UAE Corporate Tax Update – Impact on Free Zone businesses
On 31 January 2022, the Ministry of Finance (MOF) announced that the United Arab Emirates (UAE) will introduce a Federal Corporate Tax (CT) on business profits effective for financial years starting on or after 1 June 2023.
Since the announcement, the MOF released a Public Consultation Document on CT (Consultation) that contains information on the proposed UAE CT regime.
In this alert, we have captured certain key aspects concerning CT impact on Free Zone businesses in the UAE.
What would be the UAE CT impact on Free Zones activities?
Since Free Zones are an important part of the UAE economy that encourages foreign direct investment and enhances the ease of doing business in the UAE, it is confirmed in the Consultation that “tax incentives” would be granted to Free Zone companies that maintain adequate substance and comply with all regulatory requirements.
In line with the original intention and purpose of Free Zone jurisdictions, Free Zone companies would benefit from a 0% CT rate on business profits earned in the following cases:
- From transactions with businesses located outside the UAE.
- From transactions with businesses located in the same Free Zone.
- From transactions with businesses located in any other Free Zone.
- From the sale of goods by Free Zone companies located in Designated Zones to UAE mainland businesses that are importers of record of those goods.
- From transactions between Free Zone companies and their group entities located in mainland UAE. However, the associated payments made by mainland entities will not be deductible for UAE CT purposes.
- From ‘passive’ income received from mainland UAE companies. This would include interest and royalties, and dividends and capital gains from owning shares in mainland UAE companies.
- The Consultation clarifies that certain business profits would still be taxed at the regular CT rate. The document outlines the following cases:
- Where a Free Zone company transacts with mainland UAE companies.
- Where a Free Zone company that has a branch in mainland UAE receives mainland sourced income, whilst continuing to benefit from the 0% CT rate on its other income.
A Free Zone company can at any point in time make an election to become subject to regular CT in the UAE. If the regular CT status is granted to the Free Zone company, it will be irrevocable.
What would be the CT compliance requirements?
Whilst Free Zone companies might be subject to a 0% CT rate, they would still be within the scope of the UAE CT. Free Zone companies would be required to register for CT, file tax returns annually, maintain adequate substance and comply with all other regulatory requirements.
Free Zone companies that benefit from the 0% CT rate cannot elect to form a Tax group and be treated as a single taxable person under the CT regime.
How to be prepared
Since the CT impact may differ depending on transactions from which the business profit is earned, the following measures should be put in place by all Free Zone companies:
- Analyze CT requirements applicable to business activities carried out. Understand what is expected to be taxable at standard UAE CT rate resp. zero-rated
- Review the legal structure, business model, and capital structure rationalization
- Check for adequate bookkeeping. Unless included in the Tax Group for CT purposes, each legal entity is required to report taxable income separately
- Check whether the business maintains accounting records following internationally accepted accounting standards.
- Revenue subject to CT is the accounting net profit as per financial statements (after adjustments to be specified in the UAE CT Law)
- Analyze if documentation maintained by the business as on date could be adequate to justify business profits subjected to zero-rating relief or taxable at standard UAE CT rate; remediate if necessary. Tax authorities could review books of accounts and the supporting documents.
