Quarterly Newsletter

UAE Corporate Tax on Free Zones - What lies ahead?

The vast number of free zones distributed across the United Arab Emirates (“UAE”) contribute significantly to its economic development. As such, it is no secret that Free Zones have been the preferred business destination for start-ups, entrepreneurs, and multinational entities (“MNEs”). This has in turn helped the UAE attract and boost foreign trade investment.

Free zones enjoy various tax and regulatory reliefs, in addition to exemptions, including 100% foreign ownership, 100% repatriation of profits and capital, customs, VAT and corporate tax exemptions. The introduction of corporation tax in the UAE - effective with a headline tax rate of 9% - has raised major concerns for the Free Zone stakeholders as to whether they will manage to maintain their tax exemption status.

The UAE Government has thus fulfilled the objective of corporate tax exemption for Free Zones by taxing Free Zones at the rate of 0% on “Qualifying income”, provided they maintain adequate substance and comply with the transfer pricing requirements. While the applicable tax rate will be 0%, free zones will however be within the scope of the UAE corporation tax and will be required to undertake the tax compliances.

The corporation tax incentive for Free Zone entities, while in principle appearing as a welcoming move favouring Free Zone businesses, may ultimately be affected by the BEPS Pillar Two plan to implement the Global Minimum Effective Tax Rate (“GLOBE”) of 15% for MNEs with global consolidated revenue exceeding EURO 750 million (AED 2,979 million).

The intent of the GLOBE is to ensure that MNEs operating in various jurisdictions pay a minimum tax and do not derive any unfair advantage due to the lower tax rates. As such, MNEs with an effective tax rate below 15% in a particular jurisdiction will be required to pay a top-up tax to make up for any shortfall. Hence, MNEs that operate in the UAE and covered within the scope of Pillar Two may possibly end up paying taxes, since their effective rate in the UAE could fall below 15% and this may negate the corporate tax incentive offered to Free Zones in the UAE.

When considering the above backdrop and the fact that UAE is a member of the BEPS Inclusive Framework which is committed to implement GLOBE Rule, it becomes inevitable for the UAE to formulate policies that incentivise Free Zones in alternate ways that limit the impact on the effective tax rate of MNEs.