Qualifying Activities and Excluded Activities: UAE CT Update

INTRODUCTION  

Under UAE Corporate Tax Law, Qualifying Income (“QI”) of Qualifying Free Zone Person (“QFZP”) is exempted from taxation. Income from Qualifying Activities amounting to Qualifying Income is exempted from tax liability, while income from other activities, including Excluded Activities, amounts to Non-Qualifying Income which is liable for 9% tax liability as per Article 3 of the Corporate Tax Law.     

QUALIFYING ACTIVITIES – MINISTERIAL DECISION NO. 265 OF 2023 

Article 2 of the Ministerial Decision specifies the activities that are considered as Qualifying Activities when performed by Qualifying Free Zone Person as follows: 

• Manufacturing of goods or materials – This Activity includes: 
• • Production of goods or materials from raw materials; or 

• • Improvement goods or materials from raw materials; or  

• • Assembly of goods or materials from raw materials or components.  

• Processing of goods or materials – This activity includes the preparation, treatment, transformation or conversion of goods or materials from one form to another for: 
• • Commercial use; or 

• • Industrial use; or  

• • Sale purposes.  

• Trading of Qualifying Commodities – Qualifying commodities include trading of metals, minerals, energy and agriculture commodities in raw form in Recognized Commodities Exchange Market. According to this provision, physical trading (purchase and sell) and associated derivative trading (to guard against risk) activities of Qualifying Commodities are considered Qualifying Activities. Holding of shares and other securities for investment purposes – This includes holding the following: 

• • Holding of shares of any class;  

• • Holding of Negotiable or Non-Negotiable Financials  

If the Qualifying Free Zone person holds such shares or securities for a continuous period of 12 months, then, it will be deemed that the shares and other securities are held for the investment purposes.  

• Ownership, management and operation of Ships – When a ship is used for the following, then, it is considered as qualifying activities: 
• •  International transportation of goods, passengers or livestock; 

• • Towing activities;  

• • General assistance at sea to ships; 

• •  Dredging Activities at sea; 

• • Chartering and leasing of ships, etc.  

Exclusions: But if a ship is used for the following, it is not considered as Qualifying Activities: 

• • Local transport, or 

• • Leisure, or 

• • Recreational purpose, 

• • Floating Hotels, 

• • Restaurants, 

• • Casinos 

• Reinsurance services  
• Fund management services – This type of services includes portfolio and risk management, other services by a fund manager related to day-to-day management and operations of Investment Fund, etc., subjected to the regulation of the Competent Authority.  
• Wealth and investment management services – These services include discretionary and non-discretionary investment management services, general advisory services and advisory services related to wealth and investment, etc.  
• Headquarter services to Related Parties – These services include business activities such as administering, overseeing, and managing business related activities of only related parties and not any third party. This include activities such as: 
• • provision of senior and general management, 

• • captive insurance services,  

• • administrative services,  

• • procurement services,  

• • business planning, 

• • business development,  

• • risk management,  

• • coordination of group activities, etc.  

• Treasury and financing services to Related Parties – A few activities included under treasury and financing services when provided only to Related Parties are: 
• • Financing,  

• • Debt management,  

• • Financial risk management,  

• • Cash and liquidity management,  

• • Centralized Payment, etc.  

• Financing and leasing of Aircrafts – This includes financing, leasing (granting the right to use the assets in exchange of rent) & securitization of aircraft, aircraft engine or rotable components.  
• Distribution of goods or materials in or from a Designated Zone – This means buying and selling of goods or materials or other related activities, of tangible or movable items including activities: 
• • Importation,  

• • Inventory Management, 

• • Storage, 

• • Transportation,  

• • Handling, 

• • Transportation, etc. 

• Logistics services – This service means providing storage or transportation services of goods or materials without taking any title on the same. Such services include:  
• • Cargo handling,  

• • Warehousing, 

• • Storage, 

• • Transport agency services,  

• • Customs brokerage services, 

• • Order and inventory management,  

• • Freight forwarding Services   

• • Brokerage services,  

• • Packing and unpacking, etc.  

• Ancillary activities – This activity includes any kind of activity which is ancillary to above mentioned activities.  

EXCLUDED ACTIVITIES – MINISTERIAL DECISION NO. 265 OF 2023 

Article 2 of the ministerial decision also specifies the number of activities that are considered as Excluded Activities when performed by Qualifying Free Zone Person as follows:  

• Transaction with any natural person – When a Qualifying Free Zone Person is involved in any activity with a natural person, such activity is considered an excluded activity except in certain circumstances as follows: 

• • Ownership, management, and operation of Ships  

• • Financing and leasing of aircrafts 

• • Fund management services  

• • Wealth and Investment management services 
• Banking Activities – Such activities that are subjected to regulatory oversight are also considered Excluded Activities. 
• Insurance Activities – Insurance Activities that are subject to regulatory oversight are excluded activities except for: 

• • Reinsurance services and  

• • Headquarter services provided to Related Parties.  

• • Finance and leasing activities – These activities includes: 

• • Giving credit or financing any kind of consideration; 

• • Letting or Granting right to use an asset in return of rent or any other consideration; 

• • Operating Lease; etc.   
• Ownership or Exploitation of Immovable property – This is excluded when the transaction is related to Commercial Property (in Free Zone) with an FZP. 
•  Ancillary activities – This activity includes any kind of activity which is ancillary to above-mentioned activities.  

DE MINIMUS REQUIREMENT  

The De Minimus condition will be met when the NQR derived by the QFZP in a Tax Period doesn’t exceed (lower of the two):  

1. 5% of Total Revenue (TR) earned by the Qualifying Free Zone Person in the taxation period; or – 
2. AED 5 Million  

QUALIFYING INCOME FROM QUALIFYING INTELLECTUAL PROPERTY (QIP) 

Qualifying Intellectual Property includes patents, copyrighted software, and any other right equivalent to such patent rights. Article 7 of the Cabinet Decision No. 100 of 2023 specifies that the income that is generated from exploitation and ownership of Qualifying Intellectual Property shall be considered as Qualifying Income. The process to calculate such Qualifying Income is specified in this ministerial decision.  

Formula For Calculation Qualifying Income 

The formula for calculation Qualifying Income is =  

{(Qualifying Expenditure + Uplift Expenditure) ÷ Overall Expenditure} * Overall Income 

The above-mentioned terms mean as follows:  

• Qualifying Expenditure– This includes expenditure incurred for research and development activities, including creation, invention or significant development of Qualifying Intellectual Property, and such activities are conducted by: 
• •  Qualifying Free Zone Person; 

• • Outsourced to any person in the UAE;  

• • Outsourced to any non-Related Party outside the UAE.   
• Overall Expenditure – This includes total expenditure incurred for research and development activities including, creation, invention, significant development or acquisition cost of Qualifying Intellectual Property, and such activities are conducted by: 

• • Qualifying Free Zone Person; 

• • Outsourced to any person connected with such activities. 
• Uplift Expenditure – This amount is 30% increased to Qualifying Expenditure subjected to the condition that Qualifying Expenditure amount shall be less than or equal to Overall Expenditure after being up-lifted.  
• Overall Income – Income generated from royalties or in any other form, including embedded IP from sale of product or use of process related directly to QIP is considered for Overall Income. 

DOCUMENTS AND RECORDS TO BE MAINTAINED BY QFZP FOR QIP 

A Qualifying Free Zone Person shall maintain all required documents and records to prove the below mentioned in relation with QIP: 

1. Ownership and right to exploit the QIP; 
2. Qualifying Expenditures and Overall Expenditures incurred; 
3. Overall Income derived; 
4. Linkage between Qualifying Expenditures and Overall Income derived.  

ADDITIONAL CONDITIONS FOR QFZP 

Article 5 of the Decision states few additional conditions for a Free Zone Person to be considered a Qualifying Free Zone Person after fulfilling certain conditions under Article 18 of the UAE Corporate Tax Law: 

1. Non-Qualifying Revenue shouldn’t exceed the De Minimis requirement; 
2. Maintenance and preparation of Audited Financial Statements.  

Failure to meet conditions: Additionally, if a QFZP fails to meet conditions under Article 18 or decisions, it shall cease to be a QFZP from 5 Tax Periods. 

CONCLUSION 

In conclusion, the UAE Corporate Tax Law establishes a clear framework distinguishing Qualifying Activities from Excluded Activities for Qualifying Free Zone Persons (QFZP). The detailed Ministerial Decision No. 265 of 2023 outlines specific sectors deemed as Qualifying Activities, ensuring tax exemptions for income derived from these operations. Conversely, certain Excluded Activities, attract tax liabilities. The De Minimus Requirement provides flexibility, exempting income from certain excluded activities within defined limits. The incorporation of Qualifying Intellectual Property introduces a calculated approach for determining Qualifying Income for Intellectual Properties like Patents, Copyright, etc., emphasizing research and development expenditures. This comprehensive structure aims to promote transparency and compliance in the Free Zone business environment. 

FAQs

1. What is the meaning of “Ship”? 

Ship refers to any structures operating or set for operating in maritime navigation, regardless of power and tonnage. 

2. What is an “Aircraft”? 

Aircraft is defined as any machine that can derive support in the atmosphere from the reactions of the air, excluding reactions against the surface of the earth. 

3. What does “Designated Zone” mean? 

Designated Zone refers to a zone specified as a Free Zone for the purposes of the UAE Corporate Tax Law. 

4. What are the requirements for distributing goods or materials in or from a Designated Zone? 

The distribution of goods or materials must be carried out in or from a Designated Zone, and the goods or materials entering the State must be imported through the Designated Zone. 

5. What is considered an ancillary activity in relation to the Qualifying Activities? 

An activity is considered ancillary when it serves no independent function but is necessary for the performance of the main Qualifying Activity. 

6. How is an ancillary activity defined for Excluded Activities? 

An activity is considered ancillary when it serves no independent function but is necessary for the performance of the main Excluded Activity. 

7. What are the de minimis requirements for a Qualifying Free Zone Person? 

The de minimis requirements are considered satisfied when the non-qualifying revenue derived by the Qualifying Free Zone Person in a Tax Period does not exceed 5% of the total revenue of the Qualifying Free Zone Person in that Tax Period or AED 5,000,000, whichever is lower. 

8. What are the additional conditions for a Qualifying Free Zone Person? 

In addition to the conditions specified in Clause (1) of Article (18) of the UAE Corporate Tax Law, a Qualifying Free Zone Person must meet two conditions:  

(a) Its non-qualifying revenue should not exceed the de minimis requirements, and  

(b) It should prepare audited financial statements in accordance with the decision issued by the Minister. 

9. What happens if a Qualifying Free Zone Person fails to meet the conditions? 

If a Qualifying Free Zone Person fails to meet any of the conditions set out in Clause (1) of Article (18) of the Corporate Tax Law, this Decision, or any other prescribed conditions, they will cease to be a Qualifying Free Zone Person from the beginning of the relevant Tax Period and for the subsequent four Tax Periods (total 5 Tax Periods).