UAE Ministry of Finance Clarifies Definition of Qualifying Income for Free Zone Entities
Further to the UAE’s issuance of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses (CT Law), which applies with effect from 1 June 2023, the UAE Ministry of Finance has provided clarity on the taxable status of UAE Free Zone Persons.
Cabinet Decision No.55 of 2023 on Determining Qualifying Income (the Qualifying Income Decision), and Ministerial Decision No.139 of 2023 on Qualifying Activities and Excluded Activities (the Qualifying Activities Decision), both of which are relevant and applicable to UAE Free Zone Persons, clarify which Free Zone Persons may be eligible to claim qualifying income as zero rated (Qualifying Free Zone Person), and what income falls within that category (Qualifying Income).
Prior to the issuance of the Qualifying Income Decision and Qualifying Activities Decision, the CT Law prescribed that a Free Zone Person, which meets the conditions required to be considered a Qualifying Free Zone Person, can benefit from a corporate tax rate of 0% on their Qualifying Income. In assessing income that would be considered “Qualifying Income”, we note that Article 3 of Cabinet Decision No. 55 states that Qualifying Income of the Qualifying Free Zone Personal shall include:
- Income derived from transactions with other Free Zone Persons, except for income derived from Excluded Activities (further defined below);
- Income derived from transactions with a Non-Free Zone Person, but only in respect of Qualifying Activities that are not Excluded Activities; and
- Any other income provided that the Qualifying Free Zone Person satisfies De Minimis Requirement threshold.
Article 2(a) of the Qualifying Activities Decision defines ‘Qualifying Activities’ to include the following:
a) Manufacturing of goods or materials;
b) Processing of goods or materials;
c) Holding of shares and other securities;
d) Ownership, management and operation of ships;
e) Reinsurance services that are subject to regulatory oversight of the competent authority in the UAE;
f) Fund management services that are subject to regulatory oversight of the competent authority in the UAE;
g) Wealth and investment management services that are subject to regulatory oversight of the competent authority in the UAE;
h) Headquarter services to related parties;
i) Treasury and financing services to related parties;
j) Financing and leasing of aircraft, including engines and rotable components;
k) Distribution of goods or materials in or from a Designated Zone to a customer that resells such goods or materials, or parts thereof or processes or alters such goods or materials or parts thereof for the purposes of sale or resale;*
l) Logistics services; and
m) Any activities that are ancillary to the activities listed above.**
*The activity of distribution goods or materials must be undertaken in or from a designated Free Zone and the goods or materials entering the UAE must be imported through a designated Free Zone.
**An activity shall be considered ancillary where it serves no independent function but is necessary for the performance of the main Qualifying Activity.
Article 3 of Qualifying Activities Decision also outlines a list of ‘Excluded Activities’. Income generated from Excluded Activities will be subject to 9% tax (on the taxable income that exceeds AED 375,000), subject to the income exceeding the De Minimis Threshold (defined below). Excluded Activities include:
a) Any transactions with natural persons, except transactions in relation to the Qualifying Activities specified under paragraphs (d), (f), (g) and (j) of Article 2 of Qualifying Activities Decision;
b) Banking activities that are subject to the regulatory oversight of the competent authority in the UAE;
c) Insurance activities that are subject to the regulatory oversight of the competent authority in the UAE, other than the activity specified under paragraph (e) of Article 2 of Qualifying Activities Decision;
d) Finance and leasing activities that are subject to the regulatory oversight of the competent authority in the UAE, other than those specified under paragraphs (i) and (j) of of Article 2 of Qualifying Activities Decision;
e) Ownership or exploitation of immovable property, other than commercial property located in a Free Zone where the transaction in respect of such commercial property is conducted with other Free Zone Persons;
f) Ownership or exploitation of intellectual property assets; and
g) Any activities that are ancillary to the activities listed in paragraphs (a) to (f) above.
According to Article 4 of the Qualifying Income Decision, a De Minimis Threshold will be considered when a Qualified Free Zone Person earns income from: (i) Excluded Activities or (ii) activities that are not Qualifying Activities where the other party to the transaction is a Non-Free Zone Person (Non-Qualifying Revenue). If the Non-Qualifying Revenue of a Qualifying Free Zone Person which exceeds the lower of the following De Minimis Thresholds in a relevant tax period, the Free Zone Person shall cease to be Qualifying Free Zone Person:
- 5% of total revenue ; or
- AED 5 million revenue.
If a Free Zone Person exceeds the De Minimis Threshold, it shall lose its Qualifying Free Person Zone status in the current tax period and for four subsequent tax periods, and will be subject to 9% on all taxable income that exceeds AED 375,000.