In response to evolving international tax standards and the UAE’s commitment to combating tax avoidance and base erosion, the Corporate Tax Law introduced the requirement for Free Zone Persons (FZPs) to maintain adequate substance within the UAE. This new obligation ensures that businesses benefiting from the attractive Free Zone tax regime demonstrate a genuine economic presence and real business activity in the country, rather than operating as mere paper entities or conduits for profits.
Why was substance introduced?
Global efforts led by organizations such as the OECD have set guidelines to prevent tax base erosion and profit shifting (BEPS). The UAE’s substance requirements are designed to align with these standards, assuring other countries and international bodies that Free Zone companies contribute economically and comply with fair taxation principles.
How will it be monitored?
The UAE’s Federal Tax Authority (FTA) will monitor compliance with substance requirements through tax audits, documentation reviews, and reporting obligations. Companies must be prepared to demonstrate, through clear evidence, that they meet the substance criteria relative to their size, sector, and income levels.
What must companies ensure?
FZPs must carefully plan and maintain a tangible economic presence, supported by documented evidence. Failure to meet substance requirements risks losing the Qualifying Free Zone Person (QFZP) status and becoming subject to the standard 9% corporate tax rate.
Key Substance Requirements
- Sufficient Employees: The company must employ an adequate number of qualified personnel physically located in the UAE who perform core income-generating activities directly related to the licensed business. This workforce should possess the necessary expertise and be able to demonstrate active engagement in the company’s operations.
- Physical Assets: The FZP should maintain sufficient physical assets in the UAE—such as office premises, machinery, equipment, and IT infrastructure—that are used actively in its business. Merely having a registered office address without meaningful operational use will not satisfy substance requirements.
- Operating Expenses: Operating costs incurred in the UAE should be commensurate with the scale of business operations. This includes salaries, rent, utilities, and other expenses that reflect genuine economic activity rather than minimal or token expenditures.
- Management and Control: This is a critical element where the company must demonstrate that key strategic and operational decisions are made within the UAE by personnel physically present in the country. Board meetings, senior management deliberations, and corporate decision-making processes should be conducted in the UAE and documented accordingly.
Companies are advised to:
- Hold regular board and committee meetings in the UAE, with formal minutes recorded.
- Maintain attendance records, resolutions, and other governance documents as evidence.
- Ensure senior executives and decision-makers are available and actively involved in UAE operations.
Proper documentation and retention of these records are vital as they will be scrutinized during tax audits or regulatory reviews. This evidence serves to prove the company’s compliance with substance requirements and helps avoid challenges from tax authorities.