Taxation Of Free Zone Companies Under The UAE Corporate Tax Regime – Sales Taxes: VAT, GST

Introduction

The United Arab Emirates (“UAE”)
has historically positioned itself as a tax-neutral and
investor-friendly jurisdiction, enabling businesses to thrive
through liberal ownership structures, world-class infrastructure,
and simplified regulation. At the center of this strategy is the
UAE’s extensive network of over 40 Free Zones, including the
Jebel Ali Free Zone Authority
(“JAFZA”), Dubai Multi Commodities
Centre (“DMCC”), Dubai International
Financial Centre (“DIFC”), and Abu
Dhabi Global Market (“ADGM”).

Traditionally, these Free Zones offered unmatched incentives:
100% foreign ownership, exemption from customs duties, unrestricted
repatriation of profits, and—crucially—complete relief
from corporate taxation. Until very recently, the only entities
taxed directly were oil and gas companies (subject to
Emirate-specific rates of 55%–85%) and branches of foreign
banks (taxed at 20%).

This environment changed with the enactment of Federal
Decree–Law No. 47 of 2022 on the Taxation of Corporations and
Businesses (as amended by Decree–Law No. 60 of 2023).
Effective for financial years beginning on or after 1 June 2023,
the law introduced a federal corporate tax regime that applies
across the UAE, including in Free Zones. Importantly, while the new
framework preserves preferential treatment for Free Zone companies,
these benefits are now conditional and tied to strict
compliance.

The Corporate Tax Framework

The UAE Corporate Tax regime applies a tiered rate
structure:

• 0% on taxable income up to AED 375,000,




• 9% on taxable income above this threshold, and




• an anticipated 15% effective tax rate for multinational
  enterprise (“MNE”) groups with
  consolidated global revenues of at least EUR 750 million, in line
  with the (“OECD”)
  Pillar Two global minimum tax framework.

For Free Zone companies, the regime establishes the concept of a
Qualifying Free Zone Person (“QFZP”),
which allows continued access to a 0% tax rate on qualifying
income, provided the entity meets a defined set of conditions.

Free Zones under the Corporate Tax Law

Free Zones are specially designated geographic areas with their
own licensing and regulatory authorities. They play a central role
in the UAE’s economic diversification strategy, serving as
hubs for international trade, logistics, financial services,
manufacturing, technology, and investment holding structures.

The policy rationale for maintaining preferential tax treatment
for Free Zone companies is to:

1. Preserve the UAE’s competitive position as a regional
   trade and investment hub.




2. Encourage cross-border and capital-light activities, such as
   fund management, distribution through Designated Zones, and
   reinsurance.




3. Maintain the attractiveness of Free Zones as platforms for
   foreign direct investment (“FDI”)
   while ensuring alignment with global tax standards.

Policy Rationale and Global Alignment

The UAE’s corporate tax regime must be understood in the
context of global tax reform. The UAE has long balanced its role as
an investment hub with the need to maintain credibility in the
international tax community. By aligning with Organisation for
Economic Co-operation and Development
(“OECD”) and Base Erosion and Profit
Shifting (“BEPS”) standards and
conditioning Free Zone incentives on genuine substance, the UAE
ensures that benefits are reserved for real economic activity, not
artificial arrangements. This approach protects treaty access,
avoids “tax haven” stigma, and demonstrates the
UAE’s commitment to transparency while still offering one of
the most competitive environments globally.

Qualifying Free Zone Person (QFZP) Status

Article 18 of the Corporate Tax Law, together with Cabinet
Decision No. 100 of 2023 and Ministerial Decision No. 229 of 2025,
sets out the framework for QFZPs.

To benefit from the 0% corporate tax rate, a Free Zone company
must satisfy the following conditions:

1. Substance in the Free Zone – Carrying on
   core income-generating activities (CIGAs) with adequate employees,
   premises, and expenditure. Outsourcing is permitted only if the
   company supervises and controls the outsourced work.




2. Engagement in Qualifying Activities –
   Earning income from listed activities such as manufacturing,
   trading of commodities, fund management, reinsurance, holding
   shares, headquarters and treasury functions, and logistics.




3. Avoidance of Excluded Activities –
   Refraining from activities such as banking, insurance (other than
   reinsurance), general financing, IP exploitation, or residential
   real estate.




4. De Minimis Rule – Ensuring
   non-qualifying income does not exceed the lower of AED 5 million or
   5% of revenue in a tax period.




5. Audited Financial Statements –
   Maintaining audited accounts with segregation of qualifying vs
   non-qualifying income.




6. Transfer Pricing Compliance – Applying
   the arm’s-length principle and maintaining required
   disclosure and documentation.

If these conditions are breached, the company loses QFZP status
for the current year and the following four years, with all income
taxed at 9%.

Qualifying Income

Qualifying Income includes activities aligned with Free Zone
objectives and UAE’s economic strategy. Key categories
include:

• Manufacturing and processing of goods within the Free
  Zone.




• Trading of qualifying commodities (metals, minerals, energy,
  agriculture) with recognized international pricing.




• Fund and wealth management services offered by licensed
  entities.




• Reinsurance services, excluding general insurance.




• Holding of shares and securities, where income arises from
  dividends and capital gains.




• Headquarters and treasury functions for group entities.




• Financing services to related parties and intra-group cash
  pooling.




• Leasing or ownership of ships and aircraft for international
  transport.




• Distribution of goods in or from a Designated Zone, provided
  import and resale conditions are satisfied.




• Logistics services supporting regional and international supply
  chains.




• Ancillary activities directly connected to the above.

These categories represent the core functions Free Zones were
designed to encourage—export-oriented, globally connected,
and low-risk to the domestic economy.

Non-Qualifying Income

Income outside these categories or expressly excluded is subject
to 9% corporate tax. This includes:

• Banking and most insurance activities (other than
  reinsurance).




• General financing and leasing to unrelated parties.




• IP income (e.g., royalties, licensing fees) unless meeting OECD
  nexus standards.




• Real estate income – residential property in Free Zones,
  commercial property leased to non-Free Zone persons, and all
  property outside Free Zones.




• Transactions with natural persons, except in narrow cases such
  as fund management or aircraft leasing.




• Mainland supplies that do not qualify under Designated Zone
  exceptions.

Companies must carefully distinguish these income streams and
maintain proper records, as even a small misstep can jeopardize
QFZP benefits.

The De Minimis Rule

The de minimis test is a critical safeguard ensuring that QFZPs
remain focused on their qualifying activities. It allows some
tolerance but is unforgiving if breached.

• Threshold: lower of AED 5 million or 5% of total revenue per
  tax period.




• Exclusions: certain income streams (e.g., PE income and
  specific real estate income) are excluded from the
  calculation.




• Breach: exceeding the limit—by even a small
  margin—results in loss of QFZP status for five years.

Regular monitoring and early warning systems are essential to
avoid this pitfall.

Interaction with VAT and Customs

Corporate tax obligations must also be viewed alongside VAT and
customs frameworks. Certain Free Zones are classified as Designated
Zones for VAT purposes, meaning that supplies between them may be
zero-rated. However, VAT treatment does not always mirror corporate
tax treatment—an export transaction may be VAT-exempt yet
still taxed at 9% corporate tax if it is a non-qualifying activity.
Similarly, goods imported into Designated Zones remain subject to
customs controls, and movement into the mainland is treated as an
import. Companies must therefore manage VAT, customs, and corporate
tax compliance simultaneously, ensuring consistency across
reporting systems.

Permanent Establishments (PEs)

A domestic PE arises where a Free Zone entity maintains a fixed
place of business in the mainland or operates through an agent
habitually concluding contracts. Income attributable to the PE is
taxed at 9%, regardless of Free Zone benefits. A foreign PE is
similarly carved out, taxed in the host country, and subject to
double tax treaty relief or credits. Companies must carefully
monitor activities to avoid unintentionally creating taxable
PEs.

Real Estate Income

The treatment of immovable property is restrictive and
clear:

• Commercial property in Free Zones: 0% only when leased to Free
  Zone persons.




• Commercial property leased to non-Free Zone persons: taxable at
  9%.




• Residential property in Free Zones: always taxed at 9%.




• Property outside Free Zones: fully taxable at 9%.

Practical Compliance Risks

Despite clear rules, Free Zone entities face common compliance
challenges. Misclassifying transactions with natural persons (e.g.,
e-commerce sales) often results in unintended non-qualifying
income. Intragroup arrangements for financing, headquarter
services, or cost-sharing may fall foul of transfer pricing rules
if not documented at arm’s length. Outsourcing without proper
oversight undermines the substance test, while failing to account
for mainland permanent establishments leads to unexpected 9% tax
exposure. The greatest risk lies in de minimis breaches, where
minor contracts or overlooked service income cause companies to
lose their QFZP status for five years.

Substance Documentation – What the FTA Will Expect

Substance requirements are assessed based on factual evidence.
Companies should maintain:

• Employment contracts and payroll for Free Zone-based
  staff.




• Lease agreements and utilities proving premises in the Free
  Zone.




• Board minutes evidencing management decisions taken
  locally.




• Outsourcing agreements with clauses demonstrating retained
  supervision.




• Audited financial statements segregating income streams.




• Transfer pricing documentation supporting arm’s-length
  pricing.

Without this documentation, companies are vulnerable during FTA
audits and risk losing preferential status.

Sector-Specific Observations

The regime impacts industries differently. Trading and logistics
companies thrive when operating through Designated Zones but must
maintain meticulous import and resale documentation. Financial
services in DIFC and ADGM face stringent regulation, yet fund
management and reinsurance continue to qualify. Family offices and
holding companies benefit from exemption on dividends and capital
gains, provided substance is present. Real estate investors face
restrictions, with most property income taxable at 9%. Technology
and IP businesses are the most constrained, as IP income is largely
excluded from the regime unless it satisfies strict OECD nexus
conditions.

Compliance Framework

QFZPs and other Free Zone companies must comply with an
extensive framework:

• Tax registration with the FTA and obtaining a TRN.




• Annual tax return filing within nine months of year-end.




• Audited financial statements under Ministerial Decision No. 84
  of 2025.




• Transfer pricing compliance under Cabinet Decision No. 97 of
  2023.




• Record retention for seven years.




• GAAR enforcement, enabling the FTA to disregard arrangements
  primarily designed for tax benefits.

Pillar Two – Multinational Considerations

The UAE has implemented the OECD’s Pillar Two rules, with
a Domestic Minimum Top-Up Tax (DMTT) effective for financial years
beginning on or after 1 January 2025. Multinational groups with
consolidated revenues of at least EUR 750 million must maintain an
effective tax rate of at least 15%, regardless of QFZP status. This
neutralises the benefit of the 0% Free Zone regime for large groups
but does not impact smaller businesses.

Comparative Overview: Mainland vs Free Zone vs QFZP

Key Takeaways

• Free Zone tax incentives are conditional, not automatic.




• The de minimis threshold is critical — small breaches can
  eliminate benefits.




• Substance requirements and transfer pricing compliance are
  central to retaining the 0% regime.




• QFZP status, once lost, cannot be regained for five years.




• Large MNEs should prepare for the 15% minimum tax under BEPS
  Pillar Two.

Conclusion

The UAE’s Corporate Tax regime reflects a careful
balancing act: preserving 0% Free Zone incentives for genuine
economic activity while ensuring alignment with international tax
standards.

For Free Zone businesses, the message is clear: the era of
blanket exemptions is over. Companies must now demonstrate
substance, monitor the de minimis rule, and proactively manage
compliance to safeguard benefits.

Far from reducing competitiveness, these reforms enhance the
UAE’s credibility as a transparent, globally aligned hub for
trade, finance, and investment.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.