With the implementation of the UAE Corporate Tax regime from June 1, 2023, Free Zone entities now face greater scrutiny under the new tax landscape. While the UAE government continues to offer a favorable tax environment, not all income earned by Free Zone Persons is automatically exempt from Corporate Tax. The classification of income into “Qualifying” and “Non-Qualifying” plays a pivotal role in determining tax liabilities. Understanding these definitions is essential for any Free Zone entity aiming to maintain 0% corporate tax benefits.
1. Overview of Free Zone Taxation Under UAE Corporate Tax Law
The UAE’s Federal Decree-Law No. 47 of 2022 introduces Corporate Tax at a standard rate of 9% on business profits above AED 375,000. However, the law provides a special incentive for Free Zone Persons who meet certain conditions, allowing them to benefit from a 0% Corporate Tax rate on “Qualifying Income.” To avail of this preferential rate, the Free Zone Person must be a “Qualifying Free Zone Person” (QFZP), as defined under Cabinet Decision No. 55 of 2023 and Ministerial Decision No. 139 of 2023.
Failure to meet the conditions results in the Free Zone entity being treated as a regular taxable person at the standard rate of 9% on all income.
2. Who is a Qualifying Free Zone Person (QFZP)?
To be considered a QFZP and benefit from the 0% Corporate Tax rate, a Free Zone entity must meet the following conditions:
- Maintain adequate substance in the Free Zone
- Derive Qualifying Income as defined under relevant ministerial decisions
- Not have elected to be subject to regular Corporate Tax
- Comply with transfer pricing and documentation requirements
- Prepare audited financial statements
Meeting these conditions ensures continued eligibility for tax benefits. But understanding the nature of income—whether it is qualifying or not—is equally crucial.
3. What is Qualifying Income?
According to Ministerial Decision No. 139 of 2023, “Qualifying Income” includes income derived from the following sources:
- Transactions with other Free Zone Persons: Income from goods or services provided to other Free Zone Persons, provided they are not part of a mainland branch.
- Qualifying Activities with Non-Free Zone Persons: Only certain activities qualify, such as:
- Manufacturing and processing of goods
- Holding of shares and securities
- Headquarter and treasury services
- Logistics and warehousing
- Reinsurance and fund management services
- Income derived from owning or using commercial property in the Free Zone
- Income from transactions with group entities located in the mainland—provided it does not relate to excluded activities
Qualifying Income is subject to 0% tax only if it aligns with approved activities and proper compliance protocols are maintained.
4. What is Non-Qualifying Income?
Non-Qualifying Income refers to revenue streams that fall outside the scope of approved activities or involve mainland transactions that do not meet specific conditions. This includes:
- Income from Excluded Activities: These include banking, insurance (except reinsurance), finance and leasing, and ownership of real estate (except in Free Zones).
- Income from transactions with mainland customers (non-group): If a Free Zone Person supplies goods or services to non-group persons in the mainland, the income becomes non-qualifying.
- Income from immovable property outside the Free Zone
- Income from non-qualifying passive investments
Non-Qualifying Income will be taxed at the standard 9% rate, and if more than a de minimis threshold (5% of total revenue or AED 5 million) is breached, the Free Zone entity loses its QFZP status altogether.
5. Importance of Income Segregation and Record Keeping
Free Zone Persons must maintain a clear separation between Qualifying and Non-Qualifying Income in their accounting systems. This involves:
- Separate ledgers for different revenue streams
- Detailed documentation for each transaction
- Mapping income to relevant business activities
- Identifying counterparties (Free Zone vs. Mainland, group vs. third-party)
Auditable records will be critical in substantiating claims of 0% tax on qualifying income and in surviving any Federal Tax Authority (FTA) audit.
6. PEAK Business Consultancy Services: Guiding Free Zone Entities Through Corporate Tax Compliance
PEAK Business Consultancy Services is a trusted advisor for Free Zone entities navigating the complexities of the UAE’s evolving tax regime. Our VAT and Corporate Tax experts help companies identify, segregate, and report their income streams correctly to ensure full compliance with QFZP requirements.
Our Free Zone compliance solutions include:
- Assessing eligibility for QFZP status
- Advising on qualifying vs. non-qualifying income categorization
- Structuring intra-group and mainland transactions
- Preparing transfer pricing documentation
- Implementing tax-compliant accounting systems
Visit https://www.peakbcs.com/ to learn how PEAK BCS can protect your tax benefits while ensuring robust compliance.
7. Common Mistakes That Lead to Disqualification
Many Free Zone entities risk losing their QFZP status by:
- Failing to maintain sufficient economic substance in the Free Zone
- Exceeding the de minimis threshold for Non-Qualifying Income
- Misclassifying mainland transactions as qualifying
- Engaging in excluded activities without proper reporting
- Failing to prepare audited financial statements
These mistakes can trigger loss of 0% tax status, leading to a 9% tax on total income and potential penalties for non-compliance.
8. The Role of Group Structures and Transfer Pricing
Free Zone entities that operate within larger corporate groups must pay close attention to transfer pricing. All related-party transactions must be at arm’s length and documented accordingly. This includes service agreements, licensing arrangements, and cost allocations.
Failure to comply with transfer pricing requirements can disqualify Qualifying Income and attract additional scrutiny from the FTA.
9. Planning Strategies for Free Zone Entities
To maximize tax benefits while staying compliant, Free Zone entities should consider the following strategies:
- Limit mainland revenue to group-related transactions
- Restructure business operations to align with qualifying activities
- Regularly review financial thresholds for de minimis limits
- Ensure proper documentation for all revenue streams
- Seek professional guidance for borderline cases
These proactive steps can help maintain QFZP status and minimize tax exposure.
10. Conclusion
The distinction between Qualifying and Non-Qualifying Income is a cornerstone of tax planning for Free Zone entities under the UAE Corporate Tax regime. Misclassification can lead to a complete loss of tax benefits and additional compliance risks. With the right systems and professional support, businesses can confidently navigate this landscape and retain their advantageous status.
PEAK Business Consultancy Services stands ready to help Free Zone businesses safeguard their tax position. From eligibility assessments to documentation and reporting, our team provides comprehensive, practical support tailored to the unique needs of UAE Free Zone entities.
Schedule your consultation today at https://www.peakbcs.com/ and stay ahead in your corporate tax compliance journey.
