Cabinet Decision No. 100 and Ministerial Decision No. 265 for Free Zone Entities

The Cabinet of Ministers has recently enacted Cabinet Decision No. 100 of 2023, effective from June 1, 2023, to determine Qualifying Income for Qualifying Free Zone Persons under Federal Decree-Law No. 47 of 2022 (referred to as the CT Law), replacing the earlier Cabinet Decision No. 55 of 2023 issued on May 30, 2023.

Additionally, the Ministry of Finance has issued Ministerial Decision No. 265 of 2023, also effective from June 1, 2023, defining “Qualifying Activities” and “Excluded Activities” while addressing procedural conditions for the CT Law. This supplements the aforementioned Cabinet Decision and repeals Ministerial Decision 139 of 2023 issued on June 1, 2023.

Qualifying Free Zone Person (‘QFZP’) under the Corporate Tax Law

According to Article 18 of the CT Law, a Qualifying Free Zone Person must fulfill the following conditions:

• Maintain Adequate Substance in the UAE
• Derive Qualifying Income
• Not elect to be subject to Corporate Tax under the CT Law
• Comply with Transfer Pricing regulations
• Maintain audited financial statements as per IFRS/IFRS for SMEs
• Ensure Non-Qualifying Revenue does not exceed De Minimis requirements in a Tax Period

If a QFZP fails to meet these conditions at any time in a Tax Period, it ceases to be a QFZP from the beginning of the relevant Tax Period, and for the subsequent 4 Tax Periods. Consequently, the free zone person is treated as a Taxable Person subject to a 9% corporate income tax for a minimum term of 5 years.

Introduced Aspects

1. Qualifying Intellectual Property (“QIP”): Introduced to cover Patents, Copyrighted Software, and equivalent rights, excluding marketing-related intellectual property assets such as trademarks.
2. Expanded Scope of Qualifying Income: Now includes income from the ownership or exploitation of Qualifying Intellectual Property, excluding income attributable to a Domestic PE or a Foreign PE, or derived from immovable property.
3. Taxation of Non-Qualifying Income: Income from non-Qualifying Intellectual Property and income exceeding Qualifying income, calculated with the prescribed formula, is considered taxable income and taxed at 9% as per Article 3 of the CT Law.
4. Qualifying Commodities: Revenue generated from the Trading of Commodities, specifically metals, minerals, energy, and agricultural commodities traded on a recognized commodities exchange market in raw form, is considered Qualifying Income. 

Expanded Scope of Qualifying Activities

• Manufacturing and processing of goods or materials
• Trading of Qualifying Commodities
• Holding of shares and other securities for Investment Purposes
• Ownership and operation of ships
• Reinsurance services
• Fund management services
• Headquarters, treasury, and financing services to related parties
• Financing and leasing of aircraft
• Logistics
• Distribution of goods in or from a designated zone (as defined in VAT Law) subject to certain conditions
• Ancillary activities related to the above activities.

Excluded Activities

• Transactions with natural persons (exceptions apply)
• Banking and insurance activities
• Financing and leasing activities (excluding specific cases)
• Ownership or exploitation of immovable property (except Commercial Property in a Free Zone)

What is the Qualifying Income of a Qualifying Free Zone Person (QFZP)?

The types of incomes excluded and incomes included considered as “Qualifying Income” are outlined in the following table:

Excluded Incomes:

• Incomes attributable to a Domestic Permanent Establishment (‘PE’) or a Foreign PE.
• Incomes attributable to the ownership or exploitation of immovable property, as specified in point 3 below.
• Incomes derived from any Person specified in the Excluded Activities.
• Incomes derived from a Non-Free Zone Person other than Qualifying Activities.

Included Incomes:

• Any income derived from other Free Zone Persons (excluding those derived from Excluded Activities), provided that the other Free Zone Person is the Beneficial Recipient* of the relevant services or goods.
• Income derived from ownership or exploitation of Qualifying Intellectual Property, calculated in accordance with the Decisions.
• Income derived from the trading of Qualifying Commodities.
• Income derived from Qualifying Activities undertaken with a Non-Free Zone Person (provided it is not treated as Excluded Activities).
• Any other income, subject to satisfaction of De Minimis requirement, as per point 4 below.

Beneficial Recipient is defined as a Person who has the right to use and enjoy the service or the good and does not have a contractual or legal obligation to pass such service or good to another Person. Good is defined as any tangible or intangible property that has economic value in dealing, including moveable and immovable property.

Domestic Permanent Establishment

Domestic PE is a presence outside the Free Zone in the UAE. It is subject to 9% tax on taxable income, with no AED 375,000 threshold exemption.

Income from Permanent  Establishments 

Income attributable to a Domestic or Foreign PE is considered taxable income at 9%, calculated as if the PE was a separate entity.

Income from Immovable Property

Income from immovable property in a Free Zone is taxable at 9%, excluding the AED 375,000 threshold exemption.

Issuance of bonus shares

Bonus shares usually refer to additional shares that a company allocates to its existing shareholders out of its profits or reserves, without receiving new consideration from the shareholders. Since bonus shares are in effect a payment out of a company’s profit and reserves, they meet the definition of a Dividend.

Non-Qualifying Revenue and Total Revenue

Revenue derived from excluded activities or non-qualifying activities with a Non-Free Zone Person is Non-Qualifying Revenue. Total Revenue excludes certain categories, ensuring compliance with De Minimis requirements.

These decisions introduce critical concepts like QIP, expand the scope of Qualifying Income, and define activities as Qualifying or Excluded. QFZPs must meet substance requirements, and the introduced Domestic PE concept and De Minimis Rule play crucial roles. Understanding these aspects is vital for Free Zone entities to navigate tax implications effectively. 

Conclusion

In conclusion, the recent enactments of Cabinet Decision No. 100 of 2023 and Ministerial Decision No. 265 of 2023 marked significant developments in determining Qualifying Income for Free Zone Persons under the Federal Decree Law No. 47 of 2022 (CT Law). The comprehensive framework outlines conditions for Qualifying Free Zone Persons (QFZPs), introduces the concept of Qualifying Intellectual Property (QIP), and broadens the scope of Qualifying Income.

The decisions also specify Qualifying Activities, and Excluded Activities, and detail the calculation of Non-Qualifying Revenue. As Free Zone entities navigate these changes, understanding the nuances of Domestic Permanent Establishment, income attribution, and De Minimis requirements becomes imperative for effective tax compliance.

Summary

The recent enactments of Cabinet Decision No. 100 of 2023 and Ministerial Decision No. 265 of 2023 usher in a new era for Qualifying Free Zone Persons (QFZPs) under Federal Decree Law No. 47 of 2022 (CT Law). Effective from June 1, 2023, these decisions replace previous ones, emphasizing the dynamic nature of tax regulations. Article 18 of the CT Law outlines stringent conditions for QFZPs, ensuring substance maintenance and compliance with tax regulations.

Failure to meet these conditions subjects entities to a 9% corporate income tax for a minimum of 5 years. The introduced aspects, such as Qualifying Intellectual Property (QIP) and the expanded scope of Qualifying Income, redefine the landscape. Notably, the Domestic Permanent Establishment and De Minimis Rules bring nuances to the taxation framework. As Free Zone entities adapt to these changes, a comprehensive understanding of Qualifying Activities, Excluded Activities, and the complex web of income categorizations becomes paramount for effective tax navigation.

The decisions mark a pivotal moment, requiring businesses to align with the intricacies of the revised tax framework to ensure compliance and strategic financial planning in the evolving landscape.