The Federal Tax Authority (FTA) of the UAE has recently released the free zone persons’ guide, which greatly improves users’ understanding about the application of corporate tax on free zone businesses. This guide addresses multiple key points and incorporates a range of examples and illustrations.
Sections one, two, and three of the guide delve into the glossary, introduction, and overview, offering insights into the terms used, the guide’s objective, and its comprehensive content. Section 12 outlines the responsibilities of qualifying free zone persons (QFZPs), encompassing registration, financial statement preparation, auditing, tax return submission, payment, and the maintenance of records for seven years to prevent penalties. Section 13 is dedicated to the update and amendment history.
Section four outlines the criteria for becoming a QFZP, consisting of six specific requirements. A free zone person is considered a QFZP by default unless one of the conditions for QFZP status is not fulfilled, or if the QFZP chooses to be subject to tax.
Users were seeking clarification on the beneficial recipient criteria for transactions with other free zone persons to qualify for zero-rated status, which has been elaborated upon with detailed explanations and examples. Another key area of interest in this section is the categorization of revenue into out-of-scope, exempt, standard-rated (nine per cent), total revenue, non-qualifying revenue, and qualifying revenue, providing valuable guidance for calculating the de-minimus percentage.
Calculating Corporate Tax
Section five offers instructions on calculating corporate tax for QFZPs. Revenue earned by a QFZP can fall into different categories, as mentioned above. The guide emphasises that separate financial statements are not required for each revenue category. Instead, within a single financial statement, revenue should be segmented, expenses should be allocated using the appropriate allocation keys, and taxable income to be calculated following the general rules outlined in Article 20 of the law.
Section six addresses the adequate substance requirements for QFZPs conducting qualifying activities that generate qualifying income within the free zone or designated zone, particularly in distribution businesses. Core income-generating activities can be outsourced to other free zone persons, other designated zone persons in distribution businesses, any other person within the UAE, and unrelated parties outside the UAE for qualifying intellectual property businesses, provided there is adequate supervision. This requirement of adequate substance must be consistently upheld, and it has been explained with relevant examples.
Section seven elaborates on domestic and foreign permanent establishments (PE), clarifying that the income of both types of PE is directly taxed at nine per cent, and it should not be included in the de-minimum calculation. For foreign PEs, the QFZP may seek an exemption under Article 24 of the law, stating that the income and associated expenses of foreign PE should not be considered.
Section eight outlines definitions for immovable and commercial property. Revenue generated by QFZP from any immovable property, including commercial property, is taxed at the standard rate of nine per cent and is not factored into the de-minimum calculation. However, an exception applies to commercial property transaction with another free zone person who is the beneficial recipient; and income generated from such commercial property is classified as qualifying income.
A QFZP engaged in research and development (R&D) to produce qualifying intellectual property (QIP) can benefit from a zero per cent tax rate on the qualifying income derived from the QIP. This tax exemption is granted when a direct connection exists between the income and the R&D expenses that contributed to the creation of QIP. However, if a QFZP acquires QIP or outsources R&D to a related party outside the UAE, the income associated with the acquisition cost or outsourced R&D does not qualify as qualifying income. QIP are the intangible assets such as patents, software, trademarks, etc. that are owned and registered under the related laws and not including any marketing related intellectual property assets, such as trademarks. According to a specific formula, a portion of the income generated from QIP is designated as Qualifying Income (QI), while the remaining amount is subject to the standard nine per cent tax rate and is excluded from the de-minimum percentage calculation; and this all has been explained in section nine of the guide.
Sections 10 and 11 address qualifying and excluded activities, respectively. These sections offer the much-anticipated clarifications that users have been seeking, and we will delve into them in our upcoming article.
Each section provides a variety of examples to help you gain a thorough understanding. Moreover, it is recommended to verify with your respective free zone Authority to know whether you operate in a free zone or designated zone for corporate tax purposes.
The writer, Mahar Afzal, is a managing partner at Kress Cooper Management Consultants. The above article is not an official opinion of Khaleej Times but an opinion of the writer. For any queries/clarifications, please feel free to contact him at mahar@kresscooper.com.
