Unveiling the concept of Qualifying income in free zones | UAE

A strategic location and a business-friendly environment have helped Dubai become the modern city it is today. It’s a real magnet for big companies, partly thanks to its diverse free zones. There are loads of free zones in Dubai, each with its own rules and regulations.

There are some major perks to setting up a Free Zone in Dubai, like owning your business 100% yourself, having super-easy business set-up procedures, easy access to markets all around the region and beyond, and using world-class infrastructure.

But the news about corporate tax in the UAE has got people talking, especially businesses based in those previously tax-free zones. The new tax rate is 9%, as announced by the Federal Tax Authority (FTA) and the Ministry of Finance. However, the UAE government has also released a different set of rules for free zone corporate tax. They’ve come up with this thing called “qualifying income,” which is the basis for calculating tax liability in UAE-free zones.

What is the Qualifying income in UAE?

In UAE, qualifying income is income that’s exempt from corporate tax. That means income like dividends, capital gains, interest, rental income, and royalties don’t get taxed. There are two main types of qualifying income here: passive and active.

Passive income is money you make without really doing much. So, dividends, interest, capital gains, and royalties are all considered passive income. Active income, on the other hand, is money you earn by being actively involved in a business. Rental income and income from selling goods or services are examples of active income.

Criteria to Determine Qualifying Income

So, here’s the deal: if you’re a Free Zone Person (or think you are), you can earn money in certain ways that count as “qualifying income.” The government has laid out some rules to make sure everyone’s on the same page.

Here’s what counts as qualifying income:

1. Money you make from working with other Free Zone People, as long as it’s not from any of those activities the Minister decides are too shady.

2. Money you make from working with people outside the Free Zone, as long as it’s from stuff that’s not on the list of banned activities.

3. Other income is considered small potatoes, as long as it meets the government’s definition of “De Minimis.”

And here’s the catch: if you work with someone outside the Free Zone, they have to benefit from your services or goods. In other words, you can’t just pretend they’re your customer when they’re not involved.

What is De Minimis?

According to Article 4 of the Qualifying Income Decision, we have a De Minimis Threshold here for when a Qualified Free Zone Person earns income from one of two things: either Excluded Activities or activities that aren’t Qualifying Activities where the other party to the transaction is a Non-Free Zone Person (or, in other words, a Non-Qualifying Revenue). Now, if a Qualifying Free Zone Person gets Non-Qualifying Revenue that goes over the lower of two limits in a tax period, they’ll lose their Qualifying Free Zone Person status for that period and for the four tax periods that follow it.

So, the two limits are:

1. 5% of their total revenue for the tax period, or

2. AED 5 million in revenue for the tax period.

And here’s what happens if they go over one of those limits: they lose their Qualifying Free Zone Person status for the current tax period and for the four tax periods that follow it, and they’ll have to pay 9% tax on all their taxable income that goes over AED 375,000.

Understanding “Beneficial Recipient” and “Good” in Layman’s Terms

Okay, so when we talk about Qualifying Income, there are two important words you need to know:

1. Beneficial Recipient: This is the person who gets to use and enjoy a service or thing, and they don’t have to give anything in return. They’re just the lucky duck who gets to benefit from it all. In Free Zones, this definition is important because it helps figure out where the income comes from.

2. Good: This is a fancy way of saying anything that has value, like stuff or services. It can be physical (like a car) or not (like a patent). The point is, it’s anything you can buy or sell. So, when we talk about Qualifying Income, we’re including all kinds of things under this umbrella term.

Qualifying Income Categories

1. Income from Transactions with Other Free Zone Folks

When your business in the Free Zone does deal with other Free Zone businesses, you can count that income as Qualifying Income. But if it’s from something on the list of Excluded Activities, then it doesn’t count. This way, you can enjoy the tax benefits of being in the Free Zone by doing business with others in the same boat.

2. Income from Transactions with People Outside the Free Zone (as Long as It’s Not Excluded)

If your business does deal with people or businesses outside the Free Zone, but it’s for something that’s not on the Excluded Activities list, then that income can count towards your Qualifying Income. This gives you an incentive to do business with folks outside the Free Zone while still getting to enjoy the tax benefits.

3. Income from Owning or Using Qualifying Intellectual Property

Another important source of Qualifying Income is income from owning or using Qualifying Intellectual Property (as defined in Article 7). This rule is meant to encourage businesses to invest in and protect their creative ideas and inventions inside the Free Zone.

4. Other Sources of Qualifying Income

There might be other types of income that don’t fit neatly into the other categories. But if your business in the Free Zone makes enough money from these “other” sources, and it’s not from anything on the Excluded Activities list, then it can still count as Qualifying Income. This rule gives businesses some flexibility in how they make money and still take advantage of the tax benefits.

Qualifying Activities

The following activities a QFZP engages in will count towards Qualifying Activities:

1. Manufacturing goods, like clothes, cars, or toys;

2. Processing stuff, like turning raw materials into parts or assembling those parts into finished products;

3. Owning and managing stocks and other investments;

4. Operating ships;

5. Providing reinsurance services, which are insurance for insurance companies (and regulated by the relevant authorities in the UAE);

6. Managing investment funds, which are regulated by the relevant authorities in the UAE;

7. Providing wealth and investment management services, also regulated by the relevant authorities in the UAE;

8. Offering headquarter services to related companies;

9. Handling treasury and financing for related companies;

10. Financing and leasing aircraft, including the engines and parts that go with them;

11. Distributing goods or materials to customers who will resell them;

12. Logistics services, like transportation and storage;

13. And any other support activities that are related to the above.

Qualifying Income for Domestic or Foreign Permanent Establishment

• When an individual with a Qualifying Free Zone status has a Domestic Permanent Establishment or a foreign Permanent Establishment in a Qualifying Free Zone, the income they earn from those places is considered Taxable Income. The corporate Tax rate for the free zone business still applies, so these earnings will be taxed at a rate of 9%.

• Now, if this Qualifying Free Zone Person also has a Domestic or foreign permanent establishment where they work, the taxable income they make during a specific period will be treated as if it belongs to a separate person who is related to them. This means that their overall taxable income could be higher because of this connection.

Qualifying Income for a Real Estate Property in a Free Zone

When you make money from a building or land located in a Free Zone, that income is considered taxable income and needs to be reported. Here are two types of transactions that could lead to taxable income:

1. Deals with Non-Free Zone Person in respect of commercial property.

2. Deals with any person in respect of non-commercial property.

To figure out how much tax you owe, you need to take the income earned from those transactions during a specific tax period and calculate it based on the rules set by the Corporate Tax Law.

Conclusion

It is crucial for businesses operating within Free Zones to understand Qualifying Income under Article (18) of the Corporate Tax Law. To maximize their tax advantages, businesses can make informed decisions when they understand which income categories qualify for the deduction, what a “beneficial recipient” and “good” are, and the considerations for a Domestic Permanent Establishment.

Staying informed and compliant is essential in this dynamic tax environment. We hope this blog post has given you some useful info on Qualifying Income for Free Zone Persons and how it can affect your taxes. It’s a bit of a tricky subject, but we’re here to help! As your trusted corporate tax experts, we want to make sure your business is on solid ground when it comes to tax planning and compliance.

If you’re running a free zone or mainland business in the UAE, we’ve got your back. Our team of pros at BizDaddy offers top-notch corporate tax solutions tailored to your specific needs. We’ll make sure you’re staying compliant with all the rules and regulations, so you can focus on what you do best – growing your business!

So there you have it, folks! BizDaddy is your go-to source for all things corporate tax in the UAE. We’ll make sure you’re in good hands every step of the way.