These enterprises must still divide profits between manufacturing and sales operations.
The UAE Ministry of Finance has initiated a digital consultation to gather opinions regarding aspects of the corporate tax structure applicable to free zone companies.
This consultation focuses on defining the categorization and extent of qualifying activities and considering activities deemed exempt. Please provide feedback through an online form by August 2nd. The consultation process is designed to involve businesses and provide informative guidance. All relevant stakeholders must participate, share insights, and contribute to the progression.
The consultation document furnishes valuable insights into the potential tax ramifications for free zone companies.
Engaging in manufacturing goods or materials within a free zone qualifies as an activity eligible for a 0 percent tax rate. The consultation document elaborates on the two main categories under manufacturing activities:
Manufacturing One’s Own Products:
This involves the creation of goods under the entity’s brand.
Contract or Toll Manufacturing:
This entails producing items for another entity, either as a service or utilizing the customer’s provided raw materials.
It is anticipated that the corporate tax implications will differ for these categories. In the case of contract manufacturing, the free zone entity acts on behalf of another party, potentially encompassing both manufacturing service fees and raw material supply. On the other hand, Toll manufacturing requires the customer to provide raw materials, and we anticipate considering the manufacturing service fee and raw material supply/usage fee as qualifying income for the 0 percent tax rate.
Nonetheless, when manufacturing one’s proprietary product, the overall profit must be divided into two segments: manufacturing and ‘sales profits.’
The latter pertains to the profit associated with the dispersion (sale) of the produced goods. The sales profit would qualify for a 0 percent tax rate solely if it fulfills the criteria of a ‘qualifying distribution activity’ criteria. Consequently, it implies that the distribution occurs within or from a designated zone. Conversely, the manufacturing profit will be eligible for a 0 percent tax rate as qualifying income, irrespective of the manufacturing company’s location.
Challenges Faced by Manufacturers
Manufacturing enterprises operating within non-designated zones’ in free zones must assess the tax implications and actively engage in the consultation process.
Dividing profits between manufacturing and sales necessitates benchmarking to prevent undue profit allocation to manufacturing. Finally, it helps in enabling access to the 0 percent tax rate.
Considering the proposal to tax sales profit, it’s essential to determine if sales revenue linked to distribution/sales requires assessment against the de-minimis threshold (5 percent of total revenue). Companies with sales and marketing budgets surpassing 5 percent of revenue may potentially exceed this threshold.
With profit categorization expected from manufacturers, examining tax implications for ancillary activities, such as revenue from manufacturing waste, process losses, and cost allocation, is also imperative.
The processing of goods within a free zone is also a qualifying activity eligible for a 0 percent tax rate. This encompasses activities involving preparing, treating, transforming, or converting goods or materials into an alternative form for subsequent commercial or industrial utilization or sale.
It is crucial to ascertain if the processing activity yields a distinct material transformation, as this aspect could significantly influence tax considerations.
Comparable instances, particularly in the jurisprudence of countries like India, highlight the complexity of determining whether an activity truly results in an alternate form of goods. Numerous cases within India’s highest court have deliberated whether processing activities—such as fabric bleaching, resizing jumbo rolls. It also shows the basic assembly of fountain pen components, label printing, and repackaging bulk units into smaller retail packs—yielding a novel product form.
The existing body of legal decisions could hold significance for free zone enterprises engaged in processing activities. The classification of a specific processing activity as a qualifying endeavor would govern the associated tax ramifications for these companies.
Observing the introduction of a taxation system within a nation presents an exceptional occasion for businesses and consultants alike. As comprehension deepens regarding the intricacies of the tax policy progression, the value of the ongoing consultation led by the Ministry of Finance becomes evident.
It is imperative for all stakeholders to actively participate in the process, given that the regime’s ultimate purpose is to serve their interests.