Corporate Tax Impact on Manufacturing Entities in a Designated Uae Free Zone

The introduction of corporate tax in the UAE represents a significant shift in the country’s economic landscape. To recognize the continued importance of Free Zones, the UAE Corporate Tax rules enable Free Zone companies and branches that meet certain conditions to benefit from a Zero Tax rate on Qualifying Activities and transactions. In this article, we evaluate the specific implications and benefits for manufacturing entities operating within Free Zones. It is very clear from the above that, just the free zone status of the entity does not ensure a zero-tax benefit, but meeting all the required conditions shall make it 100% tax-free.

Hence, our objective should be how to ensure compliance and enjoy the optimum tax benefit allowed as per the regulation.

Qualifying Free Zone Person (QFZP) Status

To be a QFZP, the free zone person (ie. Free zone entities) must meet all the conditions required in the corporate Tax Law and the implementing cabinet and ministerial decisions in this regard as explained below:

• Maintain adequate substance in the free zone, involves having sufficient assets, adequate employees, and adequate operational expenses in the Free Zone to perform its core income-generating activities.
• Generate qualifying income as per the definitions mentioned in the law.
• The Free Zone entities must comply with the arm’s length principle for transactions with related parties. This means that all the transactions with related parties should be in similar terms and conditions which it deals with third parties.
• Must maintain audited financial statements.
• The non- qualifying revenue must satisfy the de-minimis requirements. De-minimise requirements are met if the non – qualifying revenue of the free zone entity does not exceed a) AED 5 million or b) 5% of its total revenue, whichever is lower.

Tax Impacts on Manufacturing Entities in Free Zones

Article 2 (1) of Ministerial Decision No.265 of 2023 gives a list of qualifying activities. The first two qualifying activities in the list are :
a) Manufacturing of goods or materials;
b) Processing of goods or materials; 

Manufacturing of goods or materials includes the production, improvement or assembly of products and materials from raw materials or components and processing of goods or materials which includes conversion of goods or materials into another form of good or material for commercial or industrial use or sale. It includes not only producing new goods, but also improving or assembling pre-existing components.

Ancillary activities to the main activity such as post sales activities/customer support (installation, warranty, maintenance etc.), that can be directly linked to the goods produced may also be considered as qualifying activities. One important point is manufacturing can be either own manufacture or contract or toll manufacturing as well.

The contract/toll manufacturing is also treated as a qualifying activity, irrespective of the location of the contractor, whether in free zone or outside or even overseas. Similar is the case with direct manufacturing. It is a qualifying activity irrespective of the final destination of the manufactured goods.

Accordingly, the happy news for Manufacturing entities in Umm Al Quwain Free Zone (UAQFZ) is that they can enjoy a 100% tax free status, if they meet the criteria stated above under Qualifying Free Zone Person (QFZP).  

Being a designated zone, the zero tax benefits extended to the activity of ‘Distribution of goods or materials’ gives an extra mileage to its trading entities as well and this will enhance the attractiveness of UAQ Free Zone for investors engaged in multidisciplinary activities.

Strategic Considerations for Manufacturing Entities  

• Conduct a detailed impact assessment & Evaluate Qualifying Activities: Ensure that the primary business activities align with the qualifying activities as defined by the latest Cabinet and Ministerial Decisions.
• Substance Requirements: Maintain adequate substance within the Free Zone by ensuring sufficient physical presence, assets, and operational expenses.
• Income Segregation: Carefully segregate and document qualifying income versus non-qualifying income in line with the de-minimise rules to ensure compliance and optimize tax benefits.
• Regular Compliance Reviews: Stay updated with ongoing regulatory changes and seek professional advice if required, to navigate the evolving tax landscape.

Conclusion

For manufacturing entities in Free Zones, understanding and leveraging the benefits of the new corporate tax framework is crucial. By ensuring compliance with the qualifying criteria and keeping abreast of regulatory changes, these entities can effectively enjoy zero tax benefit while contributing to the sustainable growth of the UAE economy.