Smart Alert | The Ministry of Finance announces ‘Qualifying Income’ Definition

8 June 2023

Smart Alert | The Ministry of Finance announces ‘Qualifying Income’ Definition

In a much-awaited move, the UAE Ministry of Finance has finally unveiled the definition of “Qualifying Income” for UAE Free Zone Persons. This announcement brings clarity to businesses operating in UAE Free Zones, as it determines whether their income will be subject to a 0% tax rate or taxed at 9%. With the implementation of the UAE corporate tax law on June 1, 2023, it is crucial for businesses to assess the impact of this tax regime immediately.

The release of Cabinet Decision No. 55 of 2023 on ‘Determining Qualifying Income’ and Ministerial Decision No. 139 of 2023 on ‘Qualifying Activities and Excluded Activities’ (the “Decisions”) provides valuable insights into the types of income that will qualify for the 0% tax rate and those that will disqualify Free Zone Persons from claiming this rate. The Decisions shall be considered on the context of the Federal Decree Law N. 47 of 2022 about Taxation of Corporation and Business (the “CT Law”). For clarity, “Qualifying Income” or “Qualifying Activity” are income and activities qualified for a 0% tax rate under the CT Law when carried out by UAE Free Zone persons. “Excluded Activity” is an activity that is excluded from benefiting from the 0% tax rate, and that is subject instead to the regular 9% Corporate Tax rate.

The definition of Qualifying Income was provided through the Decisions. Cabinet Decision No. 55 outlines that Qualifying Income includes income derived from (i) Other Free Zone Persons, (ii) Domestic and foreign-sourced income which is derived from conducting any of the Qualifying Activities (defined below), and (iii) any other income (i.e., Excluded Activity) provided that it is below the De Minimis threshold, as explained below.

• Income from Free Zone Persons

In considering goods transactions that are provided to another Free Zone Person, the Free Zone Person recipient must be the beneficial owner of those goods (and not merely pass on these goods to another party).

• Qualifying Activity

Under the Qualifying Activity definition, various domestic business activities and services provided to entities outside the Free Zone, including headquarters and treasury services, are considered eligible for the 0% tax rate.

As per art. 2 of the Ministerial Decision No. 139 the Qualifying Activities are as follows:

1. Manufacturing of goods or materials
2. Processing of goods or materials
3. Holding of shares and other securities
4. Ownership, management and operation of Ships
5. Reinsurance services that are subject to the regulatory oversight of thecompetent authority in the State
6. Fund management services that are subject to the regulatory oversight of the competent authority in the State
7. Wealth and investment management services that are subject to the regulatory oversight of the competent authority in the State
8. Headquarter services to Related Parties
9. Treasury and financing services to Related Parties
10. Financing and leasing of Aircraft, including engines and ”rotable” components
11. Distribution of goods or materials in or from a Designated Zone to a customer that resells such goods or materials, or parts thereof or processes or alters such goods or materials or parts thereof for the purposes of sale or resale.
12. Logistics services
13. Any activities that are ancillary to the activities listed above.

• Excluded Activities

Excluded Activities are defined under Article 3 of Ministerial Decision No. 139.

Income earned from Excluded Activities will not be treated as Qualifying Income (irrespective of where this income is derived from). Excluded Activities include the following:

• Any transaction with a natural person (i.e., individual) except for those transactions (d), (f), (g) and (j) listed in Qualifying Activities
• Banking activities, insurance activities and finance and leasing activities that are subject to regulatory oversight in the UAE unless they are specifically permitted as a Qualifying Activity under Article 2(a)
• Ownership or exploitation of immovable property, other than commercial property that is located in a Free Zone where the transaction is with other Free Zone Persons
• Ownership or exploitation of intellectual property assets
• Any activities that are ancillary to the activities listed above.

Accordingly, Free Zone entities that earn income from Excluded activities (e.g., from individuals/natural persons (such as earnings from e-commerce sales to individuals, retail businesses, restaurants, hotels, and to an extent professional service/consultancy firms) and UAE businesses that hold or exploit intellectual property (e.g., royalty and license fees from copyrights, trademarks)), are in principle subject to the 9% CT tax.

• De Minimis threshold

A Qualifying Free Zone Person (“QFZP”) can earn income from (i) Excluded Activities or (ii) activities that are non-Qualifying Activities where the other party is a Non-Free Zone Person provided that this does not exceed the De Minimis threshold, being the lower of either (i) 5% of total revenue or (ii) AED 5 million.

Income attributable to domestic or foreign permanent establishments (e.g., UAE mainland branch) is not considered for this calculation.

If the Excluded Activity income exceeds the De Minimis threshold, the entity will not be eligible as a Qualifying Free Zone Person (QFZP), and all of its income above AED 375,000 will be subject to the 9% tax rate under the UAE mainland tax regime. Additionally, the business will be excluded from seeking QFZP status for the next four tax years.

Therefore, it is crucial for Free Zone Persons to evaluate whether their income streams can be classified as Qualifying Activity income, including assessing if their Excluded Activity income falls within the De Minimis exclusion.

Moreover, Free Zone businesses must ensure they meet all the requirements outlined in Article 18 of the UAE corporate tax law, which includes having adequate substance in the UAE to qualify as a QFZP. This entails performing core income-generating activities within a Free Zone, possessing sufficient assets, employing a qualifying number of employees, and incurring an adequate amount of operating expenditure. While these substance requirements can be outsourced to related or third parties within a Free Zone, outsourcing to UAE mainland parties is not permissible.

Lastly, Article 5 of Ministerial Decision No. 139 emphasizes that Free Zone Persons seeking QFZP status must prepare audited financial statements for the tax year. Compliance with these requirements is essential to maintain their status as QFZPs.

Other clarifications regarding the CT Law

In addition to the Decisions, the UAE Government has introduced Cabinet Decision No. (49) of 2023 (the “Decision”). This Decision aims to clarify that corporate taxation is levied solely on income derived from business or business-related activities that reach a minimum threshold.

The Decision clarified that a natural person’s personal income, derived from (i) employment earnings, (ii) investments, and/or (iii) real estate income, that are not conducted or do not require to be conducted through a license from a licensing authority, and that are not considered as a commercial business in accordance with Federal Decree-Law no. 50/2022 (Commercial Transactions Law), shall not be subjected to Corporate Tax.

Furthermore, the Decision clarifies that individuals involved in business ventures or engaged in business activities will be required to register and pay Corporate Tax only if their total combined turnover exceeds.

One million United Arab Emirates Dirhams (AED 1,000,000) within a given calendar year starting or on after 1st of June of 2023.

The Decision finally clarified that the natural persons that are not conducting a Business or Business Activities subjected to Corporate Tax do not need to register for Corporate Tax.

How can we help?

LPA Middle East can advise businesses on the impact of the CT Law and identify options to comply with the law in an efficient manner.

For more information on how this might affect your business, please do not hesitate to contact us.