Qualifying income and free zone regulations are crucial elements of the UAE’s Corporate Tax Law, particularly for businesses operating in free zones. With the implementation of Federal Decree-Law No. 47 of 2022 on Corporate Tax and Cabinet Decision No. 100 of 2023, understanding these regulations ensures compliance and maximizes the benefits of operating within designated free zones. This article provides a detailed breakdown of qualifying income, relevant activities, and compliance measures under these laws.
Overview of UAE Corporate Tax Law and Free Zones
The UAE’s Corporate Tax Law, Federal Decree-Law No. 47 of 2022, applies to corporations and businesses, including those in free zones. Free zones are special economic areas with tax advantages aimed at promoting foreign investment. Cabinet Decision No. 100 of 2023 further defines the scope of qualifying income for free zone persons, ensuring transparency and clarity in tax-related matters.
Key Definitions Under Cabinet Decision No. 100 of 2023
Qualifying Free Zone Person
A “Qualifying Free Zone Person” refers to an entity established in a free zone that meets the conditions to benefit from the reduced or zero tax rates, depending on their income sources and activities. These entities must adhere to the provisions outlined in the Corporate Tax Law and Cabinet Decision.
Qualifying Activities
Qualifying activities are those that generate qualifying income. They include transactions between free zone persons and certain activities involving intellectual property. Activities not classified as excluded are typically considered qualifying, thus benefiting from preferential tax treatments
Excluded Activities
Excluded activities are those from which income is not considered qualifying. These typically include transactions involving non-free zone persons that are not related to qualifying activities. The Minister of Finance has the authority to specify which activities are excluded, impacting the tax benefits for businesses involved in such activities.
Qualifying Income for Free Zone Persons
Income from Free Zone Transactions
Income derived from transactions with another free zone person qualifies as tax-exempt income, provided it does not involve excluded activities. The recipient of the goods or services must be the beneficial owner, meaning they have the right to use and enjoy the goods or services without an obligation to transfer them to another person
Income from Transactions with Non-Free Zone Persons
In cases where free zone persons engage in transactions with non-free zone persons, only the income from qualifying activities is exempt. This means the business must ensure that the activities fall under the qualifying category to benefit from the tax advantages
Intellectual Property Income
Income generated from qualifying intellectual property, such as patents or copyrighted software, is considered qualifying income, provided it meets the criteria outlined in the decision. However, income from non-qualifying intellectual property is taxable.
The Minimum Requirements for Non-Qualifying Revenue
Under the Cabinet Decision, free zone persons can still maintain their status even if they derive some income from non-qualifying activities. However, there is a threshold known as the The Minimum requirement. This stipulates that the non-qualifying income must not exceed a certain percentage or amount of total revenue, as specified by the Minister of Finance.
Total revenue includes all income derived by a qualifying free zone person within a tax period. However, certain transactions, particularly those involving immovable property, are excluded from this calculation. Understanding the composition of qualifying and non-qualifying revenue is essential for businesses to ensure they remain within the prescribed limits.
Impact of Exceeding The Minimum Threshold
If a free zone person exceeds the The Minimum threshold, they risk losing their qualifying status for that tax period, which could result in the entire income becoming taxable under the Corporate Tax Law. Thus, maintaining accurate records and compliance with these thresholds is critical for free zone businesses
Adequate Substance Requirements for Free Zone Persons
To benefit from the qualifying free zone tax regime, businesses must demonstrate adequate substance within the free zone. This includes maintaining sufficient assets, employees, and operating expenditures to support their core income-generating activities.
Outsourcing Core Activities
While businesses can outsource certain activities, these must remain within the free zone, and the free zone person must exercise adequate supervision over the outsourced activities. Failure to comply with these requirements could jeopardize their qualifying status.
Core Activities Related to Intellectual Property
For businesses dealing with intellectual property, core activities can be outsourced outside the free zone, provided the entity exercises adequate supervision. This flexibility ensures businesses can efficiently manage their intellectual property operations while maintaining compliance with the law.
Compliance and Reporting Obligations
Free zone persons must regularly report their income and activities to ensure compliance with the Corporate Tax Law. Accurate reporting is crucial to maintain qualifying status and benefit from the tax advantages offered by the free zone regime.
Importance of Maintaining Records
Keeping detailed and accurate records of qualifying and non-qualifying income, transactions, and operational expenses is essential. These records will be necessary for tax filings and in the event of an audit by the UAE tax authorities.
Penalties for Non-Compliance
Non-compliance with the Corporate Tax Law and the Cabinet Decision could result in penalties, including the loss of qualifying status and retrospective taxation. Businesses should ensure they meet all reporting requirements and thresholds to avoid such penalties.
