Economic substance: the central condition for QFZP status

The substance requirement

Article 18(1) of Federal Decree-Law No. 47 of 2022, as detailed by Cabinet Decision No. 100 of 2023, conditions QFZP status on maintaining adequate economic substance in the free zone: the core income-generating activities (CIGA) must be carried out there, with sufficient assets, qualified employees and operating expenditure. This requirement reflects the OECD BEPS Action 5 standards and is designed to prevent "letterbox" structures from improperly benefiting from the 0% rate.

The three pillars of the test

1. Adequate premises

The entity must have its own premises, held in its name and suited to its activity. Flexi-desks and co-working spaces are, in principle, insufficient for activities involving a significant number of employees or physical operations. FTA practice distinguishes between:

• Dedicated offices — suited to the declared headcount and the nature of the activity (a warehouse for logistics, a lab for R&D, and so on).
• Flexi-desk — may be sufficient for holding companies with no employees or activities with very low operational intensity.
• Sham offices — mailing addresses with no real office: disqualifying.

2. Qualified employees

The entity must have an adequate number of qualified employees to carry out the core activities that generate the qualifying income. The FTA reviews:

• The number of employees holding a UAE work visa sponsored by the entity.
• Their level of qualification (resumes, degrees, experience).
• Their compensation (consistent with the market and the functions performed).
• Their actual physical presence (fully remote profiles based outside the UAE are closely scrutinized).

3. Operating expenditure

The operating expenditure incurred in the UAE must be proportionate to the activity and the declared income: rent, salaries, supplies, outsourced services. The FTA compares the cost structure to that of comparable entities and flags cases where the costs appear insufficient relative to the volume of business.

The core activities (Core Income-Generating Activities)

Beyond the three pillars, the test requires that the Core Income-Generating Activities (CIGA) be effectively carried out within the free zone. The CIGA depend on the qualifying activity:

Permitted outsourcing

Core income-generating activities may be outsourced to a Related Party or third party in a Free Zone under adequate supervision, with the required resources in the permitted location. Qualifying Intellectual Property has a specific rule: R&D may be outsourced within the UAE or to an unrelated foreign person, subject to adequate supervision. Distinguish this exception, supporting activities and permanent-establishment activities. Contracts and transfer pricing must reflect the functions actually performed.

Common mistakes

• Relying on a flexi-desk for an operational activity that requires dedicated offices.
• Declaring employees who are not physically present in the UAE.
• Outsourcing the CIGA outside the UAE in the mistaken belief that this is permitted.
• Failing to hold physical board meetings in the UAE with documented minutes.
• Underestimating the minimum operating expenditure the FTA expects.