One of the most common misconceptions about UAE Corporate Tax is that free zone companies are automatically exempt. They are not. A free zone company is within the Corporate Tax regime and must register and file returns. It can benefit from a 0% rate on qualifying income, but only if it meets the conditions to be a Qualifying Free Zone Person (QFZP).
Those conditions are strict, and missing one can have consequences for several years.
The conditions
To be a QFZP, a free zone entity must, among other things:
- Maintain adequate substance in the free zone. The core income-generating activities should be carried out in the free zone, with appropriate assets, qualified staff and operating expenditure.
- Derive qualifying income. Broadly, this means income from transactions with other free zone persons, and income from certain qualifying activities with others.
- Not elect to be taxed at the standard rate. A free zone business can choose to be taxed like a mainland company, but then it is no longer a QFZP.
- Comply with the transfer pricing rules and maintain the required documentation.
- Prepare audited financial statements.
- Meet the de minimis requirement. Non-qualifying revenue must not exceed 5% of total revenue or AED 5 million, whichever is lower.
Qualifying activities
The rules list specific qualifying activities. Examples include manufacturing and processing of goods, certain trading in qualifying commodities, holding shares and other securities, logistics services, distribution of goods from a designated zone, and certain headquarters, treasury and financing services provided to related parties.
Many common activities, particularly services provided to mainland customers, are not on the list. Income from these is generally non-qualifying, and if it grows beyond the de minimis limit, the QFZP status can be lost.
What happens if a condition is not met
If a free zone entity fails to meet the conditions at any point during a tax period, it ceases to be a QFZP. It is then taxed at the standard rates for that tax period and the following four tax periods.
In other words, a single mistake can remove the benefit for five years. That is why the position should be monitored throughout the year, not only checked when the return is prepared.
Where businesses most often go wrong
- Assuming a free zone licence is enough. It is not; every condition has to be met and documented.
- Growing mainland revenue without tracking it. New contracts with mainland customers can push non-qualifying revenue over the de minimis threshold.
- Thin substance. A flexi-desk with no staff or activity in the zone is unlikely to support the claim.
- Missing transfer pricing documentation for transactions with related parties.
Practical steps
Review which of your income streams are qualifying and which are not, track non-qualifying revenue against the de minimis limit during the year, make sure your substance and transfer pricing records would stand up to review, and arrange your annual audit in good time.
Large multinational groups should also note that the Domestic Minimum Top-up Tax, which applies from 2025, may apply on top of the 0% rate.
If you would like us to assess whether your free zone company qualifies, or to review the risks to its status, please get in touch.
This article is general information based on the rules as we understand them at the date of publication. It is not advice on your circumstances. Laws and practice change, so please speak to us before acting on it.
