Income Tax in the UAE: A Closer Look at Free Zones and Mainland Branches

As of June 1, 2023, the United Arab Emirates has officially introduced a new era of taxation with the implementation of corporate income tax. This significant policy shift affects both mainland companies and entities operating within free zones. For those considering business setup in Dubai, the nuances become more complex when free zone businesses engage with the mainland. Understanding the difference between qualifying and non-qualifying income is crucial, particularly for entrepreneurs managing branches or subsidiaries across jurisdictions.

0% or 9% – What’s the Difference?

Under the current tax framework, businesses earning more than AED 375,000 in annual profit are taxed at a standard 9% rate. However, companies classified as Qualifying Free Zone Person (QFZP) may still benefit from a 0% tax rate, provided they meet several strict conditions.

To qualify, income must originate from specific activities such as exports, services provided to other free zones, passive income like dividends and royalties, or transactions with foreign entities. This is particularly relevant for those involved in company formation in the UAE or structuring international operations through designated zones.

Maintaining QFZP status also requires proof of economic substance. That includes having a physical office, operational employees, and active business functions in the free zone. Companies must submit audited financial statements, follow transfer pricing guidelines, and classify income properly in accordance with the arm’s length principle.

Mainland Branches and the Risk They Pose

Opening a branch in the UAE mainland is permissible, but any income that the branch generates from mainland activity is not considered qualifying. That income is fully subject to the 9% tax rate.

Additionally, if the revenue from non-qualifying activities exceeds the de minimis threshold the lower of 5% of total revenue or AED 5 million, the parent company loses its QFZP status for four tax periods. For businesses heavily reliant on mainland operations, including those navigating mainland company formation in Dubai, this is a substantial compliance and financial risk.

What Counts as Qualifying Income?

Qualifying income eligible for the 0% rate typically includes:

• Business conducted with other firms in Designated Free Zones
• Exported services to non-UAE clients
• Passive income, such as dividends and interest from investments
• Certain mainland transactions, provided they don’t involve selling to end consumers in the UAE

On the other hand, income from mainland property leasing or consultancy services within the country falls under the standard 9% corporate tax. Those pursuing company setups in Dubai or similar jurisdictions should account for this distinction when planning their operations.

Tax Reporting and Compliance

Even companies that meet QFZP criteria must register for corporate tax and file reports with the Federal Tax Authority (FTA). They are also required to maintain detailed records, especially for transfer pricing, and demonstrate an actual operational footprint within the free zone.

These tax responsibilities often align with broader corporate services like accounting and bookkeeping in Dubai or support from pro services company in Dubai to help with ongoing documentation, submissions, and compliance reviews. Delays or errors in tax filings may lead to penalties and added scrutiny.

Operating Across Zones? Assess Every Transaction

For companies that span both a free zone and the mainland, each transaction needs careful review. Even if the legal registration is based in a free zone, income from a mainland branch could result in a 9% tax liability. Exceeding the revenue threshold means the entire business structure could lose its tax-free benefits.

Currently, there is no withholding tax in place, but that could change in the future. If the UAE Cabinet of Ministers decides to introduce one, cross-border payments and international transactions may be affected, especially for companies without double taxation treaties. This is something investors exploring offshore company formation in UAE should keep an eye on.

Final Thoughts

The UAE continues to offer significant tax advantages, particularly through its free zones. However, with increasing regulatory scrutiny, companies involved in business setup in UAE free zone or mainland business setup in Dubai must be proactive. Compliance now plays a major role in preserving tax benefits.

For long-term success, it’s not just about registering in the right place. It’s about understanding where the 0% rate applies, managing how mainland activity is structured, and making informed decisions to reduce the risk of losing preferential status.

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