UAE: Optimise tax based on the revised free zone decisions

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During the past week, the previously issued Cabinet Decision No. 55 of 2023 and Ministerial Decision No. 139 of 2023 regarding UAE Free zones have been repealed and it has been replaced by newly introduced Cabinet Decision No. 100 of 2023 which focuses on the Qualifying Income (QI) of the Qualifying Free Zone Person (QFZP); and Ministerial Decision No. 265 of 2023 that deals with Qualifying Activities (QA) and Excluded Activities (EA), respectively.

The revised decisions have introduced several new definitions, such as the definition of patent, copyrighted software, Qualifying Intellectual Property (QIP) and Qualifying Trading Commodities (QTC). Additionally, the revised Decisions are now carrying the detailed descriptions of the Qualifying Activities and Excluded Activities. Notably, the new Decisions grant leverage to the QFZP who is generating revenue through the development and exploitation of QIP, as well as through the trading of Qualifying Commodities.

Under the revised decisions, the income derived by the QFZP from the ownership or exploitation of QIP now has the potential to be classified as QI and may be subject to a 0% tax rate. This is a significant departure from the previous repealed Decision where income derived from intellectual property was classified as part of Excluded Activities, and thus subject to taxation. This change opens new opportunities for the QFZPs to enjoy favorable tax treatment for their income derived from QIP, subject to satisfying the specified criteria.

According to the revised d, the QFZP is not eligible to claim the entirety of the income derived from QIP. However, a specific formula has been provided to calculate the QI of the QIP. The QI income of the QIP = total income from the QIP*[(qualifying expenditure of the QIP + uplift expenditure of the QIP) / overall expenditure of the QIP].

Qualifying expenditures refer to the expenses that are utilized to directly support research and development activities that are closely associated with the creation, invention, or significant advancement of the QIP. On the other hand, Total expenditures encompass all costs and expenditures related to the QIP, including qualifying expenditures, acquisition costs, and any other associated expenses. Overall Income pertains to any income generated from the QIP.

In the context of intellectual property, the term “uplift expenditures” denotes the additional costs or investments made with the intention of enhancing or improving the value, quality, or functionality of intellectual property assets. Uplift expenditures are allowed up to 30% of the qualifying expenditures, provided that the qualifying expenditures, after being uplifted, do not exceed the overall expenditures.

Any income derived from non-qualifying intellectual property, as well as the NQI of the QIP, will be subjected to a 9% tax rate. Furthermore, such income will not be considered in the calculation of the deminimus criteria. The treatment of the NQI of intellectual property is similar to the income earned by the QFZP from residential property and permanent establishments.

The QIP include patents, copyrighted software, and similar rights that provide legal protection and undergo a registration process similar to patents. However, it does not include trademarks or other intellectual property assets related to marketing. Patent and copy righted software include the patents and software for which rights and protection has been granted in the UAE and out of the UAE.

The revised ministerial decision now includes the “trading of qualifying commodities” as one of the qualifying activities. The term “trading of qualifying commodities” refers to the physical trading activities involving qualifying commodities, as well as associated derivative trading aimed at hedging against risks associated with such activities.

This amendment provides an advantageous opportunity for QFZPs engaged in the trading of qualifying commodities. If a QFZP earns income from this trading activity, it can be categorized as QI and will be subject to a corporate tax rate of 0%, provided that all other conditions are met. Qualifying commodities encompass metals, minerals, energy, and agriculture commodities that are traded in their raw form on recognized commodities exchange markets, either within the UAE or internationally.

The activity previously known as “Holding of shares and other securities” has been modified to “Holding of shares and other securities for investment purposes.” The Decision provides a clear definition of investment purposes, which refers to holding these assets continuously for a minimum duration of 12 months.

Moreover, an additional flexibility has been introduced for QFZPs generating income from QIP. The core income-generating activities related to QIP are now permitted to be outsourced to any other entity within the UAE and to unrelated entities outside the UAE, as long as the QFZP ensures proper supervision of the outsourced activities.

Apart from the above-mentioned changes, there are no significant variations in the Decisions; and the overall structure of the Decisions remains largely unchanged.

We recommend the businesses operating in the Free Zone is to conduct a comprehensive analysis from the scratch in order to determine the most suitable approach that will yield the maximum impact on corporate tax.

Mahar Afzal, a managing partner at Kress Cooper Management Consultants, has shared a personal opinion which does not represent the official stance of Khaleej Times. If you have questions or require further clarification, contact Mahar at mahar@kresscooper.com.