Qualifying Free Zone Person — the 0% rate and its conditions

A Qualifying Free Zone Person pays 0% corporate tax on qualifying income and 9% on everything else. The conditions are cumulative: the company must be incorporated in a free zone; it must maintain adequate substance there, meaning core income-generating activities carried out in the zone with people, assets and expenditure proportionate to what it does; it must derive qualifying income as defined; it must not have elected to be taxed at the standard rate; it must satisfy the de minimis requirement on non-qualifying revenue; and it must comply with transfer pricing rules and prepare audited financial statements.

The de minimis requirement is where most companies are actually at risk. Non-qualifying revenue must stay below the lower of five per cent of total revenue or AED 5 million. Income from mainland customers is generally not qualifying, which means a free zone company that wins a few domestic contracts can breach the threshold without any change in what it does. And the consequence is not a proportionate adjustment: breach it and the company ceases to be a Qualifying Free Zone Person for that tax period and the four subsequent ones, taxed at 9% throughout. A single AED 400,000 mainland contract on AED 6 million of revenue can cost five years of the 0% rate.

Thresholds and deadlines

Rate

0% on qualifying income; 9% on the rest

Substance

Core income-generating activity in the zone, with people and assets

De minimis

Non-qualifying revenue below the lower of 5% or AED 5 million

Failure consequence

Disqualified for that period and the four following

Audit

Audited financial statements are a condition, not a formality

Transfer pricing

Arm's-length requirements and documentation apply

1. Establish what your qualifying income actually isTransactions with other free zone persons, and income from the defined list of qualifying activities. Mainland customer revenue generally is not.
2. Monitor the de minimis threshold monthly, not annuallyThe lower of 5% of revenue or AED 5 million. By the time the audit finds a breach the period is closed.
3. Build real substance in the zonePeople, premises and expenditure proportionate to the income. A flexi-desk against significant revenue is the weak point.
4. Get audited accounts preparedThey are a condition of the status. An unaudited qualifying claim is not sustainable.
5. Model the alternative before assuming 0%For some companies the standard-rate election with a properly structured group is worth more than a fragile qualifying position.

Related