Understanding Qualifying Income in UAE Corporate Tax
February 27, 2025
February 27, 2025
In the rapidly evolving business environment of the United Arab Emirates (UAE), the implementation of the Corporate Tax Law (CTL) on June 1, 2023, has introduced significant changes, particularly for businesses operating within Free Zones. The CTL has ushered in a corporate tax rate of 9% on income surpassing USD 102,110 (AED 375,000). However, for entities that meet the criteria to be classified as Qualifying Free Zone Persons (QFZPs), there's a compelling advantage they enjoy a preferential 0% tax rate specifically on their qualifying income.
This distinction underscores the importance of understanding and qualifying for QFZP status, as it directly impacts the tax liabilities of businesses in the UAE. The concept of qualifying income is central to this framework, and businesses that fall within the criteria stand to benefit significantly from the favorable tax treatment afforded to them.
Our informative guide to understanding Qualifying Income in UAE Corporate Tax sheds light on how businesses can navigate the intricacies of the Corporate Tax Law (CTL) in the United Arab Emirates (UAE). With the CTL coming into effect on June 1, 2023, businesses, particularly those operating within Free Zones, face a new taxation framework. This guide aims to provide clarity on the concept of qualifying income and its implications for businesses.
Interested in understanding Qualifying Income in UAE Corporate Tax? This blog will cover:
- Criteria to Determine Qualifying Income
- Who is a Beneficial Recipient?
- Qualifying Income for Domestic or Foreign Permanent Establishment
- Qualifying Income for Immovable Property Located in a Free Zone
- What are the De Minimis Requirements?
- What is Non-Qualifying Revenue in the UAE?
- Navigating Qualifying Income Compliance
Criteria to Determine Qualifying Income
To qualify as a Qualifying Free Zone Person (QFZP), certain criteria must be met in determining what constitutes qualifying income. This income should originate from transactions with other Free Zone entities, excluding any involvement in Excluded Activities. Additionally, income derived from dealings with Non-Free Zone Persons can qualify, provided it is related to Qualifying Activities that do not fall under Excluded Activities.
Qualifying Activities cover a broad spectrum, including manufacturing, processing goods or materials, holding shares and securities, and various services regulated within the UAE. Conversely, Excluded Activities encompass transactions involving natural persons (with exceptions), as well as activities in the banking, insurance, finance, and leasing sectors, subject to regulatory oversight. Ownership or exploitation of immovable property or intellectual property assets also falls under the category of Excluded Activities.
For a QFZP's income to qualify, it must adhere to specific de minimis requirements. These requirements are considered met when the Non-Qualifying Revenue of a QFZP in a tax period is either less than 5% of its total revenue for that period or below USD 1.36 million (AED 5 million), whichever is lower. Exceeding these thresholds or failing to meet the eligibility conditions outlined in Article 18 of the CTL or other prescribed conditions will result in the entity losing its QFZP status from the beginning of the relevant tax period and for the subsequent four tax periods.
Who is a Beneficial Recipient?
To be recognized as a beneficial recipient of qualifying income, an entity must fulfill specific conditions beyond income generation. A Qualifying Free Zone Person (QFZP) is obligated to carry out its core income-generating activities within a Free Zone, maintaining sufficient assets, and employing qualified staff aligned with the undertaken activities. Additionally, it is expected to incur operating expenditures consistent with its business type.
An essential requirement is the preparation of audited financial statements in accordance with the Corporate Tax Law (CTL). These financial statements serve as crucial evidence of adherence to tax rules and confirm the qualification of income under the CTL.
For entities operating within Free Zones, a prudent approach involves a careful review of activities and financial arrangements. This ensures eligibility for preferential tax treatment and demonstrates compliance with the tax regulations of the United Arab Emirates.
Qualifying Income for Domestic or Foreign Permanent Establishment
Entities that are incorporated or officially acknowledged under UAE law, including those situated in Free Zones, are designated as resident persons for the purpose of Corporate Tax (CT). This classification is pivotal as it defines the extent of taxable income and the associated obligations.
For foreign companies, being regarded as a resident for Corporate Tax (CT) purposes depends on whether their effective management and control are located within the UAE. Therefore, a company not officially registered in the UAE may still be liable to UAE CT if its central management activities and decision-making processes occur within the country.
Taxability for a non-resident entity in the UAE arises when they possess a Permanent Establishment (PE) in the country, derive state-sourced income, or maintain a connection in the UAE through income generated from property located within its borders. The definition of a PE is crucial for determining tax liability for non-resident entities, typically involving a fixed place of business where the non-resident conducts business activities, wholly or partially, within the UAE.
It's important to note that not all physical presences qualify as a PE. The Corporate Tax Law (CTL) specifies that locations used solely for preparatory or auxiliary activities do not constitute a PE, exempting certain minor or supportive operations from taxation under the CTL.
The CTL also takes into account the role of investment managers acting on behalf of non-resident individuals. An investment manager might be considered an independent agent, thereby not establishing a PE for the non-resident person they represent. This provision is particularly relevant for investment managers involved in various financial transactions, including commodities, real estate, bonds, shares, derivatives, securities, or foreign exchange. It allows non-resident entities to engage local investment managers for transactions without creating a taxable presence.
Furthermore, the CTL acknowledges family foundations, trusts, and similar entities as distinct legal persons. Typically established to manage and safeguard the assets of individuals or families, these entities possess their own legal identity. Under specific conditions, a family foundation may choose to be treated as a transparent 'unincorporated partnership' for CT purposes. This decision can prevent the income of the foundation or trust from being subject to tax in the UAE, providing a tax-efficient approach for asset management, governance, and succession planning.
Qualifying Income for Immovable Property Located in a Free Zone
Determining the tax treatment for income derived from immovable property within a Free Zone necessitates an understanding of the property's nature and the parties involved in transactions. The tax implications for commercial property are contingent on the income source. Revenue from transactions with entities outside the Free Zone is subject to the standard corporate tax rate. Conversely, income generated from transactions within the Free Zone is exempt from tax, fostering intra-Free Zone commerce and aligning with the UAE's economic objectives.
For non-commercial property, the tax rate remains consistent irrespective of the transaction parties, streamlining tax obligations for such property within Free Zones.
The de minimis rule places constraints on the amount of Non-Qualifying Revenue a Qualifying Free Zone Person (QFZP) can earn without forfeiting their tax benefits. Specifically, this revenue must be, at most, the lesser of 5% of their Total Revenue or USD 1.36 million (AED 5 million). Non-qualifying revenue includes funds derived from activities categorized as Excluded Activities and transactions with external parties outside the Free Zone that do not meet the criteria for Qualifying Activities.
Total revenue encompasses all income generated by a QFZP in a tax period before deductions, with specific exclusions. Notably, revenue from transactions involving commercially immovable property with non-Free Zone persons and all transactions with non-commercially immovable property are excluded. Additionally, income associated with a Domestic Permanent Establishment or a Foreign Permanent Establishment of the QFZP is not considered.
The de minimis rule allows QFZPs to engage in a limited scope of Non-Qualifying Activities while retaining their tax benefits. This ensures that the economic incentives within the Free Zone remain directed towards preferred activities. Entities operating within a Free Zone must diligently monitor their revenue streams to comply with the Corporate Tax Law (CTL) and optimize their tax position.
What are the De Minimis Requirements?
The de minimis requirements play a crucial role in determining the eligibility of a Free Zone Person (FZP) for tax benefits, serving as a benchmark for maintaining the status as a Qualifying Free Zone Person (QFZP).
Monitoring Non-Qualifying Revenue is imperative for an FZP to stay within the prescribed limits. This limit is determined as the lesser of 5% of their Total Revenue or USD 1.36 million (AED 5 million) within a given tax period. Non-qualifying revenue encompasses funds derived from activities that deviate from the core operations incentivized by the associated tax benefits.
Excluded Activities span various operations, including regulated financial services and transactions involving immovable property. Conversely, Total Revenue represents the total income of a QFZP before deductions, with specific exclusions.
Whether the income is domestic or foreign, revenue related to a Permanent Establishment (PE) is not considered in the Total Revenue calculation. Qualifying income includes earnings from transactions within Free Zones, excluding those from Excluded Activities and dealings with Non-Free Zone Persons that involve Qualifying Activities.
If the Non-Qualifying Revenue of an FZP exceeds the de minimis limit, it faces reclassification and taxation at the standard rate for a minimum of five years. Additionally, a mainland branch of a QFZP is typically treated as a domestic PE and taxed accordingly. These requirements, integral to the Corporate Tax Law (CTL), serve as a measure for FZPs to uphold their qualifying status and leverage the tax advantages contributing to the UAE's position as an international business center.
What is Non-Qualifying Revenue in the UAE?
Non-qualifying revenue encompasses funds from transactions that, under normal circumstances, would be eligible for tax relief but fail to qualify when the counter-party is located outside the Free Zone (FZ).
If the non-qualifying revenue of a Qualifying Free Zone Person (QFZP) surpasses the de minimis limits or if the entity fails to adhere to the eligibility conditions outlined in Article 18 of the Corporate Tax Law (CTL) or additional prescribed rules, it will lose its QFZP designation. This reclassification becomes effective from the start of the relevant tax period and extends to the subsequent four periods. During this period, the entity is prohibited from joining a tax group or carrying forward its tax losses.
Furthermore, an entity that no longer qualifies as a QFZP becomes ineligible for certain tax reliefs, including Corporate Tax (CT) rollover relief applicable to transfers within a qualifying group and business restructuring relief as detailed in Articles 26 and 27 of the CTL.
Entities within Free Zones (FZs) must also adhere to transfer pricing obligations under the CTL, requiring the auditing of annual financial statements.
Entities should conduct evaluations to ensure their operations align with the CTL's provisions for tax relief. This involves assessing the nature of their transactions, the location of their business partners, and the classification of their activities. compliance with all administrative requirements associated with QFZP status should be adhered to. In certain cases, forgoing Free Zone relief to leverage other tax provisions, such as tax grouping or transferring tax losses, may prove more advantageous.
Navigating Qualifying Income Compliance
In an ever-evolving business landscape, compliance with the UAE Corporate Tax Law is vital for entities in Free Zones. Vigilance regarding earnings, accurate categorization of activities, and regular reviews of financial thresholds are essential for maintaining QFZP economic advantages.
Compliance goes hand in hand with strategic considerations, as businesses aim to optimize tax efficiency and leverage the benefits of the UAE's tax regime. Adapting to tax structures is not just a matter of legal compliance but strategic positioning in the UAE's role as a global trade hub.
Staying informed, seeking professional advice, and aligning business activities with qualifying criteria are key elements for businesses to fully leverage the advantages of the UAE's tax regime.
