Is UAE Corporation Tax Applicable to Free Zone Companies?

The United Arab Emirates (UAE) largely relies on its free zones to achieve its goals of attracting more foreign direct investment, as well as simplifying the process of conducting business within the country for foreigners and nationals alike. These economic zones are essential to the UAE economy.

Companies and branches which are registered within a Free Zone will be subject to UAE Corporation Tax and required to file tax returns; however, the UAE Corporate Tax regime will honor all tax incentives that are currently offered to a “Free Zone Person” who maintains adequate substance while complying with all legal requirements. Free Zone Persons are businesses and company branches registered in a UAE Free Zone.

How Corporation Tax Affects UAE Free Zone Companies

A company registered in a free zone in UAE can take advantage of a zero percent corporate tax rate for income earned while trading with companies that are located outside the United Arab Emirates or from doing business with companies that are located within the same or any other free zone. This is in keeping with the intended goal and purpose of the establishment of UAE free zones. Income derived from regulated financial services that are oriented toward international markets may also qualify for the zero corporate tax.

While continuing to enjoy the advantages of the zero percent corporate tax rate on other revenue, a company in a free zone that also maintains a branch anywhere in the mainland UAE is subject to the standard corporate tax rate on any income generated from the mainland.

If a Free Zone company does business with the mainland UAE but it doesn’t have an established branch on the mainland, then the company can continue to take advantage of the 0% rate for corporate income tax UAE as long as its income from the mainland UAE is restricted to ‘passive’ income. Take note: this is provided that the Free Zone business doesn’t have a branch on the mainland. Passive income would include dividends or capital gains for owning shares of mainland UAE corporations and royalties and interests.

The United Arab Emirates (UAE) is committed to preserving its position as the favored base for doing business in the Middle East and the rest of the globe. As a result of this commitment, the 0% corporate tax in UAE will be applied to all transactions involving Free Zone companies and their respective group companies that are based in the mainland. But, in order to maintain the tax neutrality for such transactions, the mainland group companies’ payments to free zone companies will not be deductible as business expenses for tax purposes.

How UAE Promotes Fair Taxation with the Corporation Tax Regime

A business who is considered to be in a UAE Designated Zone for the purposes of value-added tax (VAT) is eligible to take advantage of the zero percent corporation tax rate on income generated from selling of goods to businesses on the UAE mainland that are importer of record (IOR) for those goods.

Any additional mainland-sourced income would exclude a Free Zone company from the 0 percent corporation tax regime with regards to all of their income. This is done to prevent the Free Zone enterprises from getting an unfair advantage in comparison to businesses that are formed in mainland UAE.

At any point, a person who is subject to the Free Zone rate will have the ability to make the irrevocable choice to switch to the standard corporation tax charge. If a company in a free zone is eligible for a tax rate of zero percent for capital gains on income derived from the mainland, then such income will be subject to a withholding tax (applied at 0 percent).

The UAE authorities has a general preference for maintaining the simplicity of UAE corporation tax rules and regulations, with the least amount of required procedures from taxable persons. But, on a more global scale, Free Zone businesses would be required to reevaluate the substance and license requirements to claim the advantages, assess interactions with the UAE mainland and the ramifications. In addition to this, the companies would have to review their capital structures, taking into account transfer pricing regulations as well as interest limitation provisions.

Consult with Corporate Tax Advisors in UAE

There are several facets that would need more clarification, most notably the computation of corporation tax for foreign source revenue for credit, the question of whether or not ESR compliance would be adequate for substance, and the adjustment to income among others. The UAE Federal Tax Authority is yet to publish more guidelines on UAE’s corporation tax regime. In the meantime, all UAE businesses are to acquire corporate tax advisory services from experts such as Corporate Tax UAE to assess the impact of the newly introduced taxation onto their respective businesses.