The United Arab Emirates (UAE) remains one of the most attractive jurisdictions globally for business due to its strategic location, robust infrastructure, and favourable tax regime. Central to this appealing landscape is the tax incentive granted to companies operating in Free Zones. For businesses incorporated in one of these zones, understanding and accurately applying the concept of “qualifying income” is crucial to unlock the benefits of the zero-percent corporate tax regime. As part of your broader strategy, partnering with reliable corporate tax compliance services in the UAE can make the difference between maximising available incentives and inadvertently triggering tax liabilities.
What is a Free Zone Person and why it matters
Within the framework of the UAE’s corporate tax legislation (Federal Decree‑Law No. 47 of 2022 on the Taxation of Corporations and Businesses), a Free Zone Person is defined as a juridical person (i.e., a company, branch or legal entity) that is incorporated, established or registered in a designated Free Zone.
However, merely being a Free Zone entity does not automatically guarantee eligibility for the zero % corporate tax rate. To benefit from it, such an entity must become a “Qualifying Free Zone Person” (QFZP) by fulfilling specific criteria set out in law and relevant guidance decisions.
Free Zone businesses in the UAE are subject to a preferential tax structure: qualifying income of a QFZP is taxed at 0 %, while income that is not qualifying may attract the standard rate of 9 %.
As you plan your entity structure within a Free Zone, integrating corporate tax compliance services from the outset ensures that your operations are aligned with the detailed conditions for qualifying status.
Defining “Qualifying Income” under the Free Zone regime
Understanding what qualifies as “qualifying income” is arguably the most critical step in ensuring your Free Zone business captures the full benefit of the regime.
Qualifying income for a QFZP generally means revenue derived from activities defined as “qualifying activities”, and from transactions that meet the “beneficial recipient” and other criteria.
Key elements include:
- Income derived from transactions with other Free Zone Persons, provided those parties are the beneficial recipients of the goods or services.
- Income derived from qualifying activities (as per Ministerial Decision) even where the counterparty is not in a Free Zone, so long as the income is not from an excluded activity.
- Ownership or exploitation of qualifying intellectual property by the Free Zone Person may count, subject to strict rules.
- Income from immovable property located in the Free Zone used for commercial purposes and rented to Free Zone Persons may qualify; if rented to non-Free Zone entities or used for residential purposes, it may be non-qualifying.
Conditions to preserve the 0% rate – beyond the income definition
Merely generating qualifying income is not sufficient. The entity must satisfy several additional conditions for its QFZP status to remain intact. If any one condition is breached, it risks loss of the favourable tax regime—and the tax liability may apply for the current and the next four tax years.
The main conditions include:
- Adequate substance – The Free Zone Person must conduct its core income-generating activities in a Free Zone, maintain an adequate number of employees, incur operating expenditure in the zone, and hold adequate assets in the zone.
- Transfer pricing and arm’s length principle – Transactions with related parties (or permanent establishments) must be arm’s length and properly documented.
- Audited financial statements – The entity must prepare audited financial statements in accordance with applicable accounting standards.
- De-minimis rule for non-qualifying income – If a QFZP earns some non-qualifying income, then that portion must not exceed the lower of AED 5 million or 5 % of total revenue in the tax period. Surpassing this threshold may disqualify the 0% rate.
- No election to be taxed under the standard regime – A Free Zone Person can elect to be taxed under the standard corporate tax rules (9 %) but doing so removes the 0% status.
Given the high stakes, engaging qualified corporate tax compliance services ensures that your business continuously meets these criteria and remains audit-ready.
Typical activities that qualify (and those that don’t)
For UAE Free Zone businesses, it’s beneficial to review which activities tend to fall within qualifying income, and which are typically excluded.
Qualifying activities often include:
- Manufacturing or processing of goods within the Free Zone.
- Logistics, distribution or supply-chain operations conducted within the Free Zone environment.
- Services provided to related entities within Free Zones, such as headquarters or treasury services (provided not excluded).
- Income from intellectual property (QIP) exploited in the Free Zone under rules.
Excluded or non-qualifying activities may include:
- Banking, insurance, and certain financial services activities that are explicitly excluded by Ministerial Decision.
- Income derived from real estate such as property renting to non-Free Zone persons or residential usage.
- Income generated by a domestic or foreign permanent establishment of the Free Zone Person located outside the Free Zone.
- Services or transactions where the counterparty is a non-Free Zone person and the activity is not listed as qualifying.
Clearly segmenting your operations and monitoring the counterparties is essential. Here again, specialised corporate tax compliance services help map your revenue streams and classify them appropriately.
Also Read: Corporate Tax Implications for Foreign-Owned Entities in UAE