UAE Corporate Tax Public Consultation Impact on Free Zones

The public consultation document on the proposed Corporate Tax ("CT") regime honors the tax exemption benefits to Free Zones ("FZ") subject to certain conditions.

The UAE, particularly, the Emirates of Dubai and Abu Dhabi are home to many different FZ and such FZ contribute significantly onto the UAE's GDP. Hence, the proposed UAE CT regime also intends to honor CT benefits to such FZ amongst other incentives.

• CT Incentives
  • Tax incentives currently being offered to FZ businesses will be honored subject to adequacy of substance and compliance with all regulatory requirements.
  • 0% CT applicable to FZ businesses in the following cases:
    • FZ entities income from outside the UAE or within the FZ.
    • FZ entities with passive income from the mainland.
    • FZ entities in Designated Zone ("DZ") for VAT purposes selling goods to mainland, if the buyer is the importer on record.
    • Transactions between FZ entities, and their mainland group companies.
  • Mainland branches of free zone entities will be taxed at the regular tax rate on mainland income.
  • Payments made by mainland group company to the FZ entities will not be a deductible expenditure

• Key Challenges
  • Meaning of "adequate substance" to be clarified. An assumption could be made that it refers to substance as explained in the Economic Substance Regulations ("ESR").
  • Applicability of substance test where the FZ loses tax exemption.
  • Explanation on inclusion of substance of mainland for assessing substance test where the FZ has businesses with mainland.
  • Possibility of adverse implication on application of tax exemption to FZ in DZ as such DZ status are regulated and approved by the FZ Authority (which could be retrospective).
  • No tax exemption for services rendered to mainland by the FZ in DZ.
  • Absence of anti-abuse rules for preventing deduction for payment made by mainland group companies to FZ entities indirectly through restructuring the transactions or the business model.

• Key Takeaways
  • The fiscal benefits of the UAE's new corporate tax will be constrained by the significant role of the FZ, which are tax exempt. Business with presence in both mainland and FZ as well as those operating under the dual license scheme should consider the impact on their operating model.
  • Considering that the proposed CT regime is not yet final and is subject to changes, the provisions relating to the taxability of FZ, and exemptions provided on connection there to may be re-examined to address the key practical challenges prosed by the existing proposal.