How to apply the qualifying income test for a free zone company

A UAE free zone company must pass the qualifying income test if it wants to be taxed as a Qualifying Free Zone Person (QFZP) at 0% on qualifying income. The process involves classifying your revenue, checking whom you do business with, and applying a detailed de minimis rule if you have non-qualifying income. Here is how the test works in practice, based entirely on Federal Tax Authority guidance.

Step 1: Identify all revenue for the period

Gather all revenue streams earned by your free zone entity during the financial period. This includes income from sales of goods, services, dividends, interest, and other sources, wherever the client or counterparty is located.

Step 2: Sort each activity and counterparty

To be treated as qualifying income, revenue must meet specific activity and counterparty tests. The law distinguishes:

• Transactions with other free zone persons
• Transactions with non-free zone persons (mainland UAE entities or natural persons)
• The type of activity (qualifying, excluded, or other)

Table: The qualifying status depends on both the recipient and the nature of the activity.

What are qualifying and excluded activities?

The FTA provides an exhaustive list of qualifying activities, including (but not limited to) manufacturing, processing, distribution in or from a designated zone, logistics, headquarter services to related parties, fund management and certain holding activities. Excluded activities are tightly defined and include activities such as regulated banking, insurance (except reinsurance), finance and leasing to non-related parties, and income from UAE immovable property.

If you earn any income from an excluded activity, that portion cannot count as qualifying income under any scenario.

Step 3: Revenue from immovable property

Special rules override the above matrix for UAE immovable property. Income from real estate located in a free zone (other than commercial property leased to a free zone person) is always excluded and taxed at 9%. Mixed-use or residential properties in a free zone do not qualify for the 0% rate, even if the renter is another free zone person.

Commercial property income may only qualify if both the land and tenant are within a free zone, and the tenant is a free zone person.

Step 4: Check if you have any non-qualifying revenue

Non-qualifying revenue includes any revenue from excluded activities or income that is not qualifying under the various recipient and activity rules. If all your revenue is qualifying income, you do not need the de minimis test. If you have any non-qualifying revenue, proceed to the next step.

Step 5: Apply the de minimis test

A free zone company with some non-qualifying revenue will retain QFZP status only if its non-qualifying revenue does not exceed the lower of:

• 5% of total revenue, or
• AED 5,000,000

This threshold must be calculated each tax period.

Table: De minimis test limits

You must apply whichever limit is lower for your circumstances. If either threshold is exceeded in a period, your company will lose QFZP status for the period and be fully subject to 9% tax on all taxable income.

Practical calculation example

Suppose your free zone company earns AED 60 million in total revenue for the tax period:

• 5% of AED 60 million = AED 3 million
• The lower threshold is AED 3 million (since it is less than AED 5 million)
• If your non-qualifying revenue is AED 2.2 million, you pass the test and QFZP status holds
• If non-qualifying revenue is AED 3.5 million, you breach the de minimis rule and lose QFZP status

Step 6: Reporting, documentation, and consequences of failing the test

You must document how you have classified your revenue streams for each tax period. If you fail to meet the qualifying income (or the de minimis) test in a tax period, you become fully taxed at 9% for that period, and relevant compliance obligations (including transfer pricing where applicable) must be met.

All allocations, especially between qualifying and non-qualifying revenue or expenses, must be reasonable, supportable, and reflected in your financial statements.

Key points for finance teams

• Check the detailed FTA lists for qualifying and excluded activities specific to your business sector
• Confirm the status of each counterparty in free zone transactions
• Track all non-qualifying revenue monthly to react early if near the 5%/AED 5m threshold
• Watch out for property income rules, these override all others

This stepwise approach is the only way to check eligibility for the free zone 0% corporate tax rate. If your revenue structure or activities are complex, detailed review is required period to period.