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How will corporate tax changes affect businesses in UAE free zones vs mainland entities

The UAE has established itself as a global business hub, attracting investors and corporations worldwide. A critical component of its appeal has been the differential treatment of businesses in free zones compared to those on the mainland, especially concerning tax. Yet, introducing new corporate tax laws is reshaping this landscape and making the discussion on “free zone or mainland?” more attractive.

Regulations and legal framework

Free zone entities
Free zones in the UAE are governed by a set of regulations and laws that are distinct from those on the mainland. There are more than 40 multidisciplinary free zones in the UAE, each with its own regulatory authority and legal system. For instance, the Dubai Multi Commodities Centre (DMCC), Jebel Ali Free Zone (JAFZA), and Abu Dhabi’s Masdar City Free Zone have their regulations, often providing benefits like 100% foreign ownership and full repatriation of profits.

Initially, free zones offered a guarantee of zero corporate and personal income taxes for up to 50 years, a benefit that has been a cornerstone of the UAE’s free zone appeal. The landscape is evolving with the introduction of the UAE’s Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses. This law introduces a corporate tax of 9% effective from June 1, 2023, but it specifies certain exemptions and special considerations for free zone entities.

Mainland entities

The introduction of corporate tax marks the UAE’s first comprehensive framework for corporate taxation. Mainland companies will be subject to a standard corporate tax rate of 9% on their taxable income over Dh375,000. The law mandates strict compliance and reporting standards, aligning the UAE with global tax practices.

Unlike free zone companies, mainland companies can conduct business in the local market and internationally without restrictions. The UAE has recently amended its Commercial Companies Law, allowing 100% foreign ownership of mainland companies in many sectors, bridging gaps between mainland and free zone entities.

Tax implications
Free zone entities that comply with all regulatory requirements may still enjoy tax exemptions under certain conditions. Article (18) of the Corporate Tax Law provides an exemption for free zone entities if they meet certain conditions and are classified as Qualified free zone Persons (“QFZP”). The conditions for obtaining QFZP status are as follows:

• Maintain sufficient substance within the UAE.
• Derive Qualifying Income.
• The free zone entity must not have elected to be subject to corporate tax, noting that entities can elect to be subject to corporate tax if they have reasons to seek exemption.
• Comply with all transfer pricing rules and documentation requirements.
• Fulfil any other conditions prescribed by the Minister in charge.

By fulfilling the conditions stated above, a free zone entity can be granted QFZP status, allowing it to be exempted from the standard corporate tax rate of 9%. Article (3) of the Corporate Tax Law specifies the applicable tax rates for QFZP: 0% tax rate on Qualifying Income and 9% tax rate on taxable income that does not qualify as Qualifying Income under Article (18) of the Corporate Tax Law or any other decision issued by the Cabinet.

Mainland entities will face the new corporate tax but with fewer operational restrictions than those imposed on free zone companies. They will also enjoy the corporate tax regime’s tax relief, allowing them to tap into benefits such as small business relief, business restructuring relief, and transfer within a qualifying group.

Adhering to new regulations might be challenging for both free zone and mainland entities, and it is crucial to navigate the complexities of the new tax law, ensuring compliance with the requirements and documentation to avoid penalties.

The introduction of corporate tax in the UAE will likely rebalance the advantages between free zones and mainland entities. The new tax and amended commercial companies laws narrow the gap between both. This significant transformation in the UAE’s tax landscape brings new challenges and opportunities. Entities may need to reassess their operational and tax structures, especially multinational corporations that have historically leveraged free zones for tax benefits.

Read the full article, as published in Finance Middle East: How will corporate tax changes affect business in UAE free zones vs mainland entities.

This article was written by tax lawyer Shamma Al Falahi and focuses on UAE Corporate Tax.

BSA is a regional Law Firm in the Middle East with offices in the UAE, Oman and Saudi Arabia. As a full-service law firm our practice areas include litigation, arbitration and corporate services, including M&A, banking & finance, Intellectual Property, TMT, Fintech, employment and insurance.

Published on 24 January, 2024.

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