Freezone person. Adequate substance needs to be proved to qualify it.
2. Condition 2 Client should be earning Qualifying Income from qualifying activities:
a. Manufacturing of goods or materials.
b. Processing of goods or materials.
c. Trading of Qualifying Commodities.
d. Holding of shares and other securities for investment purposes.
e. Ownership, management and operation of Ships.
f. Reinsurance services.
g. Fund management services.
h. Wealth and investment management services.
i. Treasury and financing services to Related Parties or for its own account.
j. Financing and leasing of Aircrafts.
k. Distribution of goods or materials in or from a Designated Zone.
l. Logistics services.
m. Headquarter services to Related Parties.
Income earned from above qualifying activities qualify as Qualifying Income.
Excluded activities cannot be treated as Qualifying Income
These include:
- Banking activities
- Insurance activities
- Finance and leasing to non-related parties
- Ownership or exploitation of immovable property (except certain cases)
- Intellectual property income
If the company earns income from excluded activities, it cannot be treated as Qualifying Income.
Application of the above law to the Client
In our case, since our client is engaged in distribution of goods. It qualify as Qualifying Income.
Distribution income qualifies only if goods are:
- Purchased from a foreign entity
- Sold to another foreign entity
- or sold within a Designated Free Zone
3. Condition 3 Arm’s length Pricing & Transfer pricing Provisions
Freezone require to adhere that all transactions with related parties within & outside UAE should be at Arm’s length Price & Transfer Pricing Documentation & study is prepared providing disclosure of transaction with related parties & connected persons.
We’ll be preparing a Transfer Pricing study for the client & benchmarking is done to ensure that transaction occur at Arm’s length Price.
4. Condition 4 Not subject to Corporate Tax
Freezone Person should not elect to subject to “Corporate tax’ To remain a Qualifying Freezone person
5. Condition 5 Other Conditions
a. De Minimis Requirement
The de minimis requirement allows a QFZP to pay 0 percent tax if their non-qualifying income in a tax period:
- doesn’t exceed 5 per cent of total revenue or
- AED 5 million, whichever is lower.
This means a free zone company can still earn some income from excluded activities and non- qualifying sources without losing its QFZP status, as long as it stays within these limits.
This is one of the most important condition as Companies should proactively monitor their revenues as even a slight change in percentage of non-qualifying income can make the client lose it Qualifying free zone person & attract 9% Corporate Tax on the total revenue.
b. Prepare Audited Financial Statements in accordance with IFRS
Conclusion: If the company qualifies as a Qualifying Free Zone Person and derives Qualifying Income from permitted activities while complying with substance requirements, transfer pricing rules, and the de minimis threshold, the income may be subject to 0% UAE Corporate Tax under the Free Zone regime. However, failure to satisfy these conditions may result in the company being taxed at the standard 9% Corporate Tax rate.
With appropriate structuring and operational alignment, the proposed UAE entity may be able to efficiently conduct international trading operations while benefiting from the UAE’s favorable Corporate Tax regime.
CA Vidhu Duggal
www.vidhuduggalandco.com | vidhu@vidhuduggalandco.com | Profile
