Filing for Corporate Tax in UAE under Free Zone Explained: Comprehensive Guide for Qualifying Businesses

Businesses looking to start in the United Arab Emirates (UAE) have the option to get a license within the Free Zone areas, in the mainland, or both under the dual license. Operating on each jurisdiction has different perks, including their treatment of what is owed under their corporate tax regime.

At its core, Free Zone areas are genuine economic hubs designed to attract global business without distorting the local market. UAE Free Zones generally allow 100% foreign ownership and zone-specific regulation. Mainland businesses can also be 100% foreign-owned for many activities, but the licensing, regulatory requirements, and scope of permitted activities differ.

These entities are invited to participate in specific economic activities (depending on the designated area specialization), and have access to incentives such as tax benefits, clear regulatory environment and designated infrastructure. Owners also benefit from faster incorporation timelines, specialized virtual hubs and integrated business services and streamlined visa processing and immigration services.

Since the Federal Decree Law No 47 on the Taxation of Corporations and Businesses has been in effect starting 1 June 2023, businesses operating in the UAE are now required to actively assess how their business structure, income sources, and operations affect their corporate tax position.

Typically, the Federal Tax Authority is responsible for managing and enforcing tax obligations set by the Ministry of Finance, but relevant Free Zone authorities are responsible for managing the incorporation and licensing of businesses applying within their zones.

Qualifying Free Zone Person status is the UAE’s way of preserving Free Zone tax incentives while maintaining a credible corporate tax system. It rewards businesses operating within these designated zones by allowing tax flexibility with how it treats the income generated by the business.

Free Zone businesses involved must now actively determine whether they qualify for preferential treatment under the Qualifying Free Zone Person tax status. In this guide, we outline how QFZP status directly affects your business and how you can qualify and apply for this in the upcoming financial year.

What is a Qualifying Free Zone Person (QFZP) under UAE Corporate Tax Law?

A Qualifying Free Zone Persons is a status which could be received by Free Zone entities that meet specific conditions under UAE Corporate Tax regime. Through the QFZP status, these entities are eligible to apply a 0% corporate tax rate on qualifying income.

QFZP status directly affects your effective applicable tax rate. This also affects how businesses operating in the Free Zone will price work done in the mainland, and potentially how much risk you can carry into future years. Additionally, since tax groups are not eligible for QFZP status, electing for this 0% tax rate will affect how you structure group entities.

Granting the QFZP status is not automatic. Free zone persons must meet the ongoing eligibility and revenue nature requirements for each tax period.

QFZP Status Requirements

1. Be a juridical person registered in a UAE Free Zone
2. Maintain adequate substance on business activities in the Free Zone
3. Earn qualifying revenue as defined under the UAE Corporate Tax framework
4. Not elect into standard corporate taxation rate
5. Not earn more than the permitted amount of nonqualifying revenue under the De Minimis Rule:
   • A Qualifying Free Zone Person may earn non-qualifying revenue only up to the de minimis threshold, which is the lower of AED 5 million OR 5% of total revenue.
6. Because of the nature and framework behind QFZP, a free zone entity cannot:
   • Be part of a Corporate Tax Group
   • Claim Small Business Relief (i.e. tax relief) while electing for QFZP status
   • Free Zone entities may only join a Tax Group if they do not claim the 0% Free Zone regime. Likewise, a non free zone person may not apply for QFZP status.

QFZP are also required to comply with the following conditions to maintain their status:

1. Comply with the arm’s length principle and relevant transfer pricing rules and documentation requirements
2. Prepare audited financial statements for the relevant tax period
3. Elect QFZP treatment in its tax returns
4. Even where the 0% rate applies, corporate tax registration is mandatory and annual filing is required

Failure to meet any of these conditions can result in the loss of the QFZP status for the start of the tax period in which the breach occurs, and for the following four tax periods. During this time, the business is treated as a regular taxable person and the 0% tax rate on qualifying income cannot be applied.

After the five tax period lock out, QFZP status may be claimed again if the business meets all conditions for eligibility, has not elected into the standard corporate tax regime, is not part of any tax groups, and properly reflects its status in its corporate tax returns.

What is a Free Zone Person?

A Free Zone person is a juridical person incorporated or registered in respective Free Zone areas and are approved for their relevant activities by the assigned Free Zone Authority.

Natural persons (i.e. sole proprietors, self employed consultants, or human beings that have registered under personal licenses), and unincorporated partnerships, cannot be classified under QFZP status for corporate tax purposes.

Individuals are subject to corporate tax law if their annual business turnover exceeds AED 1 million in a calendar year.

A Free Zone Person is a QFZP only if it meets conditions (substance, audited FS, transfer pricing, de minimis, etc.).

What is considered as Qualifying Income vs. Non-Qualifying Income?

Under UAE Corporate tax law, Qualifying Free Zone Persons are subject to a 0% tax rate on qualifying income and 9% on non qualifying income.

The federal corporate tax law seeks to separate the qualifying income earned in order to preserve the incentives without distorting the mainland economy. As a result, the 0% rate applies only to qualifying income (generally from qualifying activities and qualifying transactions), while non-qualifying income is taxed at 9%.

Additionally, taxable persons are given the opportunity to balance competitiveness with real economic activities. The system allows low tax treatment tied to the income generated by businesses involved.

As a rule qualifying income (0%) generally includes:

• Income from transactions with other free zone persons
• Income from permitted qualifying activities as per applicable CT regulation
• Income that is not derived from explicitly stated excluded activities.

Nonqualifying income (9%) generally includes:

• Income from Non-Free Zone (mainland) persons that is not derived from Qualifying Activities (or that falls under Excluded Activities).
• Income from excluded activities
• Certain UAE sourced income that does not meet qualifying conditions

What happens to businesses with dual licenses?

A dual license allows an entity to legally conduct activities in both the free zone and mainland without the need for a local mainland agent. Corporate tax treatment follows how and where the income is generated.

Important: A dual license does not automatically preserve the 0% regime. Mainland-facing revenue must be monitored for the de minimis test, and income that is not Qualifying Income is generally taxed at 9%.

Here are some examples:

What are the Qualifying Activities and Excluded Activities?

1. Qualifying activities activate the corporate tax benefits for QFZP companies. These include:
   • Manufacturing and processing
   • Trading of qualifying commodities
   • Holding shares for investment management
   • Fund and wealth management
   • HQ, treasury, and financing services to Related Parties
   • Logistics and distribution in/from Designated Zones
2. Common excluded activities, even if licensed, include:
   • Certain professional and service activities and certain transactions with natural persons
   • Certain real estate activities, including ownership, leasing or exploitation of immovable property located in the UAE, unless property is considered as commercial property located in a free zone
   • Regulated banking and insurance activities
   • Any activity specifically listed as included under Cabinet decision or Ministerial decisions

Being able to quantify both activities prevent free zones from being used as tax shelter for mainland businesses and ensure that the incentives only apply to substance-based activities.

The De Minimis Rule Explained

Under the corporate tax law, a qualifying free zone person qualifies as long as non-qualifying revenue do not go beyond AED 5 million or 5% of total revenue, whichever is lower. As an example, assume a QFZP earns this much in the current tax period.

If total revenue is calculated at AED 20,000,000, then the fixed cap would either be AED 1,000,000 (5% of AED 20m) or AED 5,000,000. In this case, since the AED 1 million is lower, this becomes the threshold amount.

• If the non qualifying revenue is at, say, AED 800,000, then the threshold is not breached and QFZP status is preserved.
• However, if it exceeds at AED 1,000,001, QFZP status is lost and the company will be taxed under corporate tax rules during this period. The loss applies from the beginning of the taxation period and the following four taxable periods.

The company may also elect to join a tax group, if the ownership requirement is met.

Essential Substance Requirements

A Qualifying Free Zone Person must demonstrate that it has real economic substance in the free zone in order to benefit from the competitive tax advantages set by the United Arab Emirates. This ensures that tax benefits are linked to genuine business activities and is not being abused by virtue of being legally registered.

What does “adequate substance” mean for corporate tax purposes?

To justify their status eligibility, a business entity must meet the substance requirements outlined below:

1. Conduct its core income generating activities (CIGAs) within the Free Zone
   These are the key activities that actually produce the company’s revenue. For example:
   • A trading company negotiates and executes trade from the FZ
   • A holding company manages investments from the FZ
   • A logistics company runs warehouse operations from a FZ facility
2. Has a physical presence in the area
   • Office space, commercial immovable properties, or facilities appropriate to the nature and scale of the business
   • Shared or flexible space may be acceptable if commercially reasonable
3. Employs adequate assets including people and other resources
   • Qualified employees or outsourced personnel based in the area
   • Decision makers and operational staff must be aligned with the activity performed
4. Incurs other expenses within the Free Zone
   • These include operating costs that reflect actual activity (e.g. rent, payroll, service providers)

Why substance matters for corporate tax?

Substance is assessed every taxation period. Failure to meet these requirements can disqualify income from being treated as qualifying income. This may also lead to loss of QFZP status and trigger taxation under standard corporate tax rules.

Tax Implications and Treatment for Foreign Entities

Foreign entities are enticed to set up in Free Zone areas due to its low friction and ease of doing business. Businesses are able to stay competitive and efficient, especially for corporate tax purposes.

Free Zones are sometimes designed for export oriented, regional or international activity. Many areas are built for a specific purpose, giving foreign businesses access to relevant regulators, industry peers and tailored infrastructure and services.

To avoid any allegations of tax avoidance, it helps to understand how the QFZP status works and how foreign tax treatment is processed.

By itself, direct taxes levied on foreign activities do not affect QFZP status. However, income arising from Excluded Activities is treated as non-qualifying revenue and counts toward the de minimis threshold, regardless of whether it is earned in or outside the UAE.

An example of income attributable to foreign sources include:

• Services provided to overseas clients
• Sales to customers outside the UAE
• Overseas investments or operations

In general, foreign-sourced income can still be qualifying income under CT Law if:

• It arises from qualifying activities
• It is earned in line with substance requirements set by FZ conditions
• It is not linked to any activity deemed as excluded

What happens if you paid foreign tax?

The tax implications on foreign tax paid do not override UAE rules. Even if a QFZP pays tax in another country, it does not change whether the income becomes qualifying or non qualifying revenue.

Essentially, UAE corporate tax classification will apply first. The Federal Tax Authority states that under CT law, qualifying revenue will always be based first on where the income is generated; whether the activity qualifies; and whether QFZP conditions are met.

Generally, certain foreign tax credits allow businesses to offset UAE Corporate Tax with tax paid overseas on the same income, but only up to the UAE tax due and without any refund of excess foreign tax. These are subject to specific conditions and applicable limits.

Transfer Pricing and Auditing for Compliance with the Federal Tax Authority

To comply with the requirements of QFZP status, businesses must ensure that related party transactions are priced fairly (arm’s length principle) and that their financial records are properly audited and defensible.

Transfer pricing rules in practice apply to transactions within a group or between entities under common ownership or control. Under the arm’s length principle, transactions need to follow prices and terms that would reflect market value if and when independent parties would agree under similar circumstances.

Businesses are required to maintain transfer pricing documentation, which typically supports:

• How prices were determined and the commercial rationale for the concerned arrangements
• Proof of why the pricing is considered as arm’s length
• How the QFZP company earns both qualifying and non qualifying income on intragroup services, financing or IP arrangements

Why audited financial records matter for FTA Compliance

Audited financial statements are a mandatory requirement for QFZPs under CT law. The audits support the accuracy of the accounting profit. A QFZP is not required to prepare separate financial statements for Qualifying Income versus other income, but it must maintain sufficient supporting documentation to demonstrate how Qualifying Income was determined.

Audited accounts also form the basis for tax returns, FTA reviews or audits. The Federal Tax Authority may review the supporting documentation. Weak documentation or any proof of non-arm’s length pricing can lead to tax adjustments, loss of preferential treatment, administrative penalties and reassessments.

Corporate Tax Registration and Filing for Corporate Tax (UAE Free Zones)

To qualify for QFZP status, you must first register for corporate tax. Once registered, a taxable person is mandated to file tax returns within 9 months from the end of the tax period. Any tax liability must also be paid by the said deadline.

This filing obligation applies equally to free zone persons and qualifying free zone persons, even when there is no tax payable.

Corporate Tax Registration for QFZP

QFZPs do not have a separate or special registration process. They can register for corporate tax the same way as all taxable persons via the EmaraTax portal. Verifying their status comes later, in how income is treated in the tax returns.

You can find more information on how to register for corporate taxes in the UAE in this full guide.

1. Step 1: Confirm you are a free zone person. Before registering, businesses must be:
   • Incorporated or registered in a UAE Free Zone and hold a valid license that is regulated by the relevant authority
   • A juridical person (i.e. a company, not an individual)
2. Step 2: Register for corporate tax with the FTA
   • Registration is done through the EmaraTax portal (FTA’s online system)
   • This is mandatory even if you expect a 0% tax outcome
   • You will receive a Corporate Tax Registration Number (CT TRN) once approved.
3. Step 3: Maintain QFZP conditions during the tax period. These conditions are assessed for each period.
   • Maintain adequate economic substance
   • Earn qualifying income
   • Track nonqualifying income and make sure it is within the de minimis threshold
   • Prepare audited financial records
   • Comply with transfer pricing documentation
4. Step 4: Elect QFZP status in the corporate tax return
   • QFZP treatment is claimed when filing.
   • The company declares itself as QFZP, tags the qualifying vs nonqualifying income, and applies equivalent tax rates to each

Calculating corporate tax for filing

Corporate tax is imposed on a business’s taxable income, which is derived from its net profit or net income, after applying relevant tax adjustments, exemptions, and tax reliefs under the law.

Under QFZP, a taxable person calculates their tax liability as:

Taxable income = accounting profit + tax adjustments

Tax payable = Taxable income x applicable CT rate (0% on qualifying; 9% on non qualifying)

For first-time founders, it helps to have a professional guide you through the process. This is where skrooge.ai can help you.

Questions? Contact us via our website and our expert professionals will walk you through our process with complete transparency and quick insight within 15 minutes.

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