Maintaining Adequate Substance for Freezone Businesses

Key Requirements for Adequate Substance

1. Core Income-Generating Activities (CIGAs)

   • CIGAs are essential and value-adding activities that generate revenue. For any Freezone business, these activities must be carried out within the Freezone to qualify for tax benefits. Ensuring that these core operations are conducted within the designated area is crucial for compliance.

2. Adequate Assets and Employees

   • A Freezone business must maintain adequate assets and employ a sufficient number of qualified full-time employees. This ensures that the business can perform its CIGAs effectively within the Freezone. The level of assets and employees should reflect the scale of the business’s operations.

3. Operating Expenditures

   • The business must incur operating expenditures in relation to its CIGAs within the Freezone. This includes costs related to office space, employee salaries, and other operational expenses necessary for conducting business activities. Proper documentation and allocation of these expenditures are essential for demonstrating adequate substance.

Practical Examples

1. Freezone Manufacturing Unit

   • Example: Company A, a manufacturing firm in a Freezone, maintains a production facility within the Freezone where it employs workers and supervisors. The firm conducts all its manufacturing processes, including assembly and quality control, within the Freezone, ensuring that all CIGAs are performed locally.

2. Outsourcing with Supervision

   • Example: Company B, an IT services company in a Freezone, outsources its software development to another Freezone entity. Company B ensures adequate supervision of these outsourced activities by maintaining regular oversight and integrating the outcomes into its overall service offerings. This arrangement meets the adequate substance requirement as the core activities remain under the firm’s control within the Freezone.

3. Substance for Qualifying Intellectual Property

   • For businesses involved in managing intellectual property, adequate substance involves performing relevant R&D activities and supervising outsourced R&D within the Freezone. This ensures that the business can substantiate its claims for qualifying income from intellectual property.

Importance of Compliance and Record-Keeping

For Freezone businesses, ensuring compliance with the adequate substance requirements is paramount. This includes:

• Documenting Core Activities: Keeping detailed records of where and how core activities are performed.

• Asset and Employee Records: Maintaining accurate records of assets and employees engaged in the business.

• Expense Tracking: Meticulously tracking and documenting operating expenditures related to Freezone activities.

Proper compliance not only helps businesses benefit from the 0% corporate tax rate but also ensures they avoid potential penalties and legal issues. Maintaining adequate substance is a continuous process that requires regular review and adjustment to align with regulatory changes and business growth. Freezone accounting plays a crucial role in managing these records and ensuring compliance.

Conclusion

Maintaining adequate substance is a fundamental aspect of compliance for Freezone businesses. By ensuring that core income-generating activities, assets, employees, and expenditures are properly aligned with regulatory requirements, businesses can optimize their tax positions and uphold the integrity of their Freezone operations.

At ProfiTrack Accounting, we specialize in helping Freezone businesses meet these requirements, providing tailored services to ensure compliance and maximize tax benefits. For more detailed guidance and specific scenarios, refer to the Free Zone Persons Corporate Tax Guide at Tax.gov.ae.