This article provides a comprehensive overview of the major tax implementations in the UAE and offers insights into the taxation landscape of the country. The article delves into the types of taxes levied in the UAE, discussing the tax rates, registration requirements, filing procedures related to VAT, and the key provisions governing its application.
The United Arab Emirates (UAE) tax regime falls under the following categories:
Oil and Gas Taxation, VAT, Banking Tax, Customs Duty, Excise Taxes, Municipal Taxes/Property Taxes, Real estate Tax/ Transfer Tax, Tourism Tax, Social Security contributions, Withholding taxes.
Timeline of recent tax reforms implemented in the UAE
- January 2018: Value Added Tax (VAT) Implementation – The UAE introduced a 5% VAT on most goods and services.
- April 2019: Economic Substance Rules (ESR) and Country-by-Country Reporting (CbCR) – The UAE implemented ESR and CbCR regulations to align with international standards and combat tax avoidance and base erosion
- June 2023: Corporate Tax (CT) Implementation – The UAE introduced a CT applicable to all businesses and commercial activities operating within the seven emirates. This marked a significant shift in the UAE’s tax landscape, as it had long been known for its tax-free commerce hub status.
Who is responsible for administering the tax regime in UAE?
The tax regime in the United Arab Emirates (UAE) is controlled by a combination of federal and emirate-level laws. The federal government is responsible for setting the overall tax policy for the country, while the individual emirates are responsible for administering and collecting taxes within their borders.
Some of the taxes that are levied at the federal level in the UAE include Corporate Tax, Value Added Tax (VAT), Excise tax, Customs duties, etc.
Each of the individual emirates also has their own tax laws, which can vary from emirate to emirate. Some of the taxes that are levied at the emirate level in the UAE include Tourism Tax, Transfer Tax, etc.
Type of Taxes in the UAE
Taxation for entities involved in Oil and Gas activities
Businesses engaged in the extraction of natural resources will remain outside the purview of the recently introduced Corporate Tax regime in the UAE. These entities continue to be subject to Emirate-level taxation.
Revenue derived by Oil and gas exploration entities are subject to a tax rate of up to 55% under applicable emirate-level income tax decrees. However, the actual rates imposed may vary depending on the various concessional agreements agreed upon by individual emirate-level authorities.
A timeline of key emirate-level decrees on income tax imposition over entities engaged in Oil and Gas exploration activities is as follows:1
- Abu Dhabi 1965 (amended by Decree 4 of 1972)
- Dubai 1969
- Sharjah 1968
- Ras Al Khaimah 1969
- Fujairah 1966
- Ajman 1968
- Umm Al Quwain 1968
VAT in UAE
Value-added tax (VAT) is a consumption tax that is applied to most goods and services supplied in the United Arab Emirates (UAE). VAT is imposed on the value added at each stage of the supply chain. Typically, the burden of VAT costs falls on end consumers, as businesses assume the role of tax collectors, responsible for gathering and reporting the tax on behalf of the government.
VAT was introduced in the UAE on January 1, 2018, with the aim of raising additional revenue for the government and creating a more level playing field for businesses.
The following are the key provisions of UAE VAT:
Registration
Businesses that meet the following thresholds are required to register for VAT :
- Entities with Annual taxable supplies and imports exceeding AED 375,000 or those who are expecting to exceed the threshold within 30 days of registration.
- Non- UAE businesses that make taxable supplies in UAE, but do not have any other person to pay the due tax in UAE.
- Additionally, entities with annual taxable supplies and imports exceeding AED 187,500 or those that are expected to exceed the limit within 30 days of the registration have the option to voluntarily register for VAT.
VAT Return filings
VAT returns are to be filed at the end of each relevant tax period. This can be:
- Quarterly for business with Annual turnover below AED 150 million and
- Monthly for business with an annual turnover exceeding AED 150 million
Tax Rates
There are four different types of VAT rates applicable:
- Standard rate 5%: this is the standard VAT rate that applies to most goods and services supplied in the UAE.
- Zero rate 0%: This applies to a limited number of goods and services such as export and certain financial services.
- Exempt: These goods and services are specifically declared to be exempted. Some examples of exempt items include educational services, transport services etc.
- Out of Scope supplies: These supplies are out of the purview of UAE VAT, hence out of scope supplies are not required to be declared in the tax returns submitted.
Banking Tax
In the United Arab Emirates (UAE), branches of foreign banks were subject to income tax at a flat rate of up to 20% on profits under separate Emirate-level bank decrees. This is known as the banking tax.
However, with the introduction of the Corporate Tax regime in the UAE, the branches of Foreign Banks effectively come under the definition of a Permanent Establishment (P.E) in UAE. Hence branches of foreign banks operating in the UAE are expected to come under the purview of the Corporate Tax regime.
Customs Duty
A 5% Customs duty is normally charged on the Cost2, Insurance, and Freight (CIF) value of imports (excluding other applicable rates for the import of specific goods like tobacco, alcohol, etc.).
As part of its membership of the GCC Customs Union in 2003, UAE does not levy customs duty on trade made between GCC member countries. Further, Free Zones within UAE are outside the scope of Customs territory.
Excise Taxes
Excise tax in UAE was introduced in 2017, primarily covering the sale of tobacco and related products, carbonated and other energy drinks. By 2019, the coverage was expanded to include the likes of sweetened drinks, e-cigarettes, and related accessories.
While tobacco, e-cigarettes, and affiliated products are charged with a 100% tax, carbonated and sweetened drinks are imposed with 50% excise tax.
Municipal Taxes/Property Taxes
Emirate Municipality Authorities usually charge a percentage of the yearly rent payable by tenants as a Municipal rental tax. The percentage may vary depending on the Emirate and property type. The fee is usually collected either at the time of registration of the tenancy contract or collected on a pro-rata basis as part of equal monthly installments through utility bills.
Real estate Tax/ Transfer Tax
A transfer tax is a tax levied on the transfer of property, such as real estate or shares. The transfer tax in the United Arab Emirates (UAE) is levied by the individual emirates, and the rates vary depending on the emirate.
The transfer tax is generally calculated as a percentage of the property’s value and is applicable when buying or selling property in the UAE. In addition to the transfer tax, there are also some fees that are payable when buying property in the UAE. These fees include registration fees, stamp duty, and legal fees.
Tourism Tax
The tourism tax is a fee imposed on guests staying at hotels, hotel apartments, guesthouses, and holiday homes. The tax is collected by the hotels and resorts on behalf of the government.
The purpose of the tourism tax is to support the growth of the UAE’s tourism industry and generate revenue for the government. Further, it is also seen as a way to make tourists more aware of the costs of tourism and to encourage them to stay in more affordable accommodation.
The tourism tax is not levied on citizens of the UAE or on residents who have valid residency visas. The rate of tourism tax may vary depending on the emirate and the classification of the hotel and is typically charged in addition to other taxes and fees.
Social Security contributions
Applicable to Citizens of Gulf Cooperation Council member countries, employees in the UAE are subject to a social security regime of 17.5%. 12.5% contribution is met by the employer and the remainder 5% is contributed as an automatic deduction from the paychecks of employees. Social Security Contribution is not applicable to non-GCC nationals in the UAE.
Withholding taxes
Withholding tax refers to a tax that is subtracted at the point of payment by a resident of a country to a non-resident, specifically targeting certain types of payments such as interest, dividends, and royalties. However, it is important to note that there is currently no active withholding tax system in place in the UAE.
Corporate Tax, Free Zone Entities and Qualifying Income
Background of the UAE’s tax-free zones
The UAE is a fast-expanding economy with trade and investment growing at a rapid pace. Today, UAE is synonymous with trade, travel, tourism, logistics, investment, finance, technology, research, and much more. But, it wasn’t before a couple of decades that the UAE was like any other Gulf economy solely dependent on oil extraction as a source of income stream. So how did UAE transform itself from an exploited oil well to a modern metropolis of the global world order? Although there were multi-pronged strategic initiatives taken at critical moments throughout its relatively short history of being a Republic nation, a key ingredient to UAE’s success story is the formidable role played by Free Zones.
Tax- Free Zones, as one would make sense of it, was not a revolutionary idea that evolved out of UAE, rather it was a tried and tested formula developed outside the state but masterfully adapted to the nation’s advantage in the most appropriate way possible.
This blog article will trace the history of Free Zones in the UAE, analyze the impact of Free Zone Establishments on the UAE economy, the effect of UAE’s introduction of Corporate Tax (CT Law) in the Free Zone Entities, understand the concepts of Qualifying activities and Qualifying Income and assess the future trends in the Free Zone Taxation.
Understanding Free Zone Entities in the UAE
History of Free Zones in the UAE
The United Arab Emirates (UAE) has a long history of free zones, dating back to the early 1980s. The first free zone, Jebel Ali Free Zone (JAFZA), was established in 1985 to attract foreign investment and diversify the UAE’s economy. JAFZA was a huge success, and it quickly became one of the largest free zones in the world.
The success of JAFZA led to the establishment of other free zones in the UAE. In the early 2000s, the UAE government launched a number of new free zones, including Dubai Airport Freezone (DAFZA), Dubai Internet City (DIC), and Dubai Media City (DMC). These free zones were designed to attract specific industries, such as logistics, technology, and media. Today, there are over 40 free zones in the UAE, located in all seven emirates. These free zones offer a wide range of benefits to businesses, including:
- 100% foreign ownership
- No import duties
- Easy access to global markets
- Excellent infrastructure
The free zones in the UAE have been a major driver of economic growth in the country. They have attracted billions of dollars in foreign investment and created hundreds of thousands of jobs. The free zones have also helped to make the UAE a global hub for trade, commerce, and logistics.
Definitions
Free Zone
As per the CT law, a Free Zone has been defined as “A designated and defined geographic area within the State that is specified in a decision issued by the Cabinet at the suggestion of the Minister.”
Who is a Free Zone Person
A juridical person incorporated, established, or otherwise registered in a Free Zone, including a branch of a Non-Resident Person registered in a Free Zone.
However, the following category of persons are excluded from the definition of a Free Zone Person:
A Natural Person conducting business in any Free Zone (including Sole establishments or Civil Companies)
Additionally, any entity incorporated outside of a Free Zone is also excluded from the definition of a free zone person.
General overview of the UAE corporate tax system
Although Free Zones came with the promise of a Taxation-free environment, the introduction of the Corporate Tax regime in UAE caused a surprise among many.
While the Corporate Tax also promises a virtual taxation-free environment (0% Taxation) for Free Zone Entities, the tax exemption has been restricted or limited to businesses that undertake certain “specified” activities and fulfill certain pre-emptive criteria. Those entities that satisfy the conditions are defined as a “Qualifying Free Zone Entity”, which is a marked deviation from the previous non-restrictive policy adopted by the state towards activities conducted by Free Zone entities in the respective free zones.
Who is considered a Qualifying Free Zone Entity?
A Free Zone person who meets the following conditions is considered a Qualifying Free Zone Entity (QFZE):
- Maintains adequate substance in the state
- Derives Qualifying Income
- Not elected to be subject to normal C.T.
- Complies with Transfer Pricing Provisions
- Prepares & maintains Audited Financial Statements
- Does not exceed the De-minimis Revenue Threshold
- Meets any other condition prescribed by the Minister
Failure to fulfill the above conditions will result in disqualification of the entity from the status of a Qualifying Free Zone Entity.
What is considered as maintaining adequate substance in the state?
The QFZE shall operate with an adequate level of assets, employees & operating expenses that correspond to its scale of business operations.
Activities may be outsourced to a related party or a third party based in the Free Zone, provided adequate supervision is maintained.
Current corporate tax rates
The taxation policy surrounding a Qualifying Free Zone Entity can be summarised as follows:
Qualifying Income will be subject to 0% taxation and
Non- Qualifying Income will be subject to 9% taxation.
Qualifying Income in the UAE
What is included under Qualifying Income?
Qualifying income comprises the following categories of income:
- Income derived from Transactions with Other Free Zone Persons where the other free zone person is the beneficial recipient (Except income derived from excluded activities).
- Income derived from transactions with a Non-Free Zone person (on Qualifying activities that are not excluded activities)
- Any other income provided that the QFZE satisfies the de-minimis requirement
Who is a Beneficial Recipient?
A beneficial recipient is a person who has the right to use the good or service and does not have a contractual/ legal obligation to pass on the good or service to another person.
What are Qualifying Activities?
Qualifying activities include any activity specified in the Ministerial Decision and conducted by a Qualifying Free Zone Person from which Qualifying Income is derived. These include:
- Manufacturing or processing of goods or materials
- Trading of Qualifying Commodities
- Holding of shares and other securities for investment purposes.
- Ownership, management and operation of ships
- Reinsurance services
- Fund management services
- Wealth and investment management services
- Headquarter services to Related Parties
- Financing and leasing of Aircrafts
- Distribution of goods or material in or from the Designated zone
- Logistics services
- Any other activities ancillary to the above.
What are excluded Activities?
This includes activities specified by the minister and conducted by a QFZE from which non-qualifying income is derived. This includes:
- Any transactions with natural persons (except ownership, management and operation of ships, fund/ wealth and investment management services, and financing & leasing of Aircraft)
- Banking activities
- Insurance activities without prejudice to Reinsurance services and headquarter services to related parties.
- Finance and leasing activities without prejudice to Ownership, management and operation of ships, Treasury and financing services to related parties and Financing and leasing of aircrafts.
- Ownership/exploitation of immovable property (other than Commercial property located within a Free Zone and where transactions are made with other Free Zone persons).
- Any activities ancillary to the above
How does the source of Income of a QFZE impact its taxation?
The income of a QFZE can be segregated into four major components. Based on these streams, the taxation rules applicable can be classified as follows:
Income from other Free Zone persons
- Income from qualifying activities (excluding income from excluded activities, where the other free zone person is the beneficial recipient of the relevant services or goods) is considered as qualifying income and subject to 0% taxation.
- Income from excluded activities will be subject to the De-minimis test.
Income from Non-Free Zone Persons
- Income from qualifying activities that do not fall under the category of excluded activities will be considered qualifying income and will be subject to 0% taxation.
- Income from the non-qualifying activity is subject to the De-minimis Test.
Income from Immovable property
- Income from a commercial property where the counterparty in the transaction is a free zone person will be considered as qualifying income and therefore will be subject to 0% taxation.
- All other income derived from a QFZE’s immovable property will be considered taxable income and taxed at 9%. However, this income will not be considered as non-qualifying income for the De-minims test.
Income from Domestic or Foreign Permanent Establishments of the QFZE
- Domestic or Foreign Permanent Establishments of a QFZE will be considered as a separate and independent Person that is a Related Party of the Qualifying Free Zone Person. The income derived from such establishments will be considered taxable income and therefore will be subject to 9% taxation.
- The income derived from these establishments would not be considered as non-qualifying income for the De-minimis Test.
What is considered Commercial Property?
Commercial property is an immovable property solely used for business purposes and not for residential or accommodation purposes.
What is the De-Minimis Test?
The De-Minimis limit prescribes the maximum permissible limit of Non-Qualifying Revenue that can be derived by a Free Zone Entity while continuing to enjoy the status of a QFZE.
- The De-Minimis threshold is the lower of:
- AED 5 million and
- 5% of Annual Revenue
- If the income derived falls within the threshold, the income so derived will be considered as a Qualifying income and subject to 0% taxation.
- Breach of the De-Minims threshold will result in disqualification of the FZE from the status of a QFZE, which will extend up to 4 subsequent years (5 years in total) during which the firm would be subject to tax at the normal CT rate of 9%.
What is included in the Non-Qualifying Revenue for the De-Minims Test?
This includes:
- Revenue from excluded activities and
- Revenue from Non-Qualifying Activities where transactions are made with a non-free zone person
What is excluded from the Non-Qualifying Revenue and Total Revenue calculation for the De-Minimis Test?
- Revenue from a Non- Free zone person with respect to a commercial property located within a Free Zone
- Revenue from any person with respect to a non-commercial property located within a Free zone
- Revenue attributed to Domestic/Foreign P.E of the QFZE.
Corporate tax exemptions and conditions
Although Corporate Tax offers much consideration to the hardships faced by ordinary taxpayers by restricting the applicability of Corporate Tax on individuals and businesses deriving income above a certain threshold limit, that is income above AED 375,000, the CT in the case of QFZE does not prescribe any such income threshold. This is due to the fact that a QFZE that is deriving qualifying income is already benefiting from a 0% taxation, however, any QFZE that derives non-qualifying income will be subject to flat 9% tax on such income without the relief of any income thresholds.
Another key matter of consideration is the unavailability of certain reliefs which is normally applicable to ordinary taxpayers. Therefore, a QFZE will not be able to avail of the benefits of Small Business Relief, Restructuring Relief, or be even part of a Qualifying group or a Tax Group.
If you are a business owner operating in a Free Zone and deriving an annual turnover of less than AED 3 million which also comprises income from the non-qualifying or excluded activities; and expects to derive revenue below the threshold limit for a foreseeable future, the QFZE may not be the best option available to you.
However, once you make up your mind to be subject to normal taxation, you will not be able to backtrack to your previous state, as the CT specifically prohibited a QFZE from returning to its former state, once it has made an irrevocable decision to be subject to normal CT rates.
Impact of Free Zone Entities on the UAE Corporate Tax System
The free zones in the UAE have had a major impact on the UAE’s economy. They have helped to diversify the economy, attract foreign investment, and create jobs. The free zones have also helped to make the UAE a global hub for trade, commerce, and logistics.
According to the UAE government, the free zones have contributed over AED 200 billion to the country’s GDP, and have contributed to the creation of over 1 million jobs. The free zones have also helped to attract billions of dollars in foreign investment.
Future Trends: Corporate Taxation and Free Zone Entities in the UAE
The free zones in the UAE are expected to become more specialized in the future. The UAE government is planning to create new free zones that focus on specific industries, such as healthcare, education, and renewable energy.
Conclusion
The free zones in the UAE are a major success story. They have helped to diversify the country’s economy, attract foreign investment, and create jobs. The free zones are expected to continue to grow in the future, and they will play a key role in the UAE’s economic development. The UAE government is committed to making the country a global hub for trade and commerce. The free zones will play a key role in achieving this goal.
If you want to register for vat or corporate tax, ATB Legal helps with vat registration and corporate tax registration in the UAE.
