With the implementation of Federal Decree-Law No. (47) of 2022 on the Taxation of Corporations and Businesses, businesses operating across the UAE have entered a new era of tax compliance. A recurring question among entrepreneurs and investors is whether free zone companies are subject to corporate tax under the new law. The answer, as outlined by the UAE Ministry of Finance and Federal Tax Authority (FTA), is both nuanced and conditional.
In this blog, we will explore the applicability of UAE corporate tax to free zone entities, including the concept of “Qualifying Free Zone Persons,” the treatment of income, exemptions, and practical compliance obligations. Whether you are already running a free zone business or planning to incorporate one, this article offers the clarity you need.
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1. General Rule: Corporate Tax Applies to Free Zones
Contrary to the popular misconception that free zone entities are exempt from corporate tax, the law states that all UAE businesses, including free zone companies, are subject to corporate tax unless they qualify for specific exemptions. The law applies across all Emirates and business sectors unless explicitly excluded.
However, there are special provisions for certain free zone companies referred to as “Qualifying Free Zone Persons” which can benefit from a 0% corporate tax rate on qualifying income.
2. Who Is a Qualifying Free Zone Person?
To benefit from the 0% tax rate, a free zone company must meet the following criteria:
- Maintain adequate substance in the UAE (i.e., core income-generating activities are conducted within the free zone).
- Derive income that falls under the category of “qualifying income.”
- Not have elected to be taxed at the standard 9% rate.
- Comply with the arm’s length principle and transfer pricing documentation requirements.
- Submit the required annual corporate tax return and disclosure forms.
Failing to meet these conditions may result in the loss of the 0% benefit and full taxation at 9% on all profits.
Want to Know If You Qualify?
Our consultants at PEAK Business Consultancy Services can assess your free zone company’s eligibility and help you structure operations to ensure compliance and maximize tax efficiency.
3. What Is Qualifying Income?
The UAE Corporate Tax regime defines “qualifying income” in the context of free zones as income derived from the following:
- Transactions with other free zone entities
- Income from qualifying activities such as manufacturing, logistics, financial services, and holding company functions
- Income from international trade (e.g., export of goods or services outside the UAE mainland)
However, income derived from conducting business with the UAE mainland is typically subject to the standard 9% tax rate, unless it qualifies as a permitted activity under special rules (e.g., warehousing, distribution under strict conditions).
4. Treatment of Mainland Transactions
If a free zone company earns income from UAE mainland clients, the treatment depends on the nature of the transaction:
- Passive income (e.g., royalties, dividends, interest) from the mainland may still be considered qualifying income.
- Active income (e.g., sale of goods or services) to mainland businesses is typically taxable at 9%.
- Using a distributor based in the mainland may allow the free zone entity to retain its 0% status, provided it complies with FTA rules.
This distinction is critical for structuring your revenue model correctly. Businesses should evaluate their client base and operational footprint.
5. Substance Requirements
To benefit from the 0% corporate tax, qualifying free zone companies must demonstrate substantial presence. This includes:
- Having physical office space in the free zone
- Employing full-time staff or outsourcing specific core functions locally
- Maintaining proper records and governance practices
The FTA may deny 0% status if a company exists merely on paper without real economic activity in the UAE.
6. Corporate Tax Compliance for Free Zone Companies
Even if your company benefits from a 0% tax rate, you are still required to:
- Register for corporate tax with the FTA
- Maintain accurate financial statements
- File annual corporate tax returns (even if no tax is payable)
- Submit transfer pricing documentation if applicable
Failure to comply with these obligations can result in financial penalties and the loss of the 0% rate.
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7. Interaction with Economic Substance Regulations (ESR)
Free zone entities performing certain activities—like holding companies, shipping, intellectual property, and financial services—must also comply with Economic Substance Regulations (ESR). This adds another layer of compliance, requiring:
- ESR notifications and reports
- Demonstration of local substance and governance
- Timely submissions to regulatory authorities
Non-compliance with ESR could further complicate corporate tax eligibility, especially for entities seeking the 0% status.
8. Strategic Recommendations
If you operate a free zone company or are considering forming one, here are some best practices:
- Perform a detailed income classification to distinguish qualifying and non-qualifying income
- Structure contracts and transactions to align with corporate tax laws
- Keep transfer pricing records and apply arm’s length principles
- File all necessary returns and maintain tax-compliant accounting systems
- Consult with tax experts for ongoing evaluation and planning
These steps not only ensure compliance but also allow you to maximize the tax advantages available under the current regime.
9. Conclusion
To summarize, free zone companies are subject to UAE Corporate Tax but may benefit from a 0% tax rate on qualifying income if they meet specific conditions. Understanding the distinction between qualifying income and non-qualifying income, meeting substance requirements, and maintaining proper documentation are all essential to retaining tax benefits.
Whether you are restructuring your business model or planning a new free zone setup, aligning with corporate tax law is crucial to avoid future liabilities and penalties.
Partner with the experts at PEAK Business Consultancy Services — a trusted name in the UAE for VAT and corporate tax consultancy. We’ll help you navigate FTA requirements, structure your income effectively, and ensure full compliance with the law. Reach out today to safeguard your tax position and optimize your business performance.
