The introduction of the UAE Corporate Tax regime under Federal Decree-Law No. 47 of 2022 brings a new dimension of compliance and opportunity for Free Zone companies. While the standard corporate tax rate stands at 9% for taxable profits exceeding AED 375,000, certain Free Zone businesses may continue to benefit from a 0% tax rate—provided they meet specific conditions, primarily related to economic substance.
This blog provides a comprehensive understanding of the substance requirements Free Zone Persons must fulfill to maintain eligibility for the 0% Corporate Tax rate. We will also highlight the role of tax advisors like PEAK Business Consultancy Services in helping businesses comply with these stringent standards.
1. Who is a Qualifying Free Zone Person?
To benefit from the 0% Corporate Tax rate, a Free Zone entity must be classified as a Qualifying Free Zone Person (QFZP). According to the Ministerial Decision No. 139 of 2023, a QFZP must meet the following criteria:
- Maintain adequate substance in the UAE
- Derive qualifying income (such as income from transactions with other Free Zone Persons or exports)
- Not have elected to be subject to the standard 9% rate
- Comply with transfer pricing and documentation requirements
- Meet any other prescribed conditions by the Minister of Finance
Failure to meet these conditions in any tax period disqualifies the entity from receiving the 0% rate for that year and the next four tax periods.
2. What is ‘Adequate Substance’ in the UAE?
‘Substance’ refers to the actual presence and operational reality of a business in the UAE. Simply having a license or registration in a Free Zone is not enough. The entity must demonstrate genuine economic activity and functional presence within the country. This includes:
- Physical Presence: Maintaining appropriate office premises in the Free Zone suited to the nature and size of the business.
- Employees: Having a sufficient number of full-time, qualified employees based in the Free Zone.
- Operational Control: Conducting core income-generating activities (CIGAs) within the Free Zone.
- Management: Exercising strategic decision-making and operational control from within the UAE.
The Free Zone company must ensure that its operational setup is not a shell or nominal establishment, but an active business center contributing to the UAE economy.
3. Core Income-Generating Activities (CIGAs)
To meet substance requirements, Free Zone companies must carry out their core income-generating activities (CIGAs) within the UAE. These activities vary depending on the industry but commonly include:
- Manufacturing or assembly processes
- Processing and packaging
- Warehousing and logistics operations
- Sales and marketing activities
- Financial service management and control
Documentation must be maintained to prove that these activities are being conducted locally and not outsourced abroad.
4. Documentation to Demonstrate Substance
Free Zone companies must be able to present evidence that supports their claim of economic substance. Key documents include:
- Office lease agreement and photos of the premises
- Employment contracts and payroll records
- Minutes of board meetings held in the UAE
- Audited financial statements
- Detailed operational reports showing activities within the UAE
Failure to maintain sufficient records may result in disqualification from the 0% tax rate and could trigger penalties from the Federal Tax Authority (FTA).
5. PEAK Business Consultancy Services – Your Substance Compliance Partner
PEAK Business Consultancy Services is a trusted name in the UAE for corporate tax and VAT advisory. We specialize in helping Free Zone companies meet their substance requirements and maintain eligibility for the 0% corporate tax rate.
Our services include:
- Substance assessment and gap analysis
- Business restructuring and strategic setup planning
- Assistance with office leasing and HR support
- Preparation of substance documentation and policies
- Liaising with Free Zone authorities and the FTA
To ensure your Free Zone company meets all compliance standards, consult with our experts by visiting https://www.peakbcs.com/.
6. Qualifying Income Criteria
To retain the 0% tax rate, a Qualifying Free Zone Person must earn qualifying income, which includes:
- Transactions with other Free Zone Persons (excluding Excluded Activities)
- Income from international transactions
- Income from qualifying intellectual property
- Income from the sale of goods stored in Free Zones
However, income from dealings with mainland UAE businesses or conducting Excluded Activities—such as banking or insurance—may be subject to the regular 9% tax rate.
7. Transfer Pricing and Economic Substance Reporting
Qualifying Free Zone Persons must also comply with:
- OECD-aligned transfer pricing rules
- Preparation of transfer pricing documentation (Master File and Local File)
- Submission of Economic Substance Reports to relevant authorities (if applicable)
Proper record-keeping and documentation are essential to defend the business’s status during audits or assessments.
8. Free Zone Substance Planning: Strategic Considerations
Free Zone businesses should take a strategic approach to substance compliance, considering:
- Scaling employee presence in line with business growth
- Consolidating physical presence in cost-efficient Free Zones
- Aligning shareholder governance with local operations
- Implementing digital systems to track CIGAs
Proactive planning helps avoid penalties and protects the business from losing its 0% tax advantage.
9. Risks of Non-Compliance
Non-compliance with substance requirements can have severe consequences, including:
- Loss of the 0% tax rate for the current and next four tax periods
- Financial penalties imposed by the FTA
- Increased scrutiny and audit frequency
- Damage to reputation and investor confidence
Thus, ensuring compliance is not just a tax obligation—it’s a business imperative.
10. Conclusion
Substance requirements are at the heart of the UAE’s tax regime for Free Zone companies. Meeting these requirements is essential for businesses aiming to benefit from the 0% Corporate Tax rate. This involves far more than just registration—it requires a real and verifiable presence in the UAE, effective governance, and ongoing documentation.
PEAK Business Consultancy Services is here to help you structure, operate, and grow your business in full compliance with UAE tax laws. From substance setup to transfer pricing and tax filings, we ensure that your Free Zone entity is not only compliant but also strategically positioned to maximize tax advantages.
Get started with a substance compliance review by visiting https://www.peakbcs.com/.
