Summary
In the fourth part of M2K’s UAE Corporate Tax Series, this alert continues to unpack the conditions required for a Free Zone Person (FZP) to qualify as a QFZP. While earlier alerts covered foundational aspects like qualifying income and substance, Alert #4 moves deeper into the election to be taxed under Corporate Tax, arm’s length compliance, and transfer pricing documentation. It also highlights how profit attribution between Free Zones and Permanent Establishments (PEs) plays a role. For Free Zone businesses targeting 0% tax benefits, these rules are non-negotiable. Here’s what to know.
Corporate Tax Election
Under the UAE CT regime, FZPs have the option to elect to be taxed under the standard Corporate Tax regime. But doing so comes at a price: they lose QFZP status.
Here’s what matters:
- The election must be made by the tax return filing deadline for the applicable tax year
- Once made, the choice applies for five years
- Entities opting in can access certain CT benefits like:
- 0% rate on income up to AED 375,000
- Small business relief
- Qualifying group and restructuring reliefs
- Loss transfers and tax group options
However, if an FZP elects for CT, they cannot be treated as a QFZP — and therefore forfeit the 0% tax on qualifying income.
Arm’s Length Principle
To maintain QFZP status, all transactions with:
- Related parties
- Connected persons
- Domestic or Foreign PEs
…must follow the Arm’s Length Principle (ALP).
The basics of ALP include:
- Using internationally accepted pricing methods
- Following the separate entity approach
- Applying a FAR analysis — which reviews the functions performed, assets used, and risks assumed
All dealings must reflect fair market value, not influenced by related-party relationships.
Transfer Pricing Documentation: Overview
Maintaining accurate and complete transfer pricing (TP) documentation is essential for compliance.
Here’s what every FZP should know:
- RPT (Related Party Transaction) Schedule:
- Mandatory if total related-party transactions exceed AED 40 million
- Transactions above AED 4 million per category must be individually disclosed
- CP (Connected Persons) Schedule:
- Required when transactions with any connected person exceed AED 0.5 million
These documents form part of the Corporate Tax return and ensure transparency.
Transfer Pricing Documentation: Advanced Requirements
TP documentation also includes the following based on thresholds:
- Master File and Local File
- Mandatory if:
- The FZP is part of a Multi-National Enterprise (MNE) group with consolidated revenue ≥ AED 3.15 billion, or
- The FZP itself earns ≥ AED 200 million in revenue
- Mandatory if:
- Country-by-Country Reporting (CbCR)
- Required only for Ultimate Parent Entities of MNEs headquartered in the UAE
- Triggered when group revenue is ≥ AED 3.15 billion
These reports must reflect a global and local view of the FZP’s pricing strategies and profitability.
Profit Attribution Requirements
In addition to compliance with TP and ALP, an FZP must also:
- Clearly attribute profits between its Free Zone operations and any Domestic or Foreign Permanent Establishments (PEs)
- Ensure this attribution is based on its FAR analysis
- Prove that each entity or establishment is receiving a fair share of profits according to its actual contribution
Without accurate attribution, the risk of losing QFZP status or facing reassessment increases significantly.
Conclusion
This alert sharpens the focus on three critical conditions for QFZPs:
- Avoiding election into the Corporate Tax regime, unless the benefits outweigh the 0% QFZP rate
- Strict adherence to the Arm’s Length Principle in all related-party dealings
- Accurate and threshold-based transfer pricing documentation to demonstrate compliance and profit attribution
As the UAE tax landscape matures, Free Zone entities must align both operationally and documentarily. Staying a QFZP is not just about the right business model — it’s about the right processes and paperwork. For businesses aiming to hold onto the 0% CT benefit, mastering these conditions is not optional — it’s essential.
