UAE Free Zones – The Key for Fulfilling Economic Substance Requirement

1 September 2016

Incorporating in the UAE offers the leverage to foreign businesses to keep up with the requirements of tax authorities for economic substance through its free zone (FZ) structures. Businesses of any size can now take the opportunity to locate their business functions in the UAE and benefit from substantial tax savings, while satisfying the criteria for economic substance.

The increasing number of double tax treaties have reinforced anti avoidance provisions, vanquishing brass plate companies off the face of the UAE. The tax authorities are taking stringent measures to downright exercise central management and control so that they can determine whether an organisation is taxable. In addition, they are evaluating the economic grounds behind each organisation, especially in countries that are labelled as a low or no tax country.   The anti avoidance legislations help tax authorities in discerning transactions that don’t have sufficient commercial substance or are incorporate to get a more favourable tax position without bona fide reasons. The Organisation for Economic Co-operation and Development (OECD) endorses domestic anti avoidance stipulations that are designed to take precedence over double tax treaties.

Anti Avoidance Provisions

A common anti avoidance clause that is included in double tax treaties is the beneficial ownership requirement. It has always been perceived that the person or entity receiving dividends, royalties, and interest is the beneficial owner. However, a new approach has been developed in which nominees and agents are no longer considered eligible to be the beneficial owners of received income.   The OECD commentary to the model tax treaty has presented only a few examples of circumstances where the recipient of income is not considered as the beneficial owner. For determining whether a recipient is the beneficial owner under circumstances other than being a nominee or agent, the decision will be left to case law to establish the outcome.   While every country has a different set of anti avoidance provisions in place to take precedence over double tax treaties, and there is still discrepancy in case law regarding beneficial ownership, a clear direction has been defined. Entities that don’t have economic substance bear the growing risk of not holding up to the standards of tax authorities upon review, resulting in declined tax benefits.   The presence of economic substance gives the proof that the company set up for tax reasons is real or has not been incorporated to gain tax favours through unlawful means, which can result in implications of anti avoidance legislation. Hence, economic substance is mandatory to establish that an entity has genuine reasons for incorporation to achieve a more favourable tax position.    

Free Zones

An entity set up in free zone (FZ) of the UAE can enjoy many tax benefits and business opportunities. However, not all entities can benefit from these commercial zones. A FZ is the best place in the UAE where setting up a business is easy and quick. The concept was first introduced in Dubai, with the first FZ being Jebel Ali. The advantages of operating a business in a free zone include:

  • • Economic substance is reinforced.
  • • No limitations on hiring labour.
  • • Complete foreign ownership.
  • • Duty free import of goods, if they are not intended to be supplied to the local market.
  • • Foreign owners and their management receive residence permits.
  • • The FZ authorities deal with procedures and formalities instead of various government departments.
  • • Free from imposition of corporation tax for up to 50 years from the date of incorporation.

    For starting a company in FZ, the owners are required to own or rent premises to fulfil the physical presence requirement. Having only a small office will suffice, and for cost effective options, Hamriyah and Ajman FZs in the northern emirates are great places.   If the foreign owners maintain a local bank account, they can apply to receive UAE tax residence certificates from the Ministry of Finance. By doing so, they will be able to produce this certificate as a proof of tax residency to banking institutions in the UAE and abroad.   One of the benefits of incorporating in the UAE is that it offers plenty of non-tax reasons for a foreign entity to set up their business. The strategic location, being an airline hub and the availability of high quality professional services make the UAE an ideal choice for establishing a business.   Furthermore, the IT infrastructure has drastically improved over the years and even the ADSL technology has been replaced with fibre optic broadband connections, giving better opportunities for e-commerce. The UAE local authorities don’t impose any minimum wage requirements, as well as offer free immigration, enabling realising substance easier.    

Double Tax Treaties

About 80 double tax treaties have been signed by the UAE with several OECD members and other countries. While there are several tax treaties that are quite attractive for businesses, some of them may discourage incorporation in the UAE mainly because of inclusion of liable to tax clauses and limitation of benefits clauses.

However, the beneficial tax treaties outweigh the unattractive ones, such as the treaties with the Netherlands, Austria, and New Zealand, providing the advantage of not having a liability to pay tax.


Other Benefits

The UAE is a renowned international financial centre that is located in the Middle East and provides quick access to Africa, Asia, and Europe, with a difference of only a few hours. It has gained a great reputation in the global market because there are proper regulations and controls in place, giving foreign entities the peace of mind that they are doing business in a country with international standards.   Dubai is a progressive, lively city having a well-established infrastructure, providing everything a foreign entity would need to incorporate. The government paperwork and the visa process are relatively simple and straightforward. Due to its thriving property market, businesses have a wide range of options for purchasing or renting office spaces.   It is home to a myriad of nationalities, with English being the preferred language among all. There are also no limits on repatriation of profits or capital, along with zero percent tax.

Related: RAK Offshore Company Formation



Nowadays, the tax authorities are focused on pressurising companies to produce real economic substance. But with the UAE’s efficient tax system, businesses can avail the opportunity to locate their operations in this country and leverage from significant tax savings. The UAE has signed many tax treaties, including some of the most efficient ones. However, some of them may restrict the extent of applicability of other beneficial tax treaties.   It is imperative to carefully study the investment structure for making well-thought-out decisions regarding business activities within the UAE, and also for outbound investments. With due diligence, businesses may be able to develop a highly tax-efficient structure for maximum savings and higher profits.

Please visit our website www.dubaicompany.com specialized in U.A.E frezones.  
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