UAE Corporate Tax: Businesses in free zones are awaiting final details on the 0% processing and distribution t
Even in the processing of goods, these companies will require input on the 0% corporate tax.
What do rocket science and tax regulations have in common? Both are intriguing and necessitate extensive research, with even tiny errors causing a quantum shift in the course. Either reach for the stars or tumble to the ground.
The UAE's corporate tax public consultation for free zones (PCD) has provided various insights as well as the potential direction of the tax regime that these centres would be subject to. The interpretation of tax rules among the finance and tax fraternity indicates important comprehension gaps, which could be harmful in the long run.
Distribution vs. processing
Income from the distribution of goods is only eligible for the preferential 0% tax rate (subject to limitations) if it occurs in or from a designated zone. However, income from the processing of commodities is exempt from taxation if the enterprise is located in a free zone.
The latter comprises preparing, treating, transforming, or converting products into another form for commercial use or sale. International jurisprudence is riddled with criteria for determining what acts constitute commodities processing.
Will the roasting and sale of coffee beans be considered processing or distribution? Is the form of the items changed when premade jackets and trousers are packed into individual suit sets? Does a scrap dealer handle or distribute old items after deconstructing them into components or merely crushing them into various pieces?
Is packing of items a form change that results in processing? Are businesses that programme debit/credit cards (with chips) before selling those products processing those goods?
The term 'preparation' has elicited various interpretations as to how this alone could transform the goods. Before completing their tax position, free zone enterprises should consider the larger tax implications of classifying their distribution activities as processing.
Manufacturing vs. processing
Income from qualifying operations - eligible for a 0% tax rate - includes income from manufacturing and processing items, among other things. The PCD advises categorising such actions as follows:
- manufacture of one's own items, and
- Manufacturing for and on behalf of someone else.
In the former, the manufacturer's money must be divided into manufacturing and sales earnings. We recently highlighted how manufacturers in free zones, other than those in authorised zones, may face tax complications.
Manufacturing profits will be taxed at 0% for all free zone-based manufacturers. However, sales profits - which are equated to 'distribution activity' - will only qualify for a 0% tax rate if the manufacturer is located in a defined zone. The practical difficulties in such profit splitting add to the complexity.
It is also possible to process goods:
- of personal property and;
- For and on behalf of someone else.
Businesses in free zones should wait for clarification on whether the concept of'sales profit' can be extended to income from the processing of their own goods, as well as the potential tax implications for their activities.
Providing 'headquarters services' to affiliated parties
Income from headquarters services to related parties is similarly tax exempt at 0%.
According to the public consultation, headquarters services include administering, overseeing, and managing related parties' business activities, such as providing senior and general management, captive insurance services, administrative services, business planning and development, risk management, coordination of group activities, procurement, and generally incurring expenditures on their behalf, as well as providing other support services to related parties.
Due to differing interpretations, corporations are intending to relocate their senior management and headquarters to free zones even though they are outside the defined zone. Businesses hope to save considerable tax outflows by allocating a portion of their overall corporate profits to such headquarters services.
A close study of the public consultation, on the other hand, may reveal a different perspective. Headquarters services may necessitate the provision of all of the operations outlined above as a single package.
Individually provided activities would not be eligible for the 0% tax rate. Furthermore, transferring management positions without any commercial or fiscal grounds may expose organisations to anti-abuse legislation.
A clarification and/or guidance from the tax authorities would be quite beneficial.
Additional restrictions would apply if the Economic Substance Regulations (ESR) could be used as guidance. A free zone firm should take on responsibility for the overall success of the group or is accountable for an important component of the overall group's performance by providing headquarters services.
The trajectory of the future
Businesses should also await further guidance/legislation on free zone taxation as a result of the public consultation process. Ask the appropriate questions to keep your company on the right track.