In Alert #2, the focus was on the foundational QFZP conditions — presence in the Free Zone, substance requirements, and a broad introduction to qualifying income. Alert #3 builds on that by exploring two key complexities: how the beneficial recipient test impacts qualifying income and how the rules apply during a start-up phase. These finer details are essential for Free Zone Persons (FZPs) who are aiming to maintain 0% corporate tax status in the UAE. This alert also discusses practical examples and offers guidance on how to avoid disqualification, especially during early-stage operations.
Recap of Previous Alert
In Alert #2, we discussed the key conditions a Free Zone Person (FZP) must meet to qualify as a QFZP, including:
- Being registered in a Free Zone
- Meeting substance requirements
- Deriving qualifying income
This alert now digs into two advanced nuances:
- Beneficial recipient test
- Treatment during the start-up phase
Beneficial Recipient: What It Means
An FZ Person is the beneficial recipient of goods or services if:
- They have the right to enjoy those goods or services
- They are not contractually obligated to supply them to another party
- The goods or services are used within the Free Zone business, not by its Domestic PE or Foreign PE
In other words, if the Free Zone business is the true end-user and decision-maker, it qualifies as the beneficial recipient.
Illustration: Company C and Beneficial Recipient
Let’s take an example:
- Company C: Free Zone Person providing legal services (a non-qualifying activity) to Company M (a non-Free Zone Person)
- Company D: Another Free Zone company that Company C hires for translation services
Here’s the flow:
- Company C uses Company D’s translation services to fulfil its client contract
- There’s no agreement between Company D and Company M
- Company C is not obligated to pass on the service to Company M
In this case:
- Company C is the beneficial recipient of Company D’s services
- Since Company C is an FZ Person, and translation is not an excluded activity, Company D’s income is qualifying
However:
- The legal services provided by Company C to Company M are not qualifying income, since:
- Company M is not an FZ Person
- Legal services are not a qualifying activity
In such a case, the test for beneficial recipient is not even applied, as other qualifying conditions aren’t met.
Key Takeaways for Beneficial Recipient Rule
- When selling to another Free Zone Person, the seller must verify if the buyer is the true beneficiary
- This helps determine whether the income qualifies for the 0% rate
- Best practice: Ask for a written declaration or confirmation from the customer
- The seller can rely on it — unless they have reason to suspect it may be false
- Example: If the goods are being shipped to a third party
Start-Up Phase of a Free Zone Person
A common concern is whether an FZ Person qualifies as a QFZP during its start-up phase, especially when it hasn’t earned revenue yet.
Here’s what the CT Guide clarifies:
- If the entity has not yet started earning qualifying income (because it’s still setting up), it is still eligible to be a QFZP
- However, if the business earns non-qualifying income (like interest from deposits), this could trigger de minimis limits
Important: Investment of surplus funds alone does not count as a qualifying activity
For example:
- If an FZ company earns only interest income, it may fail the de minimis test
- Failing this test could mean the business loses QFZP status for 5 years
De Minimis Rules Still Apply During Start-Up
Even though the CT Guide provides relief on qualifying income during start-up, it does not waive de minimis requirements.
What does that mean?
- If the company earns even a small amount of non-qualifying income (e.g., bank interest, scrap sales), and no other income — it might fail de minimis
- This would disqualify the entity from QFZP status for five years
So, Free Zone entities in early stages must:
- Monitor all revenue, even minor ones
- Structure income carefully
- Consider shifting non-qualifying transactions to a domestic PE (if applicable)
Other Scenarios Without Revenue
What if the business is not in a start-up phase but still earns no income in a tax period?
- Example: loss of customer, regulatory restrictions, or market disruptions
- Currently, no guidance exists in CT Law or the Guide for such cases
- There is ambiguity on whether QFZP status would be impacted due to temporary non-earning periods
Conclusion
The Free Zone Corporate Tax regime offers huge benefits, but the compliance framework is tight. This alert adds two crucial layers:
- Understanding the “beneficial recipient” test — especially for inter-FZ transactions
- How QFZP rules apply during the start-up phase — including risks from de minimis violations
For FZPs, early planning, documentation, and strategic structuring are essential to preserve the 0% tax benefit. Missteps — even small ones — can cost businesses five years of disqualification.
Alert #3 offers much-needed clarity on how businesses can stay compliant, even during setup. And as always, understanding the detail is the first step to managing the risk.
