Transforming the Tax Landscape: Understanding the Impact of CIT Law on UAE Free Zones

November 22, 2023
By Majed Naim, Partner at KN Legal

The introduction of the Corporate Income Tax (CIT) Law in the United Arab Emirates (UAE) marks a significant transformation in the region’s tax landscape, particularly affecting the UAE’s renowned free zones. These zones have historically been pivotal in creating an attractive business environment, largely due to their exemption from federal taxes, thereby positioning the UAE as a global business hub. The CIT Law, however, represents an evolution of this environment, integrating these zones into a broader fiscal framework while still preserving their economic vitality.

Under the new CIT regime, encapsulated in Federal Decree-Law No. 47/2022, the UAE extends the scope of taxation to encompass all businesses within its territory, including those operating within free zones. This legislation sets a 0% tax rate on ‘Qualifying Income’ for free zone companies and imposes a 9% rate on ‘Taxable Income’ exceeding AED 375,000. This nuanced approach maintains the competitive edge of free zones in the global market while aligning with international tax standards.

A critical aspect of the CIT Law is the distinction it draws between ‘Qualified Free Zone Persons’ and mainland businesses. Qualified Free Zone Persons, essentially entities registered in UAE free zones, must conduct their business activities within the free zone or outside the UAE to avail the 0% CIT rate. This ensures adherence to international tax standards and prevents the erosion of the tax base.

The CIT Law also addresses the potential for double taxation for entities operating internationally, leveraging the UAE’s extensive network of Double Taxation Agreements (DTAs). Additionally, it introduces robust economic substance requirements, mandating companies to demonstrate a significant operational presence within the UAE, a move to deter the use of shell companies for tax evasion.

Despite the continuation of tax benefits for compliant companies, the CIT Law introduces stringent anti-avoidance rules (GAAR). This empowers authorities to nullify any transactions or arrangements that are primarily designed to gain a tax advantage without a substantial commercial rationale.

With the new CIT regime, the Federal Tax Authority (FTA) is expected to implement detailed compliance and reporting requirements, marking a departure from the UAE’s historical minimal reporting obligations. Free zone entities will now be required to maintain meticulous records and file returns, even when no tax liability arises, to affirm their eligibility for CIT exemptions.

The CIT Law’s conditions for qualifying as a Qualifying Free Zone Person (QFZP) are stringent. Entities must maintain adequate substance, earn Qualifying Income, comply with Transfer Pricing requirements, and meet other criteria set by the Minister of Finance. Non-compliance results in the loss of tax benefits.

Furthermore, the Law delineates definitions for Domestic and Foreign Permanent Establishments, crucial for determining tax obligations both within and outside the UAE. It also provides clarity on ‘Qualifying Income’, covering various income categories, and introduces specific provisions for free zone companies to maintain separate financial statements for mainland activities.

In conclusion, while the CIT Law in the UAE represents a significant paradigm shift, it also preserves the essence of the free zone incentives under certain conditions, ensuring that these zones continue to thrive as vital cogs in the UAE’s economic engine.

Disclaimer: This article is for informational purposes only and is not intended as legal advice. Each case is unique, and we recommend seeking professional legal advice for specific scenarios.