Navigating Taxation in UAE Free Zones

UAE

The establishment of Free Zones in the UAE has been a strategic move to bolster the country's global market presence and attract foreign investments. However, there are misconceptions regarding tax exemptions in Free Zones. Contrary to popular belief, not all Free Zones are entirely tax-free. The Corporate Tax (CT) legislation stipulates that Free Zones are subject to taxation unless they meet specific criteria outlined in the law.

The zero per cent tax rate associated with Free Zones is applicable only under certain conditions. For instance, it applies when an entity derives income from transactions with other Free Zone persons, provided the service recipient is the beneficial recipient of the service. Additionally, income derived from specific qualifying activities can also avail the zero per cent tax regime, subject to certain conditions and exclusions.

When discussing distributors, a key condition for availing the zero per cent tax rate is for the distributor to hold title to the products. This sets distributors apart from sales agents who do not hold title to the products and therefore do not qualify for the beneficial tax rate.

The recent guide issued by the Federal Tax Authority (FTA) addresses various ambiguous areas, providing definitive clarity on several aspects. For example, the guide clarifies the definition of 'goods' and excludes the distribution of intangible products and services such as licenses and software from the distribution activity. However, software embedded onto hardware can still qualify for distribution activity.

Another area of clarification involves the taxation of 'High Sea Sales' within designated zones. The guide explains that the requirement for foreign goods to be imported through designated zones only applies to the distribution of foreign goods to customers in the UAE.

Furthermore, the guide emphasizes that distribution activities must be undertaken from designated zones to qualify for the zero per cent tax rate. Goods manufactured in the UAE do not need to pass through a designated zone, but the distribution activity must be conducted from a designated zone.

It's essential for Free Zone entities to ensure compliance with due diligence procedures, including Know Your Client (KYC) processes and obtaining confirmations through contracts or undertakings, especially concerning the concept of 'end user.'

Maintaining substance within the entity, including adequate assets, employees, and operations, is crucial for availing tax benefits. Additionally, financial statements must be audited as a compulsory requirement for compliance.

In conclusion, while Free Zones offer numerous advantages for businesses, navigating the complexities of taxation requires a comprehensive understanding of the applicable laws and regulations.