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Corporate Tax : UAE Free Zone

Key Compliances : Free Zone Corporate Tax

Calculation: Corporate Tax for a Free Zone Person

Foreign Permanent Establishment or Domestic Permanent Establishment

Immovable Property

Free Zone Corporate Tax Compliance

Record Keeping :

A QFZP is considered a taxable entity under corporate tax law, even when its income consists entirely of qualifying income subjected to a 0% corporate tax rate. This means that, despite the favorable tax treatment, free zone persons are obligated to uphold meticulous records and documentation pertaining to corporate tax requirements. Such records must be maintained for a duration of seven years following the conclusion of the relevant tax period. This requirement ensures compliance with legal obligations and facilitates any necessary audits or reviews by tax authorities, reinforcing the importance of diligent record-keeping for all entities operating within the free zone framework. Failure to comply with these regulations may lead to complications or penalties during compliance checks.

Tax Registration :

A free zone person, including those categorized under a Qualified Free Zone Person (QFZP), is required to register for corporate tax with the Federal Tax Authority (FTA). This registration must be completed in accordance with the specific form, manner, and deadlines established by the FTA. It is crucial to adhere to these prescribed timelines; any failure to submit the tax registration application within the stipulated period may lead to the imposition of administrative penalties. Such penalties can significantly impact the financial standing of the business, underscoring the importance of compliance with tax regulations in free zones. Therefore, it is advisable for entities in this category to stay informed about their obligations and ensure timely registration to avoid any adverse consequences.

All taxable persons have a responsibility to cooperate with the Federal Tax Authority (FTA) by providing any necessary information, documents, or records upon request. This obligation ensures that the FTA can efficiently assess compliance with tax regulations. To facilitate this process, it is crucial that these records are kept in an easily accessible manner. Taxable persons should be proactive in organizing their financial documents, ensuring that they can quickly respond to any inquiries from the FTA. Failure to comply with these requests could lead to complications or penalties, underscoring the importance of maintaining proper records. By adhering to this requirement, taxable individuals contribute to a transparent and accountable tax system.

Applicable Accounting Standards :

Under the corporate tax law, free zone persons operating within a free zone are not mandated to maintain separate financial statements for activities yielding qualifying income. This regulation simplifies the financial reporting process for these entities. However, it remains essential for qualified free zone persons (QFZPs) to retain adequate documentation that clearly outlines how they arrived at their qualifying income figures. This documentation is crucial not only for compliance purposes but also to ensure transparency and accuracy in the reporting of income generated from free zone activities. Proper record-keeping serves as a safeguard against potential audits and provides clarity in financial assessments, aligning with broader corporate governance standards.

In accordance with corporate tax law, a taxable person must meticulously prepare financial statements that adhere to the prescribed accounting standards. In the United Arab Emirates, the recognized accounting frameworks for corporate tax purposes include the International Financial Reporting Standards (IFRS) and IFRS for Small and Medium-sized Enterprises (SMEs). The latter is applicable to taxable entities whose revenue does not exceed AED 50,000,000 during the relevant tax period. Furthermore, taxable persons may also utilize the cash basis of accounting if they meet the specified conditions. Proper adherence to these standards is crucial for ensuring compliance and accurate reporting within the framework of corporate taxation in the UAE.

Preparing audited Financial Statements:

In a free zone context, it is essential for free zone persons designated as Qualified Free Zone Persons (QFZPs) to comply with specific financial regulations. One key requirement is the preparation and maintenance of audited financial statements for corporate tax purposes. This obligation remains applicable regardless of the revenue generated by the entity. By ensuring accurate and transparent financial reporting, QFZPs contribute to the integrity of the financial ecosystem within the free zone. The auditing process not only facilitates compliance with tax regulations but also enhances the credibility of the business in the eyes of stakeholders and investors.

A Qualifying Foreign Zone Project (QFZP) is not obligated to create separate financial statements for its qualifying income versus its other income, nor is it required to prepare separate audited financial statements for any branches it operates. This alleviates some administrative burdens for the organization, allowing it to consolidate its financial reporting. However, it remains essential for the QFZP to maintain adequate documentation that clearly outlines the methodology used to calculate its qualifying income.

Tax Return and Corporate Tax payment:

In a self-assessed corporate tax regime, entities operating within free zones must adhere to specific regulations regarding tax compliance. It is essential for these taxpayers to calculate their corporate tax liabilities accurately and remit any applicable payments to the Federal Tax Authority (FTA). Additionally, they are obligated to file their tax returns in the prescribed format and manner set forth by the FTA. This filing must occur within a strict timeframe, specifically within nine months following the conclusion of the relevant tax period.

Calculation: Corporate Tax for a Free Zone Person

Corporate Tax rate for a QFZP:

A qualified free zone person (QFZP) that meets all stipulated conditions, including the de minimis requirements, enjoys significant tax advantages. Specifically, it is subject to a 0% corporate tax rate on its qualifying income, allowing it to maximize profits from eligible activities. However, for taxable income that does not qualify, a corporate tax rate of 9% applies. It's also important to note that the 0% tax rate is not applicable to the first AED 375,000 of taxable income, meaning that this income will be taxed at the standard corporate rate.

Qualifying Income:

Qualified Income is categorized based on several key aspects.

First, it includes transactions with free zone persons from a free zone, where the recipient benefits from the exchange, provided that the revenue does not come from excluded activities.

Second, income derived from qualifying activities is considered, again excluding revenue from activities that are specifically excluded.

Third, qualifying income from qualifying intellectual property also falls under this definition.

Fourth, income from other sources, which may include revenue from excluded activities, is recognized as long as the qualifying free zone person (QFZP) meets the de minimis requirements.

In the context of income qualification, certain revenue sources are explicitly excluded from being categorized as qualifying income, despite potentially falling under the specified items.

This includes revenue generated from foreign and domestic permanent establishments, which do not contribute to qualifying income. Additionally, income derived from immovable property is not considered qualifying, except for commercial properties located in a free zone, provided the transactions occur with free zone individuals. Furthermore, revenue stemming from the ownership or exploitation of intellectual property also does not qualify, unless it is recognized as qualifying income from qualifying intellectual property.

Taxable Income that is not Qualifying Income :

To accurately determine the amount of taxable income that does not qualify for preferential treatment and is therefore liable to the 9% corporate tax rate, a qualified free zone person (QFZP) must undertake several key steps.

First, it needs to meticulously categorize the revenue reflected in its financial statements, distinguishing between the revenue attributable to qualifying income and the revenue linked to taxable income.

Second, it is essential to allocate expenses in a fair and reasonable manner, aligning with the arm’s length principle.

Third, the QFZP must apply Article 20 of the corporate tax law, which outlines the general principles for calculating taxable income, to ascertain the specific amount of taxable income that does not qualify for the favorable tax treatment.

Allocating expenses:

In the context of a Qualifying Foreign Zone Person (QFZP), when there is both qualifying income and taxable income that is not classified as qualifying, it becomes essential to accurately allocate expenses between these two components.

In cases where expenses are specifically incurred for a designated income component, it is essential to allocate those expenses directly to that category of income. However, when the qualified free zone person (QFZP) incurs deductible expenses that cannot be directly linked to either the qualifying income or taxable income components—such as interest or centralized general and administrative expenses—it becomes necessary for the QFZP to divide those expenses between the qualifying income and taxable income categories. This allocation must be performed on an arm's length basis, utilizing suitable allocation keys with respect to cause , effect and benefits derived on consistent basis over the years.

Taxable Income subject to the 9% rate of Corporate Tax:

To accurately calculate the taxable income not considered qualifying income and subject to the 9% corporate tax rate, the qualified free zone person (QFZP) must begin with a thorough assessment of non-qualifying income and related expenses. Following this initial evaluation, the QFZP should apply the standard guidelines outlined in corporate tax law to determine its taxable income, ensuring to exclude any exempt income and recognizing that certain reliefs are unavailable due to the specific status of the QFZP. By adhering to these protocols, the QFZP can effectively delineate the portion of income that is liable to corporate taxation.

In the context of determining income that is not linked to a foreign or domestic permanent establishment, it is essential for free zone entities to undertake a reasonable allocation of income components. This allocation is critical for establishing the arm’s length value of profits associated with each specific activity conducted by the free zone person.

When addressing income linked to a foreign or domestic permanent establishment, it is essential to treat each establishment as an independent entity. This perspective, known as the separate entity approach, necessitates that the foreign permanent establishment and the domestic permanent establishment be viewed as if they were distinct and unrelated parties engaging in transactions at arm’s length.

To accurately attribute profits between a free zone parent company and its foreign or domestic permanent establishments, a systematic two-step approach is essential.

The first step involves identifying and allocating the income generated by each establishment, ensuring that revenues are matched with the economic activities performed within each jurisdiction. This analysis should also take into account the assets used and the risks assumed by the Foreign Permanent Establishment or Domestic Permanent Establishment and the Free Zone parent

The second step entails the application of an appropriate transfer pricing method to ensure that the profits attributed to each entity reflect the arm's length principle.

A qualified free zone person (QFZP) will find itself excluded from several beneficial tax reliefs and provisions as follows.

First, it cannot benefit from small business relief, which is designed to support emerging enterprises,

Second, qualifying group relief that aids businesses under common control.

Third, the QFZP is ineligible for business restructuring relief, which can facilitate smoother transitions during significant organizational changes.

Four, It also lacks the capability to transfer or receive tax losses, hindering its financial flexibility.

Five, being part of a tax group, which often allows for more favorable tax treatments among affiliated entities, is not an option for a qfzp.

In the context of corporate taxation, if a qualified free zone person (QFZP) experiences tax losses related to its taxable income, as outlined in Article 20 of the corporate tax law, these losses can be carried forward to future tax periods. This provision allows the QFZP to offset its taxable income in subsequent years, although it is important to note that these tax losses cannot be used against income derived from intellectual property, except for qualifying income linked to qualifying intellectual property. To benefit from tax loss relief and the carry forward of losses, the QFZP must adhere to specific conditions. Therefore, while the flexibility to manage tax losses exists, restrictions apply to ensure that intellectual property income is treated distinctly within the tax framework.

Tax Losses:

A qualified free zone person (QFZP) cannot leverage any losses that were incurred before its corporate tax responsibilities began or prior to its status as a taxable entity.

In the context of a qualified free zone person (QFZP), it is important to understand the implications of incurring losses related to its qualifying income component. Such losses are strictly limited in their application; they cannot be utilized to offset the QFZP’s taxable income. Furthermore, these losses cannot be transferred to or received from other taxable entities. This means that if a QFZP faces financial setbacks in its qualifying income, it must absorb those losses without the option of applying them against future taxable income or leveraging them through transfers with other taxable persons.

Taxation of a Free Zone Person that is not a QFZP:

If a free zone person fails to qualify as a Qualified Free Zone Person (QFZP), they will be subject to the standard corporate tax rates beginning from the start of that tax period. This is unless they meet the criteria to be considered an exempt person under the relevant corporate tax law articles. The standard corporate tax rates dictate that there is a 0% tax rate on taxable income up to AED 375,000. However, any taxable income exceeding AED 375,000 will be taxed at a rate of 9%.

Foreign Permanent Establishment or Domestic Permanent Establishment

Permanent Establishment:

A foreign permanent establishment or a domestic permanent establishment refers to a business presence that exists outside of a designated free zone. This presence can be established in two main ways. Both methods highlight the importance of having a stable and ongoing business presence in a location to fulfill legal and financial obligations.

First, a person may maintain a fixed place of business, such as an office or facility, that allows for the continuous conduct of business activities.

Second, a foreign or domestic permanent establishment may be created by engaging a dependent agent to carry out business operations on behalf of the entity. This agent acts on behalf of the business, thereby establishing a significant connection to the market without the need for a physical storefront.

A foreign permanent establishment or a domestic permanent establishment must be regarded as a distinct and independent entity, separate from its parent company located in a free zone. This distinction is crucial for understanding the legal and financial implications of their operations.

The income or profits that are attributed to a free zone parent, foreign permanent establishment, or domestic permanent establishment must adhere to the arm's length principle.

In the context of free zone operations, it is essential for the parent company to book and document a suitable level of operating profits or losses. This evaluation must be carried out in compliance with internationally recognized profit attribution methods, notably the separate entity approach.

In scenarios where outputs from a free zone parent company are utilized in the operations of its foreign or domestic permanent establishments, the implications for taxation can be significant. The free zone parent is regarded as having generated revenue from a non-free zone entity, thus altering its financial reporting and tax obligations.

In the context of the beneficial recipient in free zone rule , it is essential to understand that neither a foreign permanent establishment nor a domestic permanent establishment will be classified as a free zone person. This distinction is critical for tax purposes, as it affects the eligibility for certain benefits and exemptions typically associated with free zone entities.

Foreign Permanent Establishment:

A foreign permanent establishment refers to a business location or entity that a resident person operates beyond the borders of the United Arab Emirates (UAE). This concept is defined by specific criteria outlined in Article 14 of the corporate tax law. Such establishments may include offices, branches, or other facilities that allow a resident individual or company to conduct business activities in a foreign jurisdiction.

A resident individual, including those classified as free zone persons, has the option to exclude the income and related expenses of their foreign permanent establishments when calculating their taxable income, provided they satisfy specific criteria. This election allows eligible free zone individuals to exempt the income generated by their foreign permanent establishments from corporate tax obligations.

Domestic Permanent Establishment:

In the context of the UAE's taxation framework, a domestic permanent establishment refers to a location or entity through which a qualified free zone person (QFZP) conducts business outside of a free zone. The income generated by such a domestic permanent establishment is liable to a corporate tax rate of 9%, unless it qualifies as exempt income. It is important to note that when determining compliance with the de minimis requirements, the income from the domestic permanent establishment is not considered.

A qualified free zone person (QFZP) establishes a domestic permanent establishment if it meets certain criteria.

First, this can occur when the QFZP engages in substantial business activities within the jurisdiction, which may involve maintaining a physical presence or having a significant level of operational activity.

Second, if the QFZP carries out business transactions that lead to a stable and continuous economic presence in the country, it also creates a domestic permanent establishment.

A Qualified Free Zone Person (QFZP) that earns income through a foreign or domestic permanent establishment will typically face a 9% corporate tax rate. However, there are specific provisions that may exempt certain types of income from this corporate tax obligation. It is important to note that when determining whether a QFZP meets the de minimis requirements, the revenue that generates this income is excluded from consideration.

Immovable Property

Immovable Property:

Immovable property encompasses a variety of assets that are permanently linked to a specific location.

This includes any area of land where rights, interests, or services can be established.
Furthermore, it refers to buildings, structures, or engineering works that are permanently fixed to the land or the seabed, contributing to the overall utility of the property.
Additionally, immovable property includes fixtures and equipment that are integral to the land or permanently affixed to any structure, ensuring their ongoing function and value.

Income derived by a Qualified Free Zone Person (QFZP) from immovable property situated in a designated free zone is subject to specific tax treatment as follows;

Income generated from transactions involving a free zone person, who is recognized as the beneficial recipient, is classified as qualifying income when it pertains to commercial property within a free zone.
Income generated from transactions involving a free zone person, who is not the beneficial recipient, regarding commercial property situated within a free zone, does not qualify as qualifying income. Instead, it is classified as taxable income, which is subject to a corporate tax rate of 9%. Furthermore, this income will be excluded from the calculations of total revenue and non-qualifying revenue when assessing compliance with the de minimis requirement.
Income generated from other immovable property situated in a free zone is categorically not classified as qualifying income. This means that such income falls under taxable income, lacking any special treatment under relevant tax laws. Consequently, it will be excluded when calculating an entity's total revenue and non-qualifying revenue for the purpose of meeting the de minimis requirement.

In the context of free zones, the ownership or exploitation of immovable property, aside from commercial property transactions involving a free zone person, is classified as an excluded activity. Additionally, it's important to note that revenue generated from this immovable property is disregarded when evaluating compliance with de minimis requirements, which are thresholds below which certain regulations and obligations do not apply.

Mixed-use property located in a Free Zone:

Income generated from a mixed-use property situated in a free zone benefits from a dual corporate tax rate structure, with rates set at 0% and 9%. The applicable rate hinges on the specific use of the various components within the property. For instance, if certain areas are designated for commercial use while others are reserved for residential purposes, the tax implications differ.

Immovable Property located outside a Free Zone:

The ownership or exploitation of immovable property situated outside of a free zone is classified as an excluded activity. Consequently, income generated from such property must be factored into the assessment of de minimis requirements, with one key exception: if the income is linked to a foreign permanent establishment or a domestic permanent establishment, it may not be included.

Immovable property refers to assets that are permanently affixed to a specific location and cannot be relocated without causing damage or altering their original structure. These types of properties encompass buildings, land, and other fixtures that are integral to the real estate. In contrast, movable constructions, such as those found at construction sites or temporary structures, do not fall under the category of immovable property.

Commercial property is defined as any immovable asset utilized primarily for business purposes, distinctively not intended for residential accommodation. This category encompasses a variety of establishments, including office buildings, retail spaces, and warehouses.