Corporate Tax for Free Zone Companies

With the introduction of corporate tax in the UAE in 2023, free zone companies now face new obligations while still enjoying some tax benefits. Businesses operating within free zones can continue to benefit from the **0% corporate tax rate**, provided they comply with specific regulations. Two key aspects that free zone companies must consider are the **De Minimis Rule** and **Transfer Pricing regulations**, alongside mandatory audits.

In this blog, we’ll explore how these rules apply to free zone companies, provide examples for clarity, and outline the audit requirements to help businesses remain compliant.

1. Corporate Tax Overview for Free Zone Companies

Free zone companies in the UAE can still benefit from the 0% corporate tax rate if they qualify as a "Qualifying Free Zone Person", meaning they meet several conditions:

- They must generate qualifying income from activities within the free zone or transactions with other free zone entities.

- Mainland UAE business income is subject to a 9% corporate tax rate but may be limited through the **De Minimis Rule**.

- They must comply with **Economic Substance Regulations (ESR)** and **Transfer Pricing rules** for transactions with related entities.

2. The De Minimis Rule Explained

The **De Minimis Rule** is crucial for free zone companies that engage in limited mainland business. The rule allows them to maintain the 0% tax rate on their qualifying income as long as income from non-qualifying activities (such as business with mainland UAE) remains below certain thresholds.

De Minimis Rule Example:

-Scenario: A free zone company generates AED 10 million in total annual revenue, including AED 450,000 from business dealings with mainland UAE.

- De Minimis Rule Threshold: According to the rule, the company's non-qualifying income (mainland UAE activities) must not exceed 5% of total revenue or AED 5 million, whichever is lower.

  In this case:

  - 5% of AED 10 million = AED 500,000

  - Non-qualifying mainland income = AED 450,000

Since the mainland income (AED 450,000) is below 5% of total revenue and also below AED 5 million, the company retains its 0% corporate tax status on free zone qualifying income. However, the AED 450,000 from mainland activities will be subject to 9% corporate tax.

Key Points to Remember:

- The company must carefully track and document its revenue sources to ensure it stays within the De Minimis threshold.

- If the mainland income exceeds 5% or AED 5 million, the company could lose its 0% tax status and be subject to the standard corporate tax on all income.

3. Transfer Pricing Regulations

Transfer Pricing rules are designed to ensure that transactions between related parties (e.g., entities under common control) are conducted at arm’s length—meaning they reflect market value, as if the parties were unrelated. These rules prevent companies from manipulating prices between related entities to reduce taxable income.

Transfer Pricing Example:

Scenario: A free zone company (Company A) sells goods to its parent company (Company B) located in mainland UAE. Both companies are under the same ownership.

Arm’s Length Principle: To comply with Transfer Pricing regulations, the price at which Company A sells the goods to Company B must reflect the fair market value, similar to the price it would charge an unrelated third party.

  If the company sells the goods to Company B at an artificially low price to reduce Company B’s taxable profits, this could violate Transfer Pricing regulations. The Federal Tax Authority (FTA) would likely adjust the transaction value and impose penalties or additional taxes.

Compliance with Transfer Pricing:

- Free zone companies must maintain proper documentation justifying that related-party transactions are priced at arm’s length.

- This documentation should include comparability studies or benchmarking analysis to show how prices were determined.

- Transfer Pricing compliance is especially critical for companies with multiple entities across different tax zones (e.g., free zones and mainland UAE).

4. Audit Requirements for Free Zone Companies

In addition to corporate tax and Transfer Pricing compliance, free zone companies are typically required to undergo annual audits. Audited financial statements are necessary to meet both free zone authority and corporate tax obligations.

A Free Zone Person is required to prepare and maintain audited Financial Statements for Corporate Tax purposes (regardless of its Revenue) as a condition of being a QFZP.137  A QFZP is not required to prepare separate Financial Statements for its Qualifying Income and its other income and is also not required to prepare separate audited financial statements for any branches that it may have. However, the QFZP should have sufficient documentation to demonstrate how it calculated its Qualifying Income.

Why Audits Are Important:

Compliance with Free Zone Authorities: Most free zone authorities, such as DMCC, JAFZA, and ADGM, require companies to submit audited financial statements annually, even if they benefit from the 0% tax rate.

Corporate Tax Filing: Audits help ensure that the financial data submitted to the Federal Tax Authority (FTA) is accurate, particularly when calculating taxable income or justifying the company’s qualifying free zone status.

5. The Importance of Professional Advice

Navigating the complexities of the UAE’s corporate tax regime, the De Minimis Rule, Transfer Pricing regulations, and audit requirements can be challenging. Free zone companies need to ensure they stay compliant while optimizing their tax benefits.

Why Seek Professional Help:

- Avoid compliance risks: Tax consultants can help businesses monitor their income streams and ensure they remain within De Minimis limits.

- Optimize tax strategies: Professionals can assist with structuring related-party transactions to comply with Transfer Pricing rules and avoid unnecessary tax liabilities.

- Simplify audits: Auditors can guide businesses through the audit process, ensuring timely submission of financials and compliance with free zone and FTA requirements.

Conclusion

The UAE's corporate tax regime brings new obligations for free zone companies, but the **De Minimis Rule** and **Transfer Pricing** offer avenues for maintaining the 0% tax rate on qualifying income. Compliance with audit requirements is also critical to avoid penalties and maintain transparency.

For expert assistance in managing corporate tax, Transfer Pricing, and audit requirements, contact **Fintrack Tax Consultants LLC**. We offer professional tax advice and audit services to help your business stay compliant and thrive under the UAE's new tax regulations.