Corporate taxation in the UAE: new rules for free zone companies

9 November 2023
Tax Messenger
In June 2023, we covered the UAE regulations clarifying how preferential tax treatment (0% tax on qualifying activities) applies to qualifying companies resident in free zones:

  • Cabinet Decision No. 55 of 2023 on Determining Qualifying Income
  • Ministerial Decision No. 139 of 2023 on Qualifying Activities and Excluded Activities

In late October 2023, new regulations were adopted to replace the previous Decisions:

  • Cabinet Decision No. 100 of 2023 on Determining Qualifying Income (Decision No. 100)
  • Ministerial Decision No. 265 of 2023 on Qualifying Activities and Excluded Activities (Decision No. 265)

The new decisions have been in force since 1 June 2023 and contain many provisions that are substantially the same as those in the repealed regulations. Both were issued after a series of public consultations held in the summer of 2023, but their final versions differ in some respects from those originally proposed for discussion. This Alert focuses on what is new compared to the previous versions.
Key changes at a glance

Decision No. 100 introduces a new category of qualifying income, that is, income from the ownership and/or use of qualifying intellectual property (but removes income from the ownership/use of trademarks).

  • The formula for calculating non-taxable income now treated as qualifying income is set out in Decision No. 265. Under the previous decision No. 139, this type of income was regarded as taxable (income from excluded activities).
  • The new version removes the option to treat as ‘qualifying’ any receipts that are incidental to qualifying income.
  • It also contains new provisions on maintaining adequate substance in a free zone and outsourcing certain activities outside a free zone. A company resident in a free zone is now allowed to conduct its core income-generating activities in a free zone or a ‘designated zone’ (as defined in Federal Decree-Law No. 8 of 2017 on Value Added Tax), depending on where such activities are required to be conducted. In addition, a company may outsource an activity to a related or third party, both in a free zone or a designated zone. An activity associated with qualifying intellectual property may be outsourced to any party within the UAE or to an unrelated party outside the UAE (subject to appropriate supervision by the company). It is further clarified that a company should have a sufficient number of qualified full-time employees.
A key change introduced by Decision No. 265 is that the list of qualifying activities has been expanded to include trading of qualifying commodities, defined as “physical trading of metals, minerals, energy and agriculture commodities that are traded on a recognized commodities exchange market in raw form”.

  • While it was originally hoped that the tax exemption would apply to all transactions in which goods never physically enter the UAE, the relief included in the final version of the Decision is narrower in scope. Trading companies need to consider whether their goods fall within the scope of the new rule.
  • A recognized commodities exchange market may be any licensed commodities exchange in the UAE or “any commodities exchange market established and recognized outside the State of equal standing”.
  • The Decision provides a more detailed description of qualifying and excluded activities. For example, it clarifies:
  1. That activities associated with the holding of shares and other securities must be carried out for investment purposes, and that shares and other securities are deemed to be for investment purposes if held for at least 12 consecutive months, i.e., it draws a distinction between investment and speculative ownership;
  2. That qualifying activities associated with trading of qualifying commodities also include derivatives used to hedge these activities;
  3. For regulated qualifying/excluded financial activities, it sets out a list of regulators and legislation governing the regulated activities;
  4. Other provisions.

  • It adds further clarity to the definition of activities that are ancillary to a qualifying/excluded activity. An activity is considered ancillary if it is necessary for the performance of the main activity or if it makes only a minor contribution to it and is so closely related to the main activity that it should not be regarded as a separate activity.
  • The Decision also provides a calculation algorithm (formula) for qualifying income from the ownership and/or use of qualifying intellectual property.
A detailed assessment is recommended to determine the impact of the amended regulations on Russian corporate groups, including whether operational restructuring is required to remain eligible for the current exemptions, whether it makes sense to consolidate taxpayers into a group, and what steps should be taken to secure adequate substance in the UAE. Companies unable to retain their tax-exempt status are recommended to undertake a review of their tax position to identify potential corporate income tax credit opportunities. Special attention should be given to free zone residents that have permanent establishments abroad or in the UAE.

B1 professionals will be glad to help you analyze the implications for companies registered in free zones and assess the impact of the new regulations on your business. For most companies, the fiscal year runs the same as the calendar year, so corporate income tax issues are looming large.

Authors:
  • Alexei Kuznetsov
    Partner
    Financial Services Group
  • Maria Savelyeva
    Senior Manager
    Financial Services Group
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