Recent Corporate Income Tax Implementations on “Distribution of Goods” for Free Zone Companies

The Minist

ry of Finance of the UAE (the “MoF”) announced the launch of a digital public consultation on its website as part of the UAE Corporate Tax’s Free Zone regulations. The public consultation was open from 19 July to 2 August 2023. The MoF extended the deadline for feedback and comments on that public consultation to 9 August 2023.

The MoF aimed to gather feedback from free zone-based companies and other relevant parties on qualifying and excluded activities laid down in the Ministerial Decision No. 139 of-2023. The consultation draft (the "Draft") provides clarifications detailing the scope of the qualifying and excluded activities with explanatory illustrations.

In Clause 11 of Article 3 in the Draft, the distribution of goods or materials is defined as buying and selling of products, materials, component parts or any other items that are tangible or movable, but not including financial assets and instruments, in or from a Designated Zone. And it also provides that the Qualifying Activity of distributing goods or materials may include functions such as the importation, storage, inventory management, handling, transportation and exportation of those goods or materials.

However, illustration 1 of Clause 11 exemplifies high sea sales transactions as given below:

The illustration and the related explanations above give rise to a literal interpretation that only Designated Free Zone companies can benefit from 0% corporate income tax over their high sea sales earnings. But it would be irrelevant to restrict companies established and operating in Free Zones other than Designated Zones benefiting from such for the reasons given below.

If high sea sales activities will be included in the scope of qualifying activities of a Free Zone Company in the context of "Distribution of Goods" per the illustration and explanations above, then all Free Zone companies' high sea sales activities should fall under the qualifying activities for two reasons.

First, and with respect to the ordinary course of international trade regarding high sea sales, those activities can be operated and managed from any Free Zone since they would not require any type of importation, storage, inventory management, handling, transportation and exportation of goods or materials.

Second, and with respect to fair taxation, if those activities are included in the qualifying activities for only Designated Zone companies in terms of taxation, then in my opinion it would be contrary to the main principles of taxation. It would be against the principles of equality and certainty in taxation to the disadvantage of companies established and operating in Free Zones other than Designated Zones.

As a result, the literal interpretation of the above-mentioned illustration is very problematic for the reasons we put forth. Therefore, if the MoF insists on providing 0% corporate income tax entitlement to only Designated Zone companies over their high sea sales earnings, it would lead other Free Zone companies to shift their headquarters to Designated Zones for tax purposes. This kind of measure that companies in Free Zones would take might cause an unfair and unjust situation for Free Zone Authorities resulting in them losing their members to Designated Zones for tax purposes.

In our opinion, the MoF should broaden the scope of "Distribution of Goods" under qualifying activities for all Free Zone companies and not restricting to Designated Zone companies only if high sea sales earnings will be included in such activities.

Accordingly, and contrary to the explanations made for illustration 2, we believe that "Distribution of Goods", requiring importation, storage, inventory management, handling, transportation and exportation of goods or materials, as exemplified in illustration 2 of Clause 11, should also be determined as a qualifying activity for all Free Zone companies.

We do hope that the MoF would enact and announce the Ministerial Decision as to clarify further the scope of “Distribution of Goods” under the qualifying activities encompassing all Free Zone companies in the contexts of fair taxation and holistic economic approach for all Free Zone companies.