The recent issuance of Cabinet Decision No. 100 of 2023 by the Cabinet of Ministers, effective from 1 June 2023, marks a significant development in determining Qualifying Income for Qualifying Free Zone Persons under Federal Decree Law No. 47 of 2022 (referred to as ‘the CT Law’). This decision replaces the earlier Cabinet Decision No. 55 of 2023, issued on 30 May 2023, which addressed the determination of Qualifying Income for Qualifying Free Zone Persons. Additionally, the Ministry of Finance has introduced Ministerial Decision No. 265 of 2023, effective from 1 June 2023, providing definitions for “Qualifying Activities” and “Excluded Activities” and outlining procedural conditions in support of the UAE Corporate Tax Law. This decision supersedes the earlier Ministerial Decision 139 of 2023, issued on 1 June 2023.
A) Who will be a Qualifying Free Zone Person (‘QFZP’) under the CT Law
A Qualifying Free Zone Person (‘QFZP’) under the UAE Corporate Tax Law is defined in Article 18 and must satisfy the following conditions:
- Maintain sufficient substance in the UAE.
- Derive Qualifying Income.
- Have not explicitly elected to be subject to Corporate Tax in UAE.
- Comply with Transfer Pricing regulations.
- Maintain audited financial statements in accordance with IFRS/IFRS for SMEs.
- Furthermore, the Non-Qualifying Revenue of a Free Zone person should not exceed the lower of the following De Minimis requirements in a given Tax Period:
● 5% of the Total Revenue of a Free Zone Person, or
● AED 5 million (as specified in the relevant Ministerial Decision).
If a Qualifying Free Zone Person (QFZP) fails to meet any of the specified conditions during a Tax Period, it will lose its QFZP status from the beginning of that relevant Tax Period and for the subsequent four Tax Periods. Consequently, the Free Zone person will be treated as a Taxable Person subject to corporate income tax at a rate of 9% for a minimum term of five years.
B) Regarding the introduced aspects:
❖ The concept of Qualifying Intellectual Property (“QIP”) has been introduced. QIP includes Patents, Copyrighted Software, and any right functionally equivalent to a Patent that is legally protected and undergoes a similar approval and registration process. This encompasses utility models, intellectual property assets protecting plants and genetic material, orphan drug designations, and extensions of Patent protection. Excluded from QIP are marketing-related intellectual property assets like trademarks.
❖ The scope of Qualifying Income has been broadened to encompass income derived from the ownership or exploitation of Qualifying Intellectual Property. This expansion applies as long as the income is not attributable to a Domestic PE or a Foreign PE and is not derived from the ownership or exploitation of immovable property.
❖ In relation to the aforementioned issue of Qualifying Intellectual Property (QIP), the following documents must be maintained and provided to the FTA upon request:
● Ownership details and the right to exploit the Qualifying Intellectual Property.
● Details of Qualifying Expenditures and Overall Expenditure incurred.
● Overall income derived from the Qualifying Intellectual Property.
● The link between Qualifying Expenditure and Overall Income derived.
❖ Additionally, it is noteworthy that income arising from the ownership or exploitation of intellectual property that does not fall under the category of Qualifying Intellectual Property, along with income surpassing the Qualifying income calculated through the prescribed formula, will be regarded as taxable income. Such income will be subject to taxation at a rate of 9%, as per Clause 2 of Article 3 of the UAE Corporate Tax Law.
❖ Furthermore, the Decisions specify that revenue generated from the Trading of Commodities is considered Qualifying Income. Qualifying Commodities include metals, minerals, energy, and agricultural commodities traded on a recognized commodities exchange market in their raw form.
c) The scope of Qualifying Activities has been expanded to encompass the following:
● Manufacturing of goods or materials.
● Processing of goods or materials.
● Trading of Qualifying Commodities.
● Holding of shares and other securities for Investment Purpose, requiring an uninterrupted period of 12 months.
● Ownership and operation of ships.
● Reinsurance services.
● Fund management services.
● Headquarter, treasury, and financing services to related parties.
● Financing and leasing of aircraft.
● Logistics.
● The distribution of goods in or from a designated zone (as defined in the VAT Law), subject to specific conditions.
● Any ancillary activities related to the above-listed activities.
D) Excluded activities are outlined as follows:
● Transactions involving natural persons, with certain exceptions applicable under Qualifying Activities related to the ownership and operation of ships, fund management services, wealth and investment management services, and financing and leasing of aircraft.
● Banking activities.
● Insurance activities, with the exception of reinsurance services and headquarter services to related parties.
● Financing and leasing activities, excluding ownership, management, and operation of ships, treasury and financing services to related parties, and financing and leasing of aircraft.
● Ownership or exploitation of immovable property, except for Commercial Property situated in a Free Zone, where transactions are conducted with a Free Zone Person.
● Any ancillary activities related to the above-excluded activities.
E) What is the Qualifying Income of a QFZP?
The Qualifying Income of a Qualifying Free Zone Person (QFZP) is categorized as follows, with incomes both excluded and included in the tabulated breakdown:
Incomes Excluded:
● Incomes attributed to a Domestic Permanent Establishment (‘PE’) or a Foreign PE.
● Incomes arising from the ownership or exploitation of immovable property, as specified in point 3 below.
● Incomes derived from any person specified in the Excluded Activities.
● Incomes derived from a Non-Free Zone Person other than Qualifying Activities.
Incomes Included:
● Any income derived from other Free Zone Persons, excluding those from Excluded Activities, provided the other Free Zone Person is the Beneficial Recipient* of the relevant services or goods.
● Income derived from the ownership or exploitation of Qualifying Intellectual Property, calculated in accordance with the Decisions.
● Income from the trading of Qualifying Commodities.
● Income from Qualifying Activities undertaken with a Non-Free Zone Person, provided it is not treated as Excluded Activities.
● Any other income, subject to satisfaction of the De Minimis requirement as per point 4 below.
*Beneficial Recipient is defined as a person who has the right to use and enjoy the service or good and does not have a contractual or legal obligation to pass such service or good to another person.
F. Domestic Permanent Establishment:
A Domestic PE is defined as a place of business or any other form of presence of a Qualifying Free Zone Person (QFZP) outside the Free Zone in the UAE. The interpretation of this definition refers to the provisions determining the Permanent Establishment (PE) of a Non-Resident Person under Article 14 of the CT Law. For example, if a Free Zone Person has a branch in the mainland region, that branch shall be subject to a 9% tax rate on its Taxable Income.
G. Income Attributable to a Domestic PE or a Foreign PE:
Income attributable to a Domestic PE or a Foreign PE of the QFZP is considered Taxable Income subject to corporate tax at a rate of 9%, without the benefit of the basic monetary threshold exemption of AED 375,000 of taxable income. This income is calculated as if the respective PE were a separate and independent entity related to the QFZP.
H. Income Derived from Immovable Property in a Free Zone:
Income derived from immovable property located in a Free Zone, resulting from the transactions outlined below, is considered Taxable Income subject to corporate tax at 9%, without the benefit of the basic monetary threshold exemption of AED 375,000 of taxable income:
● Transactions with Non-Free Zone Persons concerning Commercial Property.
● Transactions with any person regarding an immovable property that is not Commercial Property.
Commercial Property is defined as an immovable property or part thereof:
● Used exclusively for a Business or Business Activity.
● Not used as a place of residence or accommodation, including hotels, motels, bed and breakfast establishments, serviced apartments, and the like.
Other Significant Considerations:
● One essential prerequisite for a Free Zone Person to qualify as a Qualifying Free Zone Person (QFZP) is the presence of “Adequate Substance.” Compliance is achieved when the QFZP undertakes core income-generating activities in a Free Zone or a Designated Zone, depending on where such activities are required to be conducted. This consideration also takes into account the level of activities carried out, the possession of adequate assets, a sufficient number of qualified employees in a Free Zone or a Designated Zone (depending on the required location), and incurring an adequate amount of operating expenditures for each activity. It is crucial to note that, currently, there are no defined thresholds or standards for meeting these criteria.
● The core income-generating activities can be outsourced to another entity in a Free Zone or a Designated Zone, depending on the required location, provided the QFZP maintains adequate supervision of the outsourced activity. Specifically, core income-generating activities related to Qualifying intellectual property can be outsourced to any entity within the State and to any entity outside the State that is not a related party, provided there is adequate supervision of the outsourced activity. These core income-generating activities may vary depending on the specific activity but primarily consist of significant functions that derive business value for each activity carried out by a QFZP, excluding activities that are exclusively or predominantly support activities.
● The De Minimis Rule, as outlined in the subject Decisions, is crucial. It stipulates that Non-Qualifying Revenue earned by a Free Zone Person should not exceed the lower of 5% of the total revenue or AED 5 million in a Tax Period. Adherence to this rule is vital for a Free Zone entity to qualify as a QFZP and maintain the status of an exempted business. Failure to comply with any of the eligibility conditions will result in the disqualification of a Free Zone Person as a QFZP for five years (the current year and subsequent four years), subjecting it to taxation as a taxable business.
● The introduced Decisions have brought forth the concept of a Domestic PE, which plays a pivotal role in determining the taxation of Free Zone Persons, particularly when the QFZP conducts business outside the Free Zone.
● An activity is considered ancillary when it is necessary for the performance of the main activity or makes a minor contribution to it. Such activities are so closely related to the main activity that they should not be regarded as separate activities.
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