Today's Edition
A.SREENIVASA REDDY (ABU DHABI)
The Federal Tax Authority (FTA) recently issued a 134-page note on application of Corporate Tax (CT) in designated free zone areas. The elaborate note aims to explain how the CT will apply to free zone companies in various hypothetical scenarios.
The UAE has created free zones to encourage foreign companies to set up businesses locally and contribute to the economic diversification in the country. A variety of incentives, such as full ownership rights and relaxed tax, customs, visa and labour rules, are offered to the companies operating in free zones. When it comes to CT, free zone companies are entitled to tax exemptions but the FTA has issued a detailed set of conditions and requirements to be fulfilled if they want their net profits to be zero-rated.
This article tries to explain what free zone companies should do to get zero-rated tax for their income. The first expectation from free zone companies is that their core income-generating activities must be based within the jurisdiction of a free zone area. The free zone company “must have adequate assets, full-time employees, and incur an adequate amount of operating expenditures in the free zone”, the FTA note states clearly.
This looks fairly simple but it’s not. A lot of free zone companies have operations and affiliates in the mainland and foreign countries. Sometimes these operations are fused together so closely that it becomes difficult to distinguish the two. That is why the FTA has laid strict conditions to ensure the companies do not show their income from mainland operations in the free zone category and claim unfairly zero tax rate for their revenue. This outcome undermines the spirit of both of a free zone and corporate tax.
In several instances, a company has its head office in the mainland or in a foreign country and a branch in a free zone. In such cases, only revenue connected with the business transacted in the free zone will be zero rated for CT.
All free zone companies must prove that all net profits are flowing from legitimate free zone activities in order to get zero rated CT.
All their income streams should be classified into qualifying and non-qualifying zones. Qualifying income here means net profits that are entitled for zero-rated tax while non-qualifying income is taxable. The latest FTA guidelines say taxable revenue of a free zone company is not entitled to be zero-rated for the first Dh375,000, as is the case with mainland companies.
Speaking to Aletihad, Dhaval Jasani, Founder & CEO, ZTI Global, said: “The obligation to meet all the conditions of a qualified free zone company is effective from the first day of the tax period, for the entire tax period.”
Failure to meet the conditions will disqualify you from making use of tax exemption.
“Inability to meet the conditions even for a day in a tax period will invalidate their ability to qualify for exemption from corporate tax on the entire taxable income for that tax period and four subsequent tax periods,” said Jasani, who has been advising companies on tax procedures.
FTA has laid down another condition known as ‘de minimis’ rule, according to which a company’s non-qualifying revenue should not exceed 5% of its total revenue or Dh500,000, whichever is lower. If their revenues exceed this limit, FTA says the companies will forfeit the title of a qualified free zone company, which means it will be treated like a mainland company for the CT purposes.
This rule allows free zone companies to earn some non-qualifying income but that income should not cross a certain threshold and undermine the legal nature of the company.
Post-CT, all companies, especially the free zone ones, should overhaul their accounting practices to align with the tax law.
“It is certainty a challenging task for tax professionals to help companies fine-tune their accounting practices in the context of evolving regulatory landscape,” says Krishnan Narayanan, Partner - Andersen Tax LLC, in response to a query from Aletihad.
All companies are required to separate their free zone and non-free zone revenue and expenditure streams under the new regulations.
“The complexity of this task depends on the current systems being followed. Identifying different revenue streams is a far easier task than allocating common costs between qualifying and non qualifying, which can get complex and subjective,” says Narayanan, who is a chartered accountant by profession.
Regarding the complexity of bifurcating revenue and expenditure streams, another chartered accountant Neeraj Ritolia says: “The companies are required to set up relevant controls and keep track of non qualifying revenues and expenses. This will be a collaborative effort between tax experts and internal finance functions.”
FTA guidelines put special emphasis on the need to maintain “arm’s length” practice, which means free zone companies should carry out dealings with the related parties (sister companies) in transparent and rational manner. This implies that there should not be any unfair distribution of revenues, expenditures with a view to cutting corners with tax laws.
“Tax Authorities want to be certain that transactions entered into between related parties have been undertaken on same/similar lines as if the parties were independent on their own,” said Jasani, who stressed the need to maintain Transfer Pricing Documentation as prescribed by the Federal Decree Law 47 of 2022.
According to the federal decree, CT is applicable for all companies whose financial year starts on or after June 4, 2023. However, most companies in the UAE follow the Gregorian calendar, so CT will be applicable for most of the companies from January 1, 2024.
All companies should file CT returns and pay the taxes within eight months after the tax period is over. This means that the companies will start filing returns and paying CT only in the first few of months of 2025. This offers plenty of time for authorities to issue clarifications on various aspects of the implementation of the new law. It is a challenge for authorities, companies and tax professionals to ensure smooth and seamless implementation of the new tax law.
