Introduction
With the introduction of the UAE Corporate Tax (CT) regime, effective from June 1, 2023, one of the most pivotal developments has been the classification and treatment of businesses operating within Free Zones. Free Zones have historically offered tax incentives, which have been a significant driver for foreign investment. The UAE Ministry of Finance has addressed the status of these entities under the new regime through the concept of the Qualifying Free Zone Person (QFZP).
This article explores who qualifies as a QFZP, the benefits and obligations associated with this status, and key considerations for businesses operating within UAE Free Zones.
Definition and Legal Basis
Under Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses and its implementing regulations, a Qualifying Free Zone Person is a Free Zone entity that meets certain conditions allowing it to benefit from a 0% Corporate Tax rate on Qualifying Income.
The primary goal of this distinction is to preserve the attractiveness of Free Zones while aligning the UAE’s tax regime with international standards, including the OECD’s Pillar Two framework.
Eligibility Criteria for QFZP Status
To be classified as a Qualifying Free Zone Person, a business must meet all the following conditions:
1. Incorporated
or Registered in a Free Zone
The entity must be a legal person incorporated or registered in a UAE Free
Zone. Both Free Zone Establishments (FZE) and Free Zone Companies (FZC) may
qualify.
2. Maintains
Adequate Substance in the UAE
The entity must have sufficient economic substance in the UAE, which generally
means:
o Adequate office space,
o Qualified personnel,
o Operational expenditures proportionate to the business’s activity.
3. Derives
Qualifying Income
The entity must earn income that is considered "Qualifying Income"
under the law. This typically includes:
o Transactions with other Free Zone persons (subject to certain exclusions),
o Income from qualifying activities with non-Free Zone persons
o Certain passive income (e.g., interest, royalties).
Non-qualifying income (e.g., income from mainland UAE customers unless it is a qualifying activity) may disqualify the entity or be taxed at the standard 9% rate.
4. Not
Elect to be Subject to Standard Corporate Tax
The Free Zone Person must not opt to be taxed under the general regime. Such an
election, once made, is usually irrevocable for a certain period.
5. Complies
with Transfer Pricing Rules
The QFZP must comply with Arm’s Length Principle and Transfer Pricing
Documentation Requirements, especially for transactions with related
parties.
6. Prepares
Audited Financial Statements
Entities must prepare and maintain audited financial statements in accordance
with applicable standards (e.g., IFRS or other approved frameworks).
Implications of Losing QFZP Status
If an entity fails to meet the conditions in a given tax period, it loses QFZP status for that period and the subsequent four tax periods. This means all income becomes taxable at the standard 9% rate unless otherwise exempted.
Common triggers for disqualification include:
- Earning too much non-qualifying income,
- Insufficient substance in the Free Zone,
- Not maintaining audited financials,
- Failing to comply with transfer pricing documentation.
Strategic Considerations for Businesses
Businesses must proactively manage their operations to maintain QFZP status. Some key steps include:
1. Segregating
Activities
Structuring the business to clearly delineate qualifying and non-qualifying
activities.
2. Substance
Tests
Ensuring adequate operational presence and investment in the Free Zone
jurisdiction.
3. Transaction
Monitoring
Keeping detailed records and ensuring that all intercompany transactions meet
arm’s length requirements.
Conclusion
The Qualifying Free Zone Person regime represents a balanced approach by the UAE government to maintain Free Zone benefits while aligning with global tax standards. While the 0% Corporate Tax rate on qualifying income is highly attractive, maintaining compliance requires careful planning, ongoing substance in the UAE, and adherence to regulatory requirements.
Businesses currently operating in or
considering entry into Free Zones must assess their eligibility for QFZP status
and align their strategies accordingly to maximize tax efficiency while
minimizing compliance risks.
Disclaimer: Content posted is for informational and knowledge sharing purposes only, and is not intended to be a substitute for professional advice related to tax, finance or accounting. The view/interpretation of the publisher is based on the available Law, guidelines and information. Each reader should take due professional care before you act after reading the contents of that article/post. No warranty whatsoever is made that any of the articles are accurate and is not intended to provide, and should not be relied on for tax or accounting advice.
