In a significant development for regional and international businesses, UAE free zone companies can still benefit from 0% corporate tax under the recently introduced UAE Corporate Tax Law—provided they meet strict qualifying income and substance requirements.
The introduction of a 9% corporate tax on business profits exceeding AED 375,000, effective from June 2023, was a major policy shift aimed at aligning the UAE with global tax standards. However, authorities have confirmed that the new tax regime is designed to preserve the competitiveness of UAE free zones, which are vital to the country’s diversified economic growth.
Free Zones Remain Attractive Under New Corporate Tax Regime
Free zones have long been an attractive base for entrepreneurs and multinational firms, offering 100% foreign ownership, streamlined business setup, modern infrastructure, and regulatory autonomy. To maintain this appeal, the Corporate Tax Law includes special provisions allowing qualifying free zone persons (QFZPs) to pay 0% corporate tax on qualifying income.
The tax benefits apply to both designated and non-designated free zones, provided the business meets specific operational and financial criteria. Each free zone is governed by its own authority, responsible for business licensing, regulations, and enforcement.
Qualifying for 0% Corporate Tax: Conditions to Meet
A Qualifying Free Zone Person (QFZP) must comply with all the requirements set forth in Article 18 of the UAE Corporate Tax Law, as elaborated in Cabinet Decision No. 55 of 2023.
To be considered a QFZP and enjoy the 0% tax rate, a company must:
- Earn qualifying income from relevant transactions.
- Maintain adequate economic substance in a UAE free zone.
- Fulfil the de minimis requirement (limiting non-qualifying income).
- Not elect to be taxed under the standard regime.
- Adhere to the arm’s length principle for intra-group transactions.
- Follow transfer pricing regulations.
- Maintain audited financial statements.
Failure to meet any of these conditions during a tax period means the business will forfeit its QFZP status and become subject to the standard 9% corporate tax rate.
Understanding ‘Adequate Substance’ in the UAE Free Zones
To retain eligibility for the 0% corporate tax, QFZPs must demonstrate adequate substance—a cornerstone requirement under the Corporate Tax Law.
This involves:
- Conducting core income-generating activities (CIGAs) within the free zone (or a designated zone if involved in distribution).
- Maintaining physical assets, sufficient operating expenditure, and qualified full-time employees in the free zone.
- Ensuring that outsourced activities—if any—are supervised and remain compliant with UAE laws.
Core activities may include distribution, manufacturing, logistics, R&D (for intellectual property), or service delivery. Non-core activities, like back-office functions, may be conducted outside free zones without affecting eligibility.
For example, Company A, which operates from a non-designated free zone but stores goods in a designated warehouse, fails to meet substance requirements if its distribution activities are not conducted in a designated zone. However, if it trades exclusively with other free zone persons, it may still benefit from the 0% tax rate, depending on the nature of the transactions.
Qualifying Income: What Counts?
The qualifying income eligible for the 0% rate includes:
- Income from transactions with other free zone persons.
- Certain regulated activities, such as manufacturing, logistics, or R&D, carried out within the zone.
- Income derived from goods distributed from a designated zone to other free zone entities.
However, income from transactions with mainland UAE customers or other non-qualifying activities will typically be taxed at the standard 9%, unless explicitly exempted.
Key Takeaway for Free Zone Businesses
The UAE’s move to implement corporate tax brings greater transparency and long-term sustainability, but businesses must act proactively to comply with the new rules. Free zone firms should assess their operations, ensure core activities are performed within the correct jurisdiction, and maintain robust documentation.
Companies that want to benefit from UAE free zone corporate tax exemption must align their operations with the evolving tax landscape. With audits, transfer pricing rules, and substance requirements now in effect, strategic planning and tax advisory are more critical than ever.
