In a move aimed at enhancing business growth and maintaining the UAE’s free zone attractiveness, the government has introduced a 0% corporate tax rate for qualifying companies operating in designated free zones. This exemption presents a valuable opportunity for firms to capitalize on tax advantages, provided they meet certain regulatory requirements.

Understanding UAE Free Zone Tax Exemption

The UAE’s corporate tax system, which was introduced to align with global standards, applies a 9% corporate tax on taxable income exceeding Dh375,000. However, companies established in free zones can benefit from a 0% corporate tax rate under specific conditions related to qualifying income and maintaining adequate substance within the UAE free zones.

NYK Law Firm expert, explains:
“The corporate tax exemption in UAE free zones is a significant incentive for companies to invest, provided they meet strict criteria. Free zone businesses need to understand the importance of both qualifying income and substance requirements to maintain the 0% tax benefit."

How to Qualify for 0% Corporate Tax

To benefit from the 0% corporate tax rate, companies must be classified as a Qualifying Free Zone Person (QFZP). According to Cabinet Decision No. 55 of 2023, businesses must meet the following conditions to qualify:

1. Qualifying Income: The firm must derive income from specific, qualifying transactions conducted within the free zone or between free zone entities.

2. Adequate Substance: The company must maintain adequate substance within the UAE free zone to show that core income-generating activities are performed locally.

3. De Minimis Requirement: The firm must not exceed certain limits on non-qualifying activities.

4. Arm’s Length Principle Compliance: The business must ensure its transactions with related entities comply with transfer pricing rules.

5. Audited Financial Statements: Companies must prepare and maintain audited financial statements to remain in compliance.

 

The Importance of Maintaining Adequate Substance in the UAE

For businesses to maintain QFZP status, it’s crucial to meet the adequate substance requirements. This means that core income-generating activities, such as research, manufacturing, or distribution, must be carried out within the free zone. Businesses must also have the necessary assets and qualified full-time employees working on these activities within the zone.

For instance, if a company operates in a designated zone for distribution, they must ensure that the core distribution activities happen within that zone to meet substance guidelines. Non-core activities, like administrative tasks, can be conducted outside the free zone without affecting the company’s tax exemption status.

Case Study: Company A’s Journey with Substance Compliance

Consider a free zone company, Company A, which operates a warehouse in a designated zone used for storage and distribution. Its registered office and employees, however, are located in a non-designated free zone. In this case, the company fails to meet the substance requirement as its core distribution activities must occur in a designated zone.

However, if Company A's customers are other free zone persons benefiting from the company’s goods, it may still qualify for the 0% corporate tax based on transactions with other free zone entities, even if it does not fully meet the substance criteria.

Determining Adequate Substance for Free Zone Businesses

To meet the substance requirements, a free zone person needs to have:

• Qualified full-time employees in the free zone to handle core income-generating activities.

• Physical assets (not just virtual) in the free zone to conduct operations.

• Operating expenditure that justifies the scale and substance of the activities.

Each company’s case is evaluated based on these specific criteria to ensure compliance with the 0% tax benefits.

Final Thoughts: Navigating the Corporate Tax Exemption in UAE Free Zones

The UAE free zone system provides significant corporate tax advantages for businesses, particularly in the wake of the corporate tax law implementation. However, companies must ensure that they qualify for the 0% tax rate by meeting specific criteria regarding qualifying income and maintaining adequate substance within the UAE.

NYK Law Firm emphasizes that firms in UAE free zones must carefully navigate these requirements to capitalize on the full benefits of the corporate tax exemption while ensuring they remain compliant with the legal and financial regulations set forth by the UAE authorities.

With proper planning and expert legal guidance, UAE free zone businesses can unlock powerful tax advantages, promoting sustained growth and expansion.

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