Decisions on Qualifying Free Zone Income

On 3 November 2023, the Ministry of Finance (MoF) of the United Arab Emirates (UAE) published Cabinet Decision No. 100 of 2023 on ‘Determining Qualifying income for Qualifying Free Zone Person for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses’ and Ministerial Decision No. 265 of 2023 ‘Regarding Qualifying Activities and Excluded Activities for the Purposes of Federal Decree-Law No. 47 of 2022 on the Taxation of Corporations and Businesses’. 

The aforesaid decisions revoke the previously issued Cabinet Decision No. 55 of 2023 and Ministerial Decision No. 139 of 2023, respectively and are retroactively effective from 1 June 2023. 

In this alert, we have summarized below the major additions/amendments brought in through the new Published Decisions.

Expansion of the Qualifying Income and Qualifying Activities

The Decision extents the scope of Qualifying Income to include the following:

• Income derived from the ownership or exploitation of Qualifying Intellectual Property (IP):
  • Qualifying IP includes Patents, Copyrighted, and any right functionally equivalent to a Patent that is both legally protected and subject to a similar approval and registration process to a Patent but not including any marketing related property assets such as trademarks.
  • The Patents and Copyrighted software under the Qualifying IP include any patent or any copyright subsisting in the software granted under the law regulating patents in the UAE or granted under the relevant law of foreign Jurisdiction.
  • Specific formula is prescribed for the calculation of Qualifying Income from such Qualifying IP with any excess income being automatically subject to a 9% corporate tax rate.
  • Income derived from the ownership and exploitation of any IP other than Qualifying IP should be subject to a 9% corporate tax rate and should not taint the De-Minimis computation of the taxpayer (as discussed further below).
  • Lastly, the list of excluded activities in the new Decision does not include the ownership or exploitation of IP assets (unlike the earlier Ministerial Decision 139 of 2023). 
• Income from trading of Qualifying Commodities:
  • Qualifying Commodities are defined as metals, minerals, energy, and agriculture commodities that are traded on a Recognized Commodities Exchange Market in raw form. 
  • Such trading should entail physical trading of Qualifying Commodities and associated derivative trading used to hedge against risks involved in such activities. 

Clarifications added for each Qualifying and Excluded Activity

• The Decision provides further explanation and extension to the definitions of qualifying and excluded activities which are broadly in line with the Public Consultation Paper that was previously issued in July 2023. 
• The Decision highlights that the activities in respect to holding of shares and other securities are deemed to be held ‘for investment’ when held for an uninterrupted period of at least twelve (12) months.  

De-minimis threshold

For the calculation of De-Minimis threshold, the Decision requires to exclude the following revenues in addition to what was prescribed earlier: 

• Revenue derived from the ownership or exploitation of IP (except for the revenues related to the Qualifying income from Qualified IP). 

Economic Substance and Outsourcing

• For the purposes of maintaining adequate substance, the new Decision indicates that Core-income generating activities (CIGA) varies according to the activity carried out but mainly consists of the significant functions that derive the business value for each activity and are not exclusively or mostly support activities.
• The Decision continues to require the Qualified Free Zone Persons to satisfy the Economic Substance in the respective Free Zone or Designated Zone in relation to each activity.
• The Decision provides further clarity in respect to outsourcing the CIGAs, whereby it states that the CIGA can be outsourced to another Person in a Free Zone or a Designated Free Zone depending on where such activities are required to be conducted, provided that the Qualifying Free Zone Person has adequate supervision of the outsourced activity. 
• The Decision further includes that CIGA for Qualifying IP can be outsourced to any Person in the UAE and, to any Person who is not a Related Party outside the UAE, provided that the Qualifying Free Zone Person has adequate supervision of the outsourced activity. 

Incidental income

The Decision provides clarity on the classification of an activity as ancillary, stating that an activity is considered as such when it is necessary for executing the primary activity, or when it makes only a minor contribution to, but is closely related to, the primary activity to the extent where it cannot be regarded as a separate activity. Thus, any other incidental income not included based on the above explanation should no longer be categorized as Qualifying Income.

Key takeaways

The aforesaid published Decisions provide greater clarity on many specific issues but at the same time also opens few other aspects for further detailed examination/evaluation for the Free Zone Entities in UAE. Consistent with the initially issued (and now repealed) decisions, there is no update on what documentation a taxpayer must obtain/maintain when claiming the preferential tax rate for a Qualifying Free Zone Person.

The above summary covers key areas of the changes and is not a detailed analysis. Free Zone Entities should carefully assess their business and related activities to examine if they are impacted by virtue of these updated Decisions so that actions can be taken without losing any further time. As indicated in our earlier tax alert, being ready from ‘Day One’ is the key for securing Free Zone Benefit of 0%.