The UAE’s Corporate Tax regime introduces a new layer of compliance for Free Zone businesses, with strict rules around qualifying for the 0% tax rate. This second alert in M2K’s UAE CT Series dives into the conditions a Free Zone Person (FZP) must meet to be recognised as a Qualifying Free Zone Person (QFZP). The criteria cover presence, substance, type of income, and more. This blog explains these conditions clearly — highlighting what makes a business eligible and what could lead to standard taxation.
Preface
Alert #1 introduced the broad Corporate Tax (CT) framework for Free Zone Persons (FZPs). It included:
- Tax rates for Qualifying vs. Non-Qualifying Income
- Reliefs not available to QFZPs
- An overview of the conditions required to be classified as a QFZP
Alert #2 now offers a deep dive into those specific QFZP conditions.
Condition #1 – Presence in Free Zone
Not all entities with a Free Zone connection qualify as FZPs. The business must:
- Be a juridical person (i.e., a company or legal entity)
- Be incorporated, established, or registered in a Free Zone
Simply having the Place of Effective Management (POEM) in a Free Zone is not enough.
Examples that can qualify as FZPs (subject to meeting other conditions):
- Foreign companies
- Mainland UAE entities with Free Zone branches
- Free Zone companies with branches outside the UAE
However, individuals and unincorporated partnerships are excluded.
Condition #2 – Adequate Substance in a Free Zone (1/2)
A QFZP must perform Core Income-Generating Activities (CIGA) within the Free Zone or a Designated Zone (DZ). To do this, the FZP must have:
- Adequate physical assets
- Suitably qualified full-time employees
- Adequate operating expenditure
Note: The same employee cannot be counted for multiple qualifying activities.
CIGAs are the core value-generating operations of the business. FZPs in distribution activities, for instance, must perform their operations from or within a DZ.
What qualifies as “adequate” varies based on the nature and scale of the business.
- Outsourcing CIGAs is allowed — but only to vendors in the FZ/DZ, and under proper supervision
- Research & Development (R&D) activities enjoy some flexibility in how outsourcing is handled
The goal is to ensure real substance and activity within the Free Zone jurisdiction.
Condition #3 – Deriving Qualifying Income (1/2)
To be treated as a QFZP, the Free Zone entity must generate qualifying income. This includes:
- Transactions with other Free Zone Persons
(The recipient must also be a Free Zone Person, and the activity must not be excluded) - Income from qualifying activities
(Again, only if not listed under excluded activities) - Income from ownership or exploitation of qualifying Intellectual Property (IP)
- Other income — as long as it fits under de minimis limits
Some forms of income will be fully taxable at 9%, even if the entity operates from a Free Zone. These include:
- Income from a Domestic Permanent Establishment (PE) in mainland UAE
- Income from a Foreign PE
- Rental income from immovable property, unless it’s from commercial property located in a Free Zone and rented to another Free Zone Person
- Income from non-qualifying IP
Clarifications on “qualifying” and “excluded” activities will be discussed in later alerts in this series.
Conclusion
For a Free Zone business to be treated as a Qualifying Free Zone Person (QFZP), it must meet all three major conditions:
- Be registered in a Free Zone
- Have adequate substance (people, premises, spending) in the zone
- Derive qualifying income, while keeping taxable income within de minimis thresholds
Failure to meet even one of these conditions can disqualify the entity from the 0% Corporate Tax benefit — shifting it to the standard 9% regime.
These rules are strict but clearly laid out. Understanding and aligning operations accordingly is essential for tax efficiency under the new UAE Corporate Tax law.
