Modern realities force business owners to seek more advantageous jurisdictions in terms of regulation, particularly taxation. In addition, choices are influenced by the opportunities for fast and secure banking transactions.
In this overview, we would like to focus on certain aspects of taxation for residents of the free economic zones (FEZ) of the UAE, which allow for favorable tax regimes.
Until recently, the UAE essentially represented a "tax haven" with no corporate income tax in this jurisdiction. With the adoption of Federal Law No. 47 "On Corporate Income Tax" in 2022, the situation has changed: now UAE resident companies (both mainland and free zone) are subject to taxation on their profits. However, the tax rate remains one of the lowest in the world (9%), and for free zone residents, a preferential regime is provided if they comply with the regulated criteria specified by the law, allowing them to benefit from a zero tax rate.
The profit from transactions between residents of SEZ is considered qualified income by default, which allows for preferential tax treatment. However, there are exceptions: for example, regulated types of financial services (fund management, private equity or investments, banking and insurance activities (except reinsurance), leasing, ownership or operation of real estate (except transactions involving commercial real estate between SEZ residents), ownership and use of intellectual property assets, and some others are considered excluded activities. The income from such activities has a set limit: Resolution of the Ministry of Finance of the UAE No. 139 of 2023 provides that such income cannot exceed 5% of the total income or AED 5 million (whichever is lower) (de minimis rule). Otherwise, the profit will cease to meet the established criteria and will be subject to taxation under general conditions in the tax period in which the maximum amount of income from excluded activities is exceeded, as well as during the subsequent four tax periods.
The profit from transactions between residents of SEZ is considered qualified income by default, which allows for preferential tax treatment. However, there are exceptions: for example, regulated types of financial services (fund management, private equity or investments, banking and insurance activities (except reinsurance), leasing, ownership or operation of real estate (except transactions involving commercial real estate between SEZ residents), ownership and use of intellectual property assets, and some others are considered excluded activities. The income from such activities has a set limit: Resolution of the Ministry of Finance of the UAE No. 139 of 2023 provides that such income cannot exceed 5% of the total income or AED 5 million (whichever is lower) (de minimis rule). Otherwise, the profit will cease to meet the established criteria and will be subject to taxation under general conditions in the tax period in which the maximum amount of income from excluded activities is exceeded, as well as during the subsequent four tax periods.
In addition, companies must demonstrate substantial presence in the UAE, which means earning their main income in the Free Zones, having a sufficient amount of assets and a number of qualified employees, and bearing operational expenses for their activities. Compliance with the "arm's length principle" is mandatory for related parties and individuals, and violation of the Transfer Pricing rules may result in a transition from preferential tax regime to the standard one.
Residents of Free Zones are subject to income tax at a rate of 9% on profits derived from transactions with companies established on the mainland, except in cases where transactions are conducted within qualified activities, as defined in Resolution No. 139 of the UAE Ministry of Finance in 2023.
We recommend the following activities for our clients:
- Conduct an audit of counterparties, segregating them based on the type of "SEZ resident" and "all others", to determine (i) what transactions are being conducted with non-residents of SEZs (including individuals), (ii) whether they are related to activities that are inappropriate or excluded.
- Audit the terms of contracts with counterparties to ensure compliance with the subjectivity of the counterparty and the types of transactions that may or may not generate corresponding profit.
- Monitor compliance with the de minimis rule, adhere to the "income" proportion for transactions involving excluded and inappropriate activities to avoid exceeding the threshold values defined by the Ministry of Finance of the UAE.
- When dealing with related parties, ensure that contracts are made on market conditions and retain documents confirming compliance with these conditions.
- To enforce compliance with the de minimis rule, adhere to the "income" proportion for transactions related to exempted and non-compliant activities in order not to exceed the threshold values set by the Ministry of Finance of the UAE.