Are free zone companies subject to transfer pricing rules?

Article 18 – Qualifying Free Zone Person 1. A Qualifying Free Zone Person is a Free Zone Person that meets all of the following conditions: a. Maintains adequate substance in the State. b. Derives Qualifying Income as specified in a decision issued by the Cabinet at the suggestion of the Minister. c. Has not elected to be subject to Corporate Tax under Article 19 of this DecreeLaw. d. Complies with Articles 34 and 55 of this Decree-Law. e. Meets any other conditions as may be prescribed by the Minister. 2. A Qualifying Free Zone Person that fails to meet any of the conditions under Clause 1 of this Article at any particular time during a Tax Period shall cease to be a Qualifying Free Zone Person from the beginning of that Tax Period. 3. Notwithstanding Clause 2 of this Article, the Minister may prescribe the conditions or circumstances under which a Person may continue to be a Qualifying Free Zone Person, or cease to be a Qualifying Free Zone Person from a different date. 4. The application of paragraph (a) of Clause 2 of Article 3 of this Decree-Law to a Qualifying Free Zone Person shall apply for the remainder of the tax incentive Federal Decree-Law No. 47 of 2022 and its amendments – Unofficial translation (as published by the Ministry of Finance) 25 period stipulated in the applicable legislation of the Free Zone in which the Qualifying Free Zone Person is registered, which period may be extended in accordance with any conditions as may be determined in a decision issued by the Cabinet at the suggestion of the Minister, but any one period shall not exceed (50) fifty years.

In other words, the Related Parties must earn arm’s length income and record operating profits or losses in line with their respective functions, assets, and risks and contributions to the value chain across the group. Section 5.4 discusses the practical application of the arm’s length principle to the attribution of profits of a Free Zone Person between the Free Zone parent and its Foreign Permanent Establishments or Domestic Permanent Establishments. 4.5.3. Transfer Pricing documentation Another condition to be a QFZP is that a Free Zone Person must comply with the Transfer Pricing documentation requirements relating to transactions and arrangements with its Related Parties and Connected Persons.22 This would require the maintenance of documentation to demonstrate the arm’s length nature of the relevant transactions and the preparation of a master file, local file, and other Transfer Pricing documentation requirements for the Free Zone Person as a whole if the relevant Transfer Pricing compliance thresholds are met.23 In addition, a QFZP should maintain sufficient documentation to be able to demonstrate how the profits attributed to the Free Zone parent and its Foreign Permanent Establishments or Domestic Permanent Establishments are commensurate with their relative functions performed, assets deployed, and risks assumed. 4.6. Election not to be a QFZP Being a beneficiary to the 0% Corporate Tax rate, a QFZP will not be eligible for some of the standard features of the Corporate Tax regime. For instance, a QFZP does not qualify for the 0% Corporate Tax rate on Taxable Income up to AED 375,000 that is available to a Person that is not a QFZP. A QFZP also does not qualify for Tax Grouping and specific relief provisions available under the Corporate Tax Law such as Small Business Relief, Qualifying Group Relief, Business Restructuring Relief and transfer of Tax Losses. The Corporate Tax regime does, however, provide flexibility to allow a Free Zone Person to elect not to be treated as a QFZP, and to be subject to Corporate Tax in the same manner as other Taxable Persons in general.24 A Free Zone Person would, in those instances, be able to qualify for the specific provisions listed above, subject to meeting the necessary conditions. 22 Article 18(1)(d) of the Corporate Tax Law read with Article 55 of the Corporate Tax Law. 23 Article 2(1) of Ministerial Decision No. 97 of 2023. 24 Article 19(1) of the Corporate Tax Law. Corporate Tax Guide | Free Zone Persons | CTGFZP1 32

and its branches collectively as a single Qualifying Free Zone Person. However, if a Taxable Person based in a Free Zone has a branch that is not in a Free Zone, then that branch is treated as a Domestic or Foreign Permanent Establishment. The income attributable to that Permanent Establishment is calculated as if the establishment was a separate and independent Taxable Person that is a Related Party of the Qualifying Free Zone Person. Its income is not Qualifying Income and its activities are not taken into account in assessing the conditions for a Qualifying Free Zone Person19. Q If a Taxable Person does not record certain transactions at arm’s length prices in its financial statements, but makes an appropriate transfer pricing adjustment in its Corporate Tax Return, can it still be a Qualifying Free Zone Person? A Yes, where a transfer pricing adjustment is made to the Corporate Tax Return to meet the arm’s length principle for Related Parties 20, a Free Zone Person will not be disqualified from being a Qualifying Free Zone Person for that Tax Period for not recording arm’s length transactions in its financial statements. Free Zones – Adequate substance Q A Free Zone Person rents out property located in a Free Zone to Related Parties in the Free Zone. Can it pass the adequate substance test21 to be a Qualifying Free Zone Person even if it has no employees? A The adequate substance test should be applied on a case-by-case basis having regard to the level of activities carried out, and whether there are adequate assets, an adequate number of qualified full-time employees and an adequate amount of expenditure in relation to each activity22, and does not provide an exception where an activity is asset-based or passive in nature. For example, for a business that lets out property, the absence of any full-time employees may indicate that no personnel are dedicated to performing the core income-generating activities associated with leasing, such as contract administration, compliance monitoring, oversight of lease renewals, or enforcement of contractual rights and obligations, and the adequate substance test is not met. Q Can employees working full-time in a Free Zone, under a Free Zone Person’s control and supervision, but holding visas from other Related Parties, be qualified full-time employees of the Free Zone Person for the adequate substance requirement23? A Yes, the fact that the employees hold work visas issued by other Related Parties does not prevent a Free Zone Person from meeting the adequate substance requirement of having an adequate number of qualified full-time employees in a Free Zone, if the Free Zone Person bears the economic expense of the employees and is responsible for the substance of the employment relationship. Q Can the adequate substance test24 be met if a Free Zone company has no separate physical office but uses a shared workspace in a Free Zone to carry out its activities? A This depends on whether the shared workspace is sufficient for the company to carry out its core incomegenerating activities. The space where the Applicant conducts its operations should be commensurate with its level of Qualifying Activity. The Applicant must have adequate substance 19 Article 5 of Cabinet Decision No. 100 of 2023 20 Article 18(1)(d) and Article 34 of the Corporate Tax Law 21 Article 8(1) of Cabinet Decision No. 100 of 2023 22 Article 8(1) of Cabinet Decision No. 100 of 2023 23 Article 8(1) of Cabinet Decision No. 100 of 2023 24 Article 8(1) of Cabinet Decision No. 100 of 2023 5