Free Zones are an integral part of the UAE economy and play a crucial role in driving economic growth of both in the UAE and internationally. Business setup in Free Zones are preferred by overseas investors as it offers a gamut of advantages and streamlined administrative procedures.
Recognizing the importance of Free Zones, the UAE Corporate Tax legislation provides for zero rate taxation for Free Zone Companies and branches that meet certain specified conditions. Generally, the corporate tax provisions provide for zero rate tax on qualifying income from:
· Transactions between Qualified Free Zone Persons (QFZP) and Fee Zone Persons (FZP) where FZP is the beneficial recipient of the goods or services, and
· Certain activities performed from within the prescribed geographical areas of a Free Zone or a Designated Zone.
As per the Article 18 of Federal Decree Law No. (47) Of 2022 of UAE Tax Legislation read with Ministerial Decision No 265 of 2023 and Cabinet Decision No 100 of 2023, in order to claim the benefit of zero rate tax regime provided for QFZP, following mandatory conditions must be fulfilled:
1. Free Zone Person (FZP) maintains adequate substance in the State.
2. FZP must derive Qualifying Income from Qualifying Activities as specified under Article 2 of Ministerial Decision No. 265 of 2023.
3. FZP complies with the Arm’s Length Principle in respect of transactions with the Related Party in accordance with Transfer Pricing methods as provided under Article 34 of the Decree-Law.
4. FZP maintains documentation in respect of Transfer Pricing provisions applicable for transactions with Related and Connected Persons as provided under Article 55 of the Decree-Law.
5. FZP has not elected to be subject to Corporate Tax under Article 19 of this Decree-Law.
6. FZP has prepared audited financial statements in accordance with the Ministerial Decision on the requirements to prepare and maintain audited financial statements i.e. in accordance with International Financial Reporting Standard (IFRS).
7. Further, in order to qualify as Qualified Free Zone Person, Non-Qualifying Revenue should not exceed the De-minimis amount as set out in the Ministerial Decision No. 265 of 2023, i.e. 5% of the Total Revenue or AED 5 million, whichever is lower.
In case Qualified Free Zone Person elects to be subject to standard rate or fails to meet any of the mandatory conditions at any time during the tax period then the FZP will not be considered as Qualified Free Zone Person not only in respect of the current tax period but also will be considered as Non-Qualified Person for subsequent four tax period(s) and therefore will not be eligible for zero (0%) rated tax.
Considering the above, FZP must carefully examine the meeting of the conditions in order to qualify for the zero-rate taxation under the UAE Corporate Tax as available to a Qualified Free Zone Person.
One of the qualifying activities, income from which is considered as qualifying income for the purpose of availing the zero rate tax regime as applicable to QFZP is Distribution of Goods or materials in or from a Designated Zone.
As to bring out more transparency and clarity in the conditions and the provisions that are applicable to Free Zone Persons, FTA recently issued detailed Guidelines on Free Zone Persons. Combined reading of guideline along with the Legislation and Ministerial decision no. 265 of 2023, we delve upon the detailed criteria or conditions that must be met in order to qualify under Distribution of goods or materials in or from a |Designated Zone.
Sub clause (l) of clause 3 of Article 2 of the Ministerial Decision No. 265 of 2023 defines Distribution as under:
Distribution of goods or materials in or from a Designated Zone includes the buying and selling of goods, materials, component parts or any other items that are tangible or movable and may include the importation, storage, inventory management, handling, transportation and exportation of those goods or materials to a customer that resells such goods or materials, or parts thereof or processes or alters such goods or materials or parts thereof for the purposes of sale or resale, provided such activities are conducted in or from a Designated Zone and the goods or materials entering the State are imported through the Designated Zone.
The foremost criteria is the Distribution activity of goods or materials must be conducted in or from a Designated Zone. Cabinet Decision No. 100 of 2023 defines a Designated Zone to mean according to what is stated in Federal Decree Law No. 8 of 2017 in relation to Value Added Tax (VAT).
Cabinet Decision 59 of 2017 provides the list of Designated Zones for VAT purposes. Article 1 of Cabinet Decision 59 of 2017 provide that Designated Zone as annex hereto which meet the conditions stipulated in the Cabinet Decision No. (52) of 2017 on the Executive Regulation of the Federal Decree-Law No (8) of 2017 on Value Added Tax, shall be considered as Designated Zones for the purposes of implementing the Federal Decree-Law No. (8) of 2017 on Value Added Tax.
Cabinet Decision No, 52 of 2017 on the Executive Regulation of the Federal Decree-Law No (8) of 2017 on Value Added Tax stipulates following conditions:
a. The Designated Zone is a specific fenced geographic area which has security measures and Customs controls to monitor entry and exit of individuals and movement of goods to and from the area.
b. The Designated Zone shall have internal procedures regarding the method of keeping, storing and processing of Goods therein.
c. The operator of the Designated Zone complies with the procedures set by the Authority.
Therefore, the FZP must carry out the activity of distribution from a notified Designated Zone which meets the above conditions. Further the guideline provides that all the taxpayers should check with their respective Free Zone Authority to confirm if they operate in a Free Zone or Designated Zone for Corporate Tax purposes.
Thereafter, what is important is to ascertain the activity of “Distribution”. Distribution typically involves the process of buying goods from a manufacturer or a producer or a stockiest and then further selling it to the wholesalers/retailers and that may involve transportation, storage, sorting, delivery and logistics, inventory management, order processing, labelling, packaging, or re-packaging. Essentially buying would mean that the title to the goods passes on to the Distributor.
The definition of Distribution as provided under Ministerial Decision No. 265 of 2023 requires that the goods so bought must be sold to a customer that either resells such goods or materials or parts thereof or processes or alters such goods or materials or parts thereof for the purpose sale or resale. Therefore, if the goods or materials are sold to the “end user” who consumes the same then such activity will not be treated as Qualifying Activity.
Therefore, it is important to ascertain if the goods are being consumed by the customer or will the goods or materials resold or processed or altered for the purpose of reselling. As advised under the guideline, it is better to obtain a certificate from the customer to confirm the above so as to ensure that the same falls within the qualifying activity.
Certain instances that may qualify under this activity are listed under:
High Sea Sale or Third Port Trading: A FZP carrying out the activity from a Designated Zone of buying goods/materials from a manufacturer or a producer from a Country outside UAE and then selling it to a customer who is not an end user in another country and will be reselling the goods/material as it is or after processing or altering it, will be considered as qualifying activity of Distribution of Goods or materials in or from a Designated Zone.
Import of Goods in the UAE through the Designated Zone: A FZP located in a Designated Zone importing goods in the UAE through a Designated Zone and then selling it to a customer in the UAE who is not the end user and will be reselling the goods/material as it is or after processing or altering it, will be considered as qualifying activity of Distribution of Goods or materials in or from a Designated Zone.
The condition for goods entering into UAE through a Designated Zone applies when the goods are to be imported into the UAE for the purpose of distribution of goods to Customers in the UAE who is not the end user and will be reselling the goods/material as it is or after processing or altering it.
Export of Goods or materials from the UAE: A FZP operating from a Designated Zone buys goods or materials from a juridical person in the UAE who may or may not be located in a Free Zone and the goods have been either manufactured in UAE or imported in the UAE by another Person and the goods are directly shipped by the manufacturer/importer in the UAE to a customer outside the UAE who is not the end user and will be reselling the goods/material as it is or after processing or altering it, will be considered as qualifying activity of Distribution of Goods or materials in or from a Designated Zone.
Since the condition of goods passing through the Designated Zone only applies when entering the UAE, and not at the time of exit, the goods need not pass through the \designated \Zone and the activity of exports by a FZP operating from a Designated Zone shall be considered as qualifying activity.
Distribution of Goods or materials within the UAE: A FZP operating from a Designated Zone buys goods or materials from a juridical person in the UAE who may or may not be located in a Free Zone and the goods have been either manufactured in UAE or imported in the UAE by another Person and the goods are directly transported or transferred by the manufacturer/importer in the UAE to a customer within the UAE who is not the end user and will be reselling the goods/material as it is or after processing or altering it, will be considered as qualifying activity of Distribution of Goods or materials in or from a Designated Zone.
Since the condition of goods passing through the Designated Zone only applies when entering the UAE, and not at the time of exit, the goods need not pass through the Designated Zone and the activity of buying and selling within the UAE by a FZP operating from a Designated Zone shall be considered as qualifying activity.
It is imperative that a FZP must carefully ascertain the conditions and whether it meets the desired conditions to be considered as Qualified Free Zone Person and eligible for zero rate tax under the UAE Corporate Tax legislation.