Free zone corporate tax in the UAE

How free zone companies are taxed

Every free zone company must register for corporate tax and file a return. Being in a free zone does not remove those obligations. What changes is the rate that can apply to some of your income.

A free zone company that meets all the conditions is a Qualifying Free Zone Person, or QFZP. A QFZP pays 0% on qualifying income and 9% on non-qualifying income. A free zone company that does not meet the conditions is taxed like a mainland company: 0% on the first AED 375,000 of taxable income and 9% above that.

QFZP status is not something you apply for once. It depends on meeting the conditions in each tax period, so it needs to be checked every year.

The conditions for QFZP status

To be a QFZP, a free zone company must maintain adequate substance in the free zone, earn qualifying income, meet the de minimis rule, comply with transfer pricing rules, prepare audited financial statements, and not elect to be taxed under the standard rules.

Substance means your core income-generating activities are carried out in the free zone, with adequate staff, premises, assets and operating costs for the business you run. A licence and a flexi-desk with no real activity is unlikely to be enough.

If a QFZP fails a condition, it loses its status. Under the current rules, the loss applies for that tax period and the following four tax periods, which makes a single failure expensive. That is why we check the conditions before the year ends, not only when the return is due.

Qualifying and non-qualifying income

Qualifying income generally comes from transactions with other free zone persons, and from qualifying activities carried out with anyone. Qualifying activities include manufacturing and processing, trading qualifying commodities, holding shares, logistics services, fund and wealth management, headquarter services and certain treasury and financing services to related parties.

Income from excluded activities is non-qualifying. These include most transactions with natural persons, regulated banking and insurance activities, and most income from immovable property. Revenue from mainland customers that does not come from a qualifying activity is usually non-qualifying as well.

Getting this classification right is the main work of a free zone return. We go through your revenue line by line, because one customer type or one contract can change the result. Where a contract is unclear, we look at the substance of what you actually supply, not just the label on the invoice.

The de minimis rule

A QFZP can earn some non-qualifying revenue and keep its status, but only up to a limit. Non-qualifying revenue must not exceed 5% of total revenue or AED 5 million, whichever is lower.

For a company with total revenue of AED 40 million, 5% is AED 2 million, so the limit is AED 2 million. For a company with total revenue of AED 150 million, 5% is AED 7.5 million, so the lower AED 5 million limit applies.

Crossing the de minimis limit means losing QFZP status, not just paying 9% on the excess. Companies close to the limit should track non-qualifying revenue during the year so they can act before it is too late.

Audit and transfer pricing

Audited financial statements are a condition for QFZP status, whatever the size of the company. Your audit needs to be complete before the return can be finalised, so we plan the timing with you and your auditor.

Transactions with related parties and connected persons must be at arm's length. For free zone groups, this often covers management fees, shared staff costs and intercompany sales. We review these arrangements and prepare the disclosures required with the return.

Many free zone authorities already require an annual audit for licence renewal. The corporate tax requirement is separate, but one audit can serve both purposes if it is planned well. We make sure the auditor has what is needed to support the QFZP position, not only the licence renewal.