The UAE has long been known for its business-friendly environment, particularly its free zones, which offer companies attractive benefits such as tax exemptions, full foreign ownership, and simplified regulatory frameworks. Historically, these benefits have made the UAE free zones a hotspot for foreign investment and business operations. However, with the introduction of a new federal corporate tax regime in 2023, there have been significant changes to the tax landscape, including implications for businesses operating within UAE’s free zones. In this article, we will explore the tax implications of corporate tax in UAE free zones, how the new rules affect businesses, and what companies need to consider for ongoing compliance.

1. Overview of UAE Free Zones

UAE free zones are special economic areas that offer incentives to businesses in the form of tax exemptions, customs duties exemptions, and other regulatory benefits. There are over 40 free zones across the UAE, catering to various industries such as finance, media, technology, healthcare, logistics, and manufacturing. One of the primary attractions of setting up in a free zone is the tax exemption on income, which can be as long as 50 years, depending on the zone.

Free zones also generally allow 100% foreign ownership of businesses, which is not always the case in mainland UAE, where certain restrictions on foreign ownership exist. Businesses in free zones also benefit from simplified procedures for obtaining licenses, visas, and permits, and are often not required to pay certain local taxes or comply with specific regulatory requirements.

2. Changes in Tax Structure: Corporate Tax Introduction

For years, the UAE has relied on oil revenues and other non-tax sources to fuel its economy. However, in an effort to diversify its economy, improve the sustainability of its revenue streams, and align with global tax standards, the UAE government introduced a federal corporate tax for the first time in 2023. The new corporate tax, effective from June 2023, applies a flat rate of 9% on profits exceeding AED 375,000.

The introduction of this corporate tax is a landmark shift in the UAE’s tax policy, as it marks the end of the era when businesses in the UAE, including those in free zones, enjoyed complete tax exemptions. This move brings the UAE closer in line with international tax practices, and aligns with the Organisation for Economic Co-operation and Development (OECD) guidelines for tax transparency.

3. Corporate Tax in Free Zones: What’s Changed?

While free zones remain an attractive option for businesses, the introduction of the 9% corporate tax has specific implications for companies operating in these zones:

a. Exemptions for Qualifying Free Zone Activities

Not all activities carried out in a free zone are subject to the new 9% corporate tax. Businesses that continue to meet the conditions for qualifying activities—such as manufacturing, trading, and other core activities—may still benefit from tax exemptions or preferential rates. In particular, businesses engaged in import/export activities, services to foreign customers, and certain industrial activities may be able to continue enjoying tax exemptions, depending on the specific free zone in which they are registered.

Additionally, certain free zone companies may continue to benefit from the existing tax-free periods, where their profits are entirely exempt from corporate tax for a fixed number of years. The duration of these exemptions depends on the free zone in question, with some zones offering exemptions for up to 50 years.

b. Non-Qualifying Activities

Businesses that operate in free zones but engage in non-qualifying activities, such as retail operations targeting local customers, may be subject to the new corporate tax. As such, businesses involved in non-core activities should reassess their operations to understand whether their activities are taxable under the new corporate tax regime. If they are deemed non-qualifying, they may face the standard 9% tax on profits exceeding the AED 375,000 threshold.

c. VAT and Other Tax Implications

In addition to corporate tax, businesses in free zones are also subject to the UAE’s Value Added Tax (VAT), which is set at 5%. VAT applies to goods and services unless exempt or zero-rated under specific conditions. Businesses involved in taxable activities, including trading and service provision, must ensure they are properly VAT-registered, especially as tax authorities ramp up their enforcement of compliance. Free zone businesses may be able to reclaim VAT on inputs directly related to their taxable activities, but it is essential for businesses to consult with tax professionals to navigate VAT reporting requirements.

4. Implications for Foreign Investment

One of the main advantages of operating in a UAE free zone has been the ability to establish a fully foreign-owned company. Despite the new corporate tax introduction, foreign investors can still benefit from the UAE’s tax advantages, such as no personal income tax and potential VAT refunds. However, foreign investors must carefully assess the activities of their businesses to ensure they qualify for tax exemptions, especially if their operations are expanding to include activities subject to the new corporate tax.

5. Next Steps for Free Zone Businesses

Businesses operating in UAE free zones must take several key steps to ensure compliance with the new tax laws:

• Assess Business Activities: Review the nature of business activities to determine whether they qualify for tax exemptions under the new regime.
• Tax Registration: If the business exceeds the AED 375,000 profit threshold, it must register for corporate tax with the UAE Federal Tax Authority (FTA).
• Consult with Tax Advisors: Due to the complexity of the new tax laws, businesses should work with tax professionals to ensure they are making the most of available exemptions and ensuring compliance.
• Consider Business Structure: Some businesses may need to restructure or adjust their operations to meet new regulatory requirements.

6. Conclusion

The introduction of corporate tax in UAE free zones marks a significant change for businesses operating in these areas. While many companies may still enjoy tax exemptions based on the type of activity they engage in, the new tax regime means that businesses need to reassess their operations and understand the full implications of the corporate tax on their profits. By staying informed and seeking professional guidance, businesses can navigate the evolving tax landscape, maintain compliance, and continue to benefit from the UAE’s attractive free zone incentives. For more details, Visit https://thevatconsultant.com