Have you ever asked yourself, “What is qualifying income in the UAE?” Understanding qualifying income in corporate tax is essential for businesses operating within the Free Zones of the United Arab Emirates. By implementing the UAE Corporate Tax Law on 1 June 2023, companies now navigate a taxation framework that includes a 9% corporate tax rate on income above USD 102,110 (AED 375,000).
However, for Qualifying Free Zone Persons, a favourable 0% tax rate applies to their qualifying income. In contrast, their non-qualifying income is taxed at the standard rate. This introduction will delve into the criteria that distinguish qualifying income from non-qualifying revenue, the implications for Free Zone businesses and the strategic considerations to optimise tax efficiency under the new corporate tax regime.
In the context of the United Arab Emirates (UAE) Corporate Tax Law (CTL), which kicked in on 1 June 2023, the concept of ‘Qualifying Income’ is essential for businesses, especially those operating within free zones. The CTL sets a primary corporate tax rate of 9% on income that exceeds USD 102,110 (AED 375,000). But for Qualifying Free Zone Persons (QFZPs), a 0% tax rate is applied to their qualifying income. In comparison, non-qualifying revenue gets taxed at 9%.
To figure out what counts as qualifying income for a QFZP, several boxes need to be ticked. The income must come from transactions with other Free Zone entities, as long as it doesn’t stem from Excluded Activities. Income from dealings with Non-Free Zone Persons can also qualify, but only if it’s related to Qualifying Activities that aren’t Excluded Activities.
Qualifying Activities are diverse and include manufacturing, processing goods or materials, holding shares and other securities, and a range of services regulated within the UAE. On the flip side, Excluded Activities span various transactions, such as those with natural persons (with some exceptions). Activities in the banking, insurance, finance, and leasing sectors that are under regulatory watch are also out of the running. Ownership or exploitation of immovable property or intellectual property assets falls under Excluded Activities, too.
Your QFZP’s income might qualify if it meets specific de minimis requirements. These are met when the Non-Qualifying Revenue of a QFZP in a tax period is either less than 5% of its total revenue for that period or below USD 1.36 million (AED 5 million), whichever is lower. If these thresholds are exceeded, or if the QFZP doesn’t meet the eligibility conditions set out in Article 18 of the CTL or other prescribed conditions, the entity will lose its status as a QFZP from the start of the relevant tax period and for the next four tax periods.
For an entity to be seen as a beneficial recipient of qualifying income, it’s not enough to generate such income; it must also satisfy additional conditions. A QFZP is required to conduct its core income-generating activities within a Free Zone. It must have adequate assets and employ qualified staff in line with the activity being undertaken. Plus, it’s expected to incur operating expenditures that make sense for its business type.
Another critical requirement is the preparation of audited financial statements in line with the CTL. These financial statements are vital for showing you’re playing by the tax rules. They also prove that the income qualifies under the CTL.
If you’re operating within Free Zones, reviewing your activities and financial arrangements carefully is smart. Doing so ensures you’re in the running for preferential tax treatment and that you’re keeping up with the UAE’s tax regulations.
Entities incorporated or recognised under UAE law, including those in Free Zones, are considered resident persons for CT purposes. This classification is crucial as it determines the scope of taxable income and associated obligations.
For foreign companies, the criteria for being treated as a resident for CT purposes depend on whether their effective management and control are within the UAE. Thus, a company not incorporated in the UAE could still be subject to UAE CT if its central management activities and decision-making occur within the country.
A non-resident entity becomes taxable in the UAE when they have a permanent establishment (PE) there, derives state-sourced income, or has a connection in the UAE through income from property located within the country. The definition of a PE is essential for determining tax liability for non-resident entities. Typically, a PE is a fixed place of business through which the non-resident conducts their business activities, wholly or partially, within the UAE.
However, not all physical presences qualify as a PE. The CTL specifies that locations used solely for preparatory or auxiliary activities do not constitute a PE. This distinction is important as it exempts certain minor or supportive operations from being taxed under the CTL.
The CTL also considers the role of investment managers who act on behalf of non-resident persons. An investment manager may be regarded as an independent agent and thus not establish a PE for the non-resident person they represent. This is pertinent for investment managers involved in various financial transactions, such as those concerning commodities, real estate, bonds, shares, derivatives, securities, or foreign exchange. This provision allows non-resident entities to engage local investment managers for transactions without creating a taxable presence.
Furthermore, the CTL recognises family foundations, trusts, and similar entities as separate legal persons. These entities are typically established to manage and protect the assets of individuals or families and possess their own legal identity. Under certain conditions, a family foundation may opt to be treated as a transparent ‘unincorporated partnership’ for CT purposes. This choice can prevent the income of the foundation or trust from being subject to tax in the UAE, offering a tax-efficient method for asset management, governance, and succession planning.
Determining the tax treatment for income derived from immovable property within a Free Zone requires understanding the nature of the property and the parties involved in the transactions. For commercial property, the source of the income dictates the tax implications. Income from transactions with entities outside the Free Zone is subject to the standard corporate tax rate. However, income from transactions within the Free Zone is exempt from tax, promoting intra-Free Zone commerce and supporting the UAE’s economic objectives.
For non-commercial property, the tax rate is consistent regardless of the transaction parties, simplifying the tax obligations for such property within Free Zones.
The de minimis rule limits the amount of Non-Qualifying Revenue a QFZP can earn without forfeiting their tax benefits. Specifically, this revenue must be at most the lesser of 5% of their Total Revenue or USD 1.36 million (AED 5 million). Non-qualifying revenue encompasses funds from Excluded Activities and transactions with parties outside the Free Zone that do not meet the criteria for Qualifying Activities.
Total revenue encompasses all the income a QFZP generates in a tax period before deductions, with certain exclusions. Specifically, revenue from transactions involving commercially immovable property with non-free zone persons and all transactions with non-commercially immovable property are excluded. Additionally, income associated with a Domestic Permanent Establishment or a Foreign Permanent Establishment of the QFZP is not considered.
The de minimis rule allows QFZPs to engage in a limited scope of Non-Qualifying Activities while maintaining their tax benefits, ensuring that the Free Zone’s economic incentives remain focused on preferred activities. Entities within a Free Zone must monitor their revenue streams to comply with the CTL and optimise their tax position.
The de minimis requirements are pivotal in determining the eligibility of a Free Zone Person (FZP) for tax benefits. These conditions are centred around the permissible limit of Non-Qualifying Revenue for an FZP to retain its status as a QFZP.
An FZP must monitor its Non-Qualifying Revenue to ensure it does not breach the specified threshold. This threshold is the lesser of 5% of their Total Revenue or USD 1.36 million (AED 5 million) within a tax period. Non-qualifying revenue includes funds from activities that do not align with the core operations incentivised by the tax benefits.
Excluded Activities cover a spectrum of operations, including regulated financial services and transactions involving immovable property. Conversely, Total Revenue is the aggregate income of a QFZP before deductions, with certain exclusions.
Whether domestic or foreign, income related to a PE is not included in the Total Revenue calculation, qualifying income encompasses earnings from transactions within Free Zones, barring those from Excluded Activities and from dealings with Non-Free Zone Persons that involve Qualifying Activities.
If an FZP’s Non-Qualifying Revenue surpasses the de minimis limit, it will be reclassified and taxed at the standard rate for a minimum of five years. Additionally, a mainland branch of a QFZP is typically viewed as a domestic PE and is taxed accordingly. These requirements are integral to the CTL, acting as a gauge for FZPs to sustain their qualifying status and capitalise on the tax advantages that bolster the UAE’s status as an international business centre.
Non-qualifying revenue also includes funds from transactions that, under normal circumstances, would be considered for tax relief but fail to qualify when the counter-party is outside the FZ.
If a QFZP’s non-qualifying revenue exceeds the de minimis limits or if the entity does not adhere to the eligibility conditions in Article 18 of the CTL or additional prescribed rules, it will be stripped of its QFZP designation. This reclassification is effective from the beginning of the tax period in question and extends to four subsequent periods. During this period, the entity is barred from joining a tax group or carrying forward its tax losses.
Moreover, an entity that no longer qualifies as a QFZP is ineligible for certain tax reliefs, such as CT rollover relief, which pertains to transfers within a qualifying group and business restructuring relief as outlined in Articles 26 and 27 of the CTL.
Entities in FZs must also adhere to transfer pricing obligations under the CTL, which necessitate auditing annual financial statements.
Entities should evaluate whether their operations align with the CTL’s provisions for tax relief. This involves assessing the nature of their transactions, their business partners’ location, and their activities’ classification. They must also ensure compliance with all administrative requirements associated with QFZP status. In some cases, forgoing the FZ relief to take advantage of other tax provisions, such as tax grouping or transferring tax losses, may be more beneficial.
In an ever-evolving business landscape, the UAE’s Corporate Tax Law presents opportunities and challenges for entities operating within its jurisdiction.
Staying vigilant about the nature of your earnings, ensuring activities are correctly categorised, and consistently reviewing financial thresholds are more than just good practices; they’re essential for maintaining the economic advantages of being a QFZP.
As the UAE continues to cement its position as a global trade hub, adapting to its tax structures is not just about legal compliance but strategic business positioning.
Remember, navigating the CTL effectively requires keeping updated with changes, seeking professional advice, and meticulously aligning your business activities with the qualifying criteria. Only then can businesses fully leverage the benefits of the UAE’s tax regime.