A Free Zone company is not automatically taxed at 0%. It pays 0% on qualifying income only if it meets the conditions to be a Qualifying Free Zone Person (QFZP) for the whole tax period. Other income is taxed at 9%. Here is what that takes.
The conditions
- Maintain adequate substance in the Free Zone: real assets, staff and operating spend for its core activities
- Earn qualifying income, such as transactions with other Free Zone persons and qualifying activities set by the Ministry
- Pass the de minimis test on non-qualifying revenue
- Comply with transfer pricing rules and keep documentation for related-party transactions
- Prepare audited financial statements
- Not elect to be subject to the standard 9% rate
The de minimis test
Non-qualifying revenue must not exceed the lower of 5% of total revenue or AED 5 million in the tax period. Revenue from a permanent establishment outside the Free Zone is handled separately and is left out of this calculation.
Example
A Free Zone trading company has AED 20 million of revenue. Its limit is AED 1 million (5%), not AED 5 million. If AED 1.2 million comes from sales to mainland customers that do not count as qualifying, it fails the test.
What happens if you fail
Under the Corporate Tax law a company that stops meeting the conditions loses QFZP status from the start of that tax period and for the following four tax periods. All its taxable income is then taxed at the normal rates. One misclassified contract can cost five years of 0%.
The records that prove you qualify
QFZP status is decided by your books, not your licence. Set up your accounts so that each revenue line can be traced to:
- The customer and where they are based (Free Zone, mainland or abroad)
- The activity performed and whether it is a qualifying activity
- Whether the income is attributable to a mainland or foreign permanent establishment
- Related-party status, with transfer pricing support
A separate revenue account for each category, reviewed every quarter, shows early whether you are drifting towards the de minimis limit while there is still time to restructure.
Need help?
SMAS Venture sets up Free Zone books to track qualifying income, runs the de minimis test each quarter and coordinates the audit. Book a free consultation.
