The plan sounds simple enough. You set up a company in a free zone in Dubai or one of the other emirates, the licence arrives within a few weeks, and from that moment on the profit is taxed at 0%. It is the story that circulates at every network event, and it is not entirely wrong. The zero rate genuinely exists, it is written into the corporate tax law, and thousands of companies apply it every year.

What that story leaves out is the part that decides whether you actually get there. The 0% rate does not attach to your company, it attaches to your income, and only to the part of it that qualifies. Everything else is taxed at 9%, and a single misstep can cost you the status for five years in a row. In this article we set out what qualifying income really is, which conditions sit underneath it, how the test works per income stream and where free zone companies most often come unstuck. Not a complete legal handbook, but a practical overview of the points that matter most in practice.

Table of contents

1. What the 0% rate really is

2. Not one test, but five conditions at once

3. Substance: the work has to happen in the zone

4. Qualifying income: four routes, tested per income stream

5. Selling to another free zone company: who really receives it

6. Selling outside the zone: only the list counts

7. Income from intellectual property: the nexus fraction

8. The de minimis rule: how a small sale costs you five years

9. Where it goes wrong in practice

10. How to keep the 0% defensible

1. What the 0% rate really is

A company registered in a free zone is, in the language of the corporate tax law, a free zone person. If it meets all the conditions it becomes a qualifying free zone person, and that status carries two rates rather than one: 0% on its qualifying income and 9% on the taxable income that is not qualifying income. There is no exemption for the company as a whole. The rate follows the income, which is why the whole exercise comes down to sorting your revenue into the right boxes.

Not everyone can be a free zone person to begin with. It has to be a legal entity that is incorporated, established or registered in a free zone, and a branch registered there counts as well. An individual cannot be one. Neither can a company that was set up somewhere else and is simply managed from a free zone address, which is an anti-abuse rule worth knowing before you buy into a structure that relies on it.

The zero rate also does not put you outside the system. A qualifying free zone person remains a taxable person: it registers for corporate tax, it files a return within nine months after the end of its tax period, and it prepares audited financial statements regardless of how small it is. Paying nothing and filing nothing are two very different things, and the second one costs you the status.

2. Not one test, but five conditions at once

The law sets five conditions and they apply cumulatively. You maintain adequate substance in the UAE, you derive qualifying income, you have not elected to be taxed under the regular regime, you comply with the arm’s length principle and the transfer pricing documentation rules, and you meet any further conditions set by the Minister. Those further conditions turned out to be two: your non-qualifying revenue stays within the de minimis limit, and you prepare audited financial statements.

What makes this regime unforgiving is the sanction. If you fail any one of the conditions at any moment during a tax period, you lose the status from the start of that period and for the four following ones. That is five years in total, and it is not undone by fixing the problem in month eleven. Recovery afterwards is not automatic either: when the quarantine ends you are simply tested again, on the same conditions.

There is also a deliberate way out. A free zone person can elect to be taxed under the regular regime instead, which means giving up the zero rate in exchange for the things a qualifying free zone person cannot have: the 0% band on the first AED 375,000 of taxable income, small business relief, qualifying group relief, business restructuring relief, the transfer of tax losses and tax grouping. For most companies that trade is a poor one, because they hand in the rate that made the structure attractive in the first place. It becomes worth considering when the qualifying income is marginal anyway, or when the status has become impossible to defend.

3. Substance: the work has to happen in the zone

Substance is the condition that fails most often, and it is more specific than an office and a visa. The rule is that you carry out your core income-generating activities in the free zone itself, with assets, qualified full-time employees and operating expenditure that are adequate for each separate activity. Core income-generating activities are the essential, value-adding things you do to earn the revenue, so they differ per business: for a trading company they sit in sourcing and dealing, for a manufacturer in production, for a holding company in the investment decisions.

Adequate has no fixed number attached to it. It is a sliding scale that follows the nature, the scale and the revenue of the activity, and it cuts both ways. A holding company without employees can be fine with a modest office and board decisions that are demonstrably taken in the zone. A trading operation with substantial turnover and one part-time administrator will not be. If you run several activities, the same employee cannot be counted twice for two of them.

Outsourcing is allowed, within limits. You may outsource core activities to a related party or a third party inside a free zone or a designated zone, provided you exercise adequate supervision, and for qualifying intellectual property the circle is wider: anyone in the UAE, and unrelated parties outside it. Two things break the test quietly. Activities carried out through a permanent establishment on the mainland do not count towards the substance of the free zone company. And a company that only executes decisions taken by a foreign parent is not performing its core activities in the zone at all, whatever the organisation chart says.

One detail catches goods businesses off guard. For distribution, and for goods physically entering the country, you need a designated zone rather than any free zone. A designated zone is a zone that is also recognised as such for VAT purposes, and not every free zone has that status. It is worth confirming with your own free zone authority which of the two you are in, before the goods start moving.

4. Qualifying income: four routes, tested per income stream

Qualifying income comes in four categories. The first is income from transactions with another free zone person, as long as it does not come from an excluded activity. The second is income from transactions with anyone outside the free zones, but only where it relates to an activity that appears on the list of qualifying activities. The third is income from qualifying intellectual property, calculated with a formula rather than taken in full. The fourth is everything else, which only qualifies if it stays inside the de minimis limit.

Three types of income are pushed out before you even reach those categories. Income attributable to a permanent establishment, whether on the mainland or abroad, is never qualifying income. Neither is income from immovable property, with a narrow exception for commercial property inside a free zone in a transaction with another free zone person. And intellectual property income that falls outside the qualifying intellectual property regime is out as well.

The practical consequence is the one most people miss: this is not an all-or-nothing test at company level. You test each income stream separately, against the counterparty and the activity behind it. A company can have rental income that qualifies, service income that qualifies and one advisory fee to a mainland customer that does not, all in the same year. Sorting that out afterwards, from an accounting system that was never set up to distinguish them, is considerably harder than tagging the streams as they arise.

5. Selling to another free zone company: who really receives it

Income from another free zone person only qualifies if that other company is the beneficial recipient of the goods or the services. The definition is deliberately plain: the beneficial recipient is the person with the right to use and enjoy what it received, and without a contractual or legal obligation to pass it on to someone else. A conduit, an agent or a nominee therefore fails the test, and when it does, the consequence lands with you as the seller rather than with them.

The distinction is finer than it looks. A free zone buyer that is contractually obliged to deliver the same goods straight on to a third party is not the beneficial recipient. A free zone buyer that uses what it bought in its own business and later sells its own output onward remains the beneficial recipient of the original purchase. What matters is whether the goods or the services stop with them, not whether the company eventually sells something.

Because you cannot see inside your customer’s contracts, the tax authority accepts that a seller may rely on a written confirmation from the buyer that it is the beneficial recipient, unless there is reason to doubt it. Building that confirmation into your standard terms of delivery is a small administrative step that protects a large part of your revenue, and it is far easier to arrange at the start of a relationship than during an audit.

6. Selling outside the zone: only the list counts

As soon as your customer sits outside the free zones, the question is no longer who they are but what you do. The income qualifies only where it relates to one of the listed qualifying activities: manufacturing, processing, trading in qualifying commodities, holding shares and securities for investment, owning and operating ships, reinsurance, fund management, wealth and investment management, headquarter services to related parties, treasury and financing services to related parties, aircraft financing and leasing, distribution in or from a designated zone, logistics services, and anything genuinely ancillary to those. The list was widened in 2025 with retroactive effect, so an activity that did not qualify under the older list may qualify now.

Against the list stand the excluded activities, which never qualify no matter who the counterparty is. Any transaction with an individual is excluded, apart from a few carve-outs such as ships, fund management, wealth management and aircraft. Banking is excluded, insurance is excluded apart from reinsurance and captive arrangements under headquarter services, finance and leasing are excluded apart from named exceptions, and so is owning or exploiting real estate, again apart from commercial property inside a free zone in a transaction with a free zone person.

For a goods business the sharpest distinction sits between manufacturing and distribution. Manufacturing, which covers producing, improving or assembling products from raw materials or components, carries no restriction on who your customer is, so selling to the end user qualifies. Distribution does carry restrictions: it must take place in or from a designated zone, and your customer has to resell or process the goods rather than consume them. The same sale can therefore qualify along one route and fail along the other, which makes it worth deciding early which of the two describes what you genuinely do.

Two further limits are easy to trip over. Trading in qualifying commodities stops being a qualifying activity if revenue from distribution, warehousing, logistics or inventory management makes up 51% or more of your total revenue in that period. And shares or securities only count as held for investment purposes once you have held them for at least twelve uninterrupted months, which turns the timing of a sale into a tax decision.

7. Income from intellectual property: the nexus fraction

Intellectual property has its own regime and it does not work like the other categories. Only qualifying intellectual property counts: patents, copyrighted software and rights that are functionally equivalent to patents, such as utility models and plant protection rights. Marketing-related intellectual property is explicitly outside it, so income from a brand or a trademark does not qualify however valuable it is.

Even for qualifying intellectual property you rarely get the whole income at 0%. The qualifying part is determined by a fraction that compares the research and development spending you did yourself, or outsourced to someone in the UAE or to an unrelated party abroad, with the total spending on that asset, including its acquisition cost and development outsourced to a related party abroad. The qualifying spend gets a 30% uplift, capped so that it can never exceed the total spend, and the resulting percentage is applied to the income. Income embedded in your products counts as well, so a company that never invoices a royalty can still have qualifying intellectual property income, within the limits of the fraction.

The structure of that fraction explains the most common mistake in this area. Research and development bought from a related company outside the UAE lands in the denominator only, which drags the percentage down, and it fails the substance test at the same time, because those core activities are precisely the ones you are not allowed to place with a group company abroad. On top of that comes an administrative demand that is easy to underestimate: you have to be able to show ownership, the spending on both sides of the fraction and the link between that spending and the income, over the entire life of the asset rather than for the current year alone.

8. The de minimis rule: how a small sale costs you five years

Some non-qualifying revenue is tolerated, but the margin is narrow. Your non-qualifying revenue in a tax period has to stay below the lower of two limits: 5% of your total revenue, or AED 5,000,000. For most companies the percentage bites long before the absolute amount does, which makes the limit a great deal tighter than the five million figure suggests.

Non-qualifying revenue means revenue from excluded activities, revenue from activities that are not qualifying activities where the customer sits outside the free zones, and revenue from transactions with a free zone person that turns out not to be the beneficial recipient. A few categories are left out of the calculation entirely, on both sides of the ratio, including revenue attributable to a permanent establishment and most real estate revenue.

The tax authority’s own guidance contains the example that makes the point better than any warning. A free zone company in its start-up year sells an office chair to an employee for AED 100. A sale to an individual is an excluded activity, so that AED 100 is non-qualifying revenue, and in a year with no other revenue it represents 100% of the total. The company loses its status for that year and the four that follow, over a chair. The lesson is not that chairs are dangerous, it is that the ratio is measured per tax period and that a quiet year has no cushion. Checking the position each quarter is a modest effort compared with what it prevents.

9. Where it goes wrong in practice

The mainland is the most frequent source of trouble. Activities carried out outside the free zone quickly create a domestic permanent establishment, whose income is taxed at 9%, stays outside your qualifying income and is left out of the de minimis calculation as well. There is also an anti-fragmentation rule: if you and a related mainland company between you carry on what would be a single coherent business had it not been split up, the exception for preparatory or auxiliary activities falls away and the permanent establishment appears anyway. The common structure of a free zone entity next to a mainland company deserves a deliberate look for that reason.

The second cluster is documentary. Every qualifying free zone person has to comply with the arm’s length principle and file the transfer pricing disclosure form, whatever its size, with master file and local file obligations on top once the group or the company passes the thresholds. Audited financial statements are required regardless of turnover. These are conditions, not formalities, and failing them triggers the same five-year consequence as a substance failure.

Then there are the traps inside the qualifying activities themselves: distribution to end users instead of resellers, distribution from a free zone that is not a designated zone, shares sold just before the twelve-month mark, commodity trading where warehousing and logistics have quietly grown past half of revenue, and research and development for your own intellectual property placed with a group company abroad. Each of these is invisible in the accounts until someone tests the position.

Finally, two developments that sit above the regime. If your group has consolidated revenue of at least EUR 750 million, a domestic minimum top-up tax applies for periods starting on or after 1 January 2025 and brings the effective rate on that income to 15%, so the zero rate no longer survives at group level. And the general anti-abuse rule applies to free zone structures as it does to everything else, which is why the commercial reason for the structure, including the choice of the zone itself, belongs in the file alongside the functions, the assets and the people that support it.

10. How to keep the 0% defensible

The companies that hold this position comfortably tend to do the same few things. They map their revenue by stream rather than by customer, and they know for each stream which of the four routes it travels and why. They set up the accounting system to make that split visible during the year, instead of reconstructing it when the return is due.

They also treat substance as something to record while it happens. Board decisions are taken and minuted in the zone, employees are allocated to activities without double counting, outsourcing arrangements are on paper with evidence that the supervision is real, and the file holds the licence, the confirmation of free zone or designated zone status and the audited financial statements. For intellectual property the spending records start on day one, because reconstructing years of research and development afterwards is close to impossible.

And they watch the two numbers that decide the outcome: the de minimis ratio, checked quarterly rather than annually, and any mainland activity that could mature into a permanent establishment. Both give plenty of warning if you look, and neither is fixable once the year has closed.

A free zone structure is a legitimate and well-used route, and for many entrepreneurs it is exactly the right choice. What it is not is automatic. The 0% rate is earned per income stream and per tax period, and the price of an oversight is five years rather than one. If you are considering a free zone company, or you already have one and want to know whether the position holds up when someone examines it properly, we are happy to think it through with you, preferably before the structure is built rather than after.