Corporate Tax in the UAE – All in One

The introduction of corporate tax in the UAE marks a significant milestone in the country’s economic landscape. As businesses and tax professionals navigate this new regime, understanding the nuances of the law especially concerning free zones and transitional provisions is crucial. This article is focusing on the latest decisions around qualifying free zone income and transitional rules under the UAE corporate tax framework.

Understanding the New UAE Corporate Tax Landscape

The UAE’s corporate tax law introduces a fresh set of challenges and opportunities. With the Ministry of Finance actively issuing ministerial and cabinet decisions, the regulatory environment is evolving rapidly. Businesses, especially those operating within free zones, must now grasp the complexities behind qualifying income, tax rates, and compliance requirements.

At the core of the new regime is the concept of a qualifying free zone person, a taxable resident entity that meets specific criteria under Article 18 of Cabinet Decree No. 47. Such entities can benefit from a preferential corporate tax rate of zero percent on qualifying income, while non-qualifying income is generally taxed at nine percent. However, this classification comes with strict conditions and limitations, including restrictions on group consolidation and loss transfers.

Qualifying Free Zone Persons: Criteria and Conditions

To be recognised as a qualifying free zone person, entities must satisfy several conditions, such as:

• Maintaining adequate substance in the UAE free zone.
• Ensuring all related party transactions comply with arm’s length transfer pricing principles and are properly documented.
• Generating qualifying income, which excludes certain excluded activities.
• Not electing to be taxed under the standard corporate tax regime, which would forfeit qualifying free zone status.
• Having audited financial statements signed off by an auditor.
• Ensuring non-qualifying income does not exceed specified de minimis thresholds.

Failure to meet any of these conditions in a given year may result in the loss of the qualifying free zone status for that year and the subsequent four years, subjecting the entity to the standard nine percent corporate tax rate.

Key Restrictions for Qualifying Free Zone Persons

• They are not eligible for the small business relief or the AED 375,000 tax-free threshold.
• They cannot be part of a corporate tax group or qualifying group for loss transfer purposes.
• Special attention must be given to transfer pricing rules and VAT considerations.

Qualifying Income vs. Non-Qualifying Income

Understanding which income qualifies for the zero percent tax rate is fundamental. The law and cabinet decisions distinguish between:

1. Category A: Income from transactions exclusively between free zone persons, unless derived from excluded activities.
2. Category B: Income from transactions with non-free zone persons related to qualifying activities.
3. Category C: Other income not captured in categories A or B that falls within the de minimis threshold.

Excluded activities include regulated sectors such as banking, insurance, financing and leasing, intellectual property exploitation, and ownership of immovable property. Income derived from these activities is subject to the standard nine percent tax, regardless of the counterparty.

De Minimis Rule Explained

Category C allows qualifying free zone persons to maintain their status even if they have some non-qualifying income, as long as it does not exceed the lower of:

• 5% of adjusted total revenue (total revenue minus excluded income), or
• A fixed amount of AED 5 million.

If this threshold is breached, the entity loses its qualifying status, and all income becomes taxable at nine percent for the current and four subsequent years.

Tax Treatment of Immovable Property Income

Given the UAE’s dynamic real estate market, special rules address income from immovable properties owned by free zone persons. The tax treatment depends on:

• Whether the property is located inside or outside a free zone.
• Whether the property is commercial or non-commercial in nature.
• Whether the income is earned from transactions with free zone persons or non-free zone persons.

Summary of Taxation on immovable property income:

• Income from immovable property located on the mainland (non-free zone), whether commercial or non-commercial, is taxed at nine percent.
• Income from non-commercial property located within a free zone is taxed at nine percent.
• Income from commercial property located within a free zone is taxed at zero percent if earned from a free zone person; otherwise, it is subject to nine percent.

Transitional Rules: Capital Gains on Immovable Property

The corporate tax law includes transitional provisions to ease compliance and ensure fairness, especially concerning assets held before the law’s effective date.

For immovable properties such as land, taxpayers can elect relief for capital gains realized before their first tax year. This election requires meeting specific conditions:

• Assets must be owned before the first tax period (e.g, 1 January 2024 for calendar-year taxpayers).
• Assets should be measured on a historical cost basis in the opening balance sheet.
• The election must be submitted with the first tax return.

Taxpayers can choose between two methods to calculate the exempt portion of capital gains:

1. Direct Method: Uses market value at the start of the first tax year minus the cost or net book value to determine exempt gain.
2. Holding Period Method: Calculates exempt gain proportionally based on the holding period before the first tax year relative to the total holding period.

This relief reinforces principles of neutrality and fairness, allowing businesses to exclude historical gains from taxation under the new regime.

VAT Considerations and Interplay with Corporate Tax

While the corporate tax decisions do not explicitly address VAT, businesses must consider the interaction between VAT and corporate tax, especially within free zones.

Key VAT points include:

• Transactions between designated zones are generally out of scope for VAT.
• Supplies from designated zones to the mainland are subject to 5% VAT.
• Supplies from designated zones to outside the UAE are out of scope for VAT.

The alignment between VAT treatment and corporate tax qualifying income requires careful analysis to optimise compliance and tax planning.

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