Tax Policies Affecting Free Zone Residents

Modern realities compel business owners to seek more favorable jurisdictions in terms of regulation, particularly taxation. Additionally, the choice is influenced by the opportunities for quick and safe banking transactions. This review aims to highlight some aspects of the taxation of residents in the UAE's Free Economic Zones (FEZ) that allow for a preferential tax regime.

Until recently, the UAE was effectively a "tax haven" with no corporate income tax in this jurisdiction. However, with the adoption of Federal Law No. 47 "On Corporate Income Tax" in 2022, the situation changed: now, UAE resident companies (both mainland and FEZ) are subject to taxation on their profits. Nevertheless, the tax rate remains one of the lowest in the world (9%), and FEZ residents can benefit from a preferential regime with a zero tax rate if they meet the criteria set forth by the Law.

By default, profits from transactions between FEZ residents qualify as "qualified income," allowing them to benefit from the preferential tax regime. However, there are exceptions: for instance, regulated financial services (such as fund management, private equity or investment management, banking, and insurance activities (excluding reinsurance), leasing, ownership or operation of real estate (excluding transactions involving commercial real estate between FEZ residents), ownership and use of intellectual property assets, and certain other activities are considered excluded activities). Income from such activities is subject to a cap: UAE Ministry of Finance Decree No. 139 of 2023 stipulates that such income cannot exceed 5% of total income or AED 5 million, whichever is lower (de minimis rule). Otherwise, the profits will no longer meet the established criteria and will be taxed under general conditions in the tax period in which the maximum income from excluded activities is exceeded, as well as for the subsequent four tax periods.

In addition, companies must demonstrate adequate presence (substance) in the UAE, meaning they must generate their primary income within the FEZ, have sufficient assets and qualified employees, and incur operational expenses for their activities. Related parties and entities are required to comply with the "arm's length" principle, and violations of Transfer Pricing rules may result in a "shift" from the preferential tax regime to the standard regime.

Profits of FEZ residents from transactions with companies established on the mainland are subject to corporate income tax at the standard rate (9%), except when the transactions involve so-called qualified activities, a closed list of which is established by UAE Ministry of Finance Decree No. 139 of 2023.

We recommend our clients undertake the following measures:

1. Audit of counterparties (segregation by type “FEZ resident” - “all others”) to determine (i) which transactions are conducted with non-FEZ residents (including individuals), (ii) whether they involve activities that are non-qualified or excluded;

2. Audit of contract subjects with counterparties. Check whether the conditions regarding the counterparty's status and types of transactions that may or may not generate qualified income are met;

3. Monitor compliance with the de minimis rule, adhere to the "income" proportion for transactions involving excluded and non-qualified activities to avoid breaching the thresholds set by the UAE Ministry of Finance;

4. Monitor compliance with the de minimis rule, adhere to the "income" proportion for transactions involving excluded and non-qualified activities to ensure the thresholds set by the UAE Ministry of Finance are not exceeded.