Preferential Taxation in the UAE Free Zones
Since the introduction of corporate taxation in the UAE, companies incorporated in free zones have retained the possibility of operating under a preferential regime.
Federal Decree-Law No. 47 of 2022 set a 9% corporate tax rate for companies with profits exceeding AED 375,000 (approximately US$100,000). However, free zone entities may apply a 0% rate provided they meet certain criteria.
In the autumn of 2023, the UAE authorities made significant adjustments to the tax framework by adopting Cabinet Decision No. 100 and Ministerial Decision No. 265. These instruments replaced the previously applicable regulations and introduced updated requirements for obtaining Qualifying Free Zone Person status.
A key innovation was the expansion of the list of permitted activities. Companies may now engage in the trading of certain exchange-traded commodities, including metals, mineral resources, energy commodities and raw agricultural products, on the condition that such commodities are listed on recognised commodity exchanges. The approach to intellectual property was also revised: activities involving patents and copyright-protected software are no longer excluded from the preferential regime.
To maintain the right to apply the 0% rate, a company must simultaneously satisfy several conditions. In addition to conducting qualifying activities, the organisation must maintain adequate substance in the UAE, which entails holding the necessary assets, employing suitably qualified full-time personnel, and incurring operating expenditure commensurate with the scale of its business. The company must also prepare audited financial statements and comply with transfer pricing principles in transactions with related parties.
Particular attention is paid to the composition of the company’s income. The legislation introduces a de minimis threshold for non-qualifying income, which must not exceed 5% of total income or AED 5,000,000 (approximately US$1,500,000), whichever is lower. If this limit is exceeded, the company loses the right to the preferential rate.
There have been significant changes to transactions between free zone residents. Income from such dealings is recognised as qualifying only where the counterparty is the end recipient of the goods or services and is not obliged to pass them on to third parties. This restriction is aimed at preventing abuse of the preferential regime through the creation of artificial chains of transactions.
Work involving intellectual property has been given detailed regulation. A special formula has been introduced to calculate qualifying income from patents and software, taking into account the ratio of research and development expenditure to total costs. For calculation purposes, expenditure on the creation of IP may be increased by 30%.
A breach of any of the established criteria entails serious consequences. The company not only loses its preferential status in the current tax period, but is also barred from reinstating it for the following four years. In effect, this means a five-year period during which the standard 9% corporate tax rate applies.
The new rules allow for the outsourcing of key functions, but subject to significant limitations. Outsourcing of core activities to third parties is permitted only where the Qualifying Free Zone Person retains sufficient control. For activities related to intellectual property, outsourcing is permitted to any organisations in the UAE or to independent foreign companies.
Conclusion
The evolution of tax regulation for UAE free zones demonstrates the regulator’s intention to balance the fiscal interests of the state with the preservation of competitive advantages for international business. The introduction of stricter qualification criteria and detailed regulation of various activities indicates a shift from a formal approach to tax planning towards a requirement for genuine economic substance. On the one hand, this transformation raises barriers for companies using free zones solely for tax planning purposes; on the other, it creates a more transparent and predictable environment for organisations conducting real commercial activities in the jurisdiction. In the longer term, this should help strengthen the UAE’s reputation as a responsible financial jurisdiction that complies with international tax standards.
Authors: Artem Khandriko, Anna Miritskaya
