Adequate Substance: What a Free Zone Company Has to Actually Do Here

Substance is the condition companies assume they satisfy because they have an office and a visa quota. That is not what the rule asks. It asks where the activity that actually earns the income is carried on, and whether the resources behind it are proportionate to the income being claimed at 0%.

The requirement sits in Article 8 of Cabinet Decision No. 100 of 2023, and it is more specific than most summaries of it.

What Article 8 actually requires

A Qualifying Free Zone Person must undertake its core income-generating activities in a Free Zone or a Designated Zone — depending on where those activities are required to be conducted — and, having regard to the level of the activities carried out, must:

• have adequate assets;
• have an adequate number of qualified full-time employees in the Free Zone or Designated Zone; and
• incur an adequate amount of operating expenditures.

The second qualifier does almost as much work: "having regard to the level of the activities carried out". Adequacy is proportionate, not absolute. There is no headcount threshold and no minimum spend, because the same two employees can be ample for one business and obviously insufficient for another earning ten times as much from the same activity. Growth in revenue without corresponding growth in people, assets or cost is therefore capable of turning a compliant position into a non-compliant one without anything else changing.

What counts as a core income-generating activity

Article 8(4) defines it, and the definition is where most self-assessments go wrong. Core income-generating activities may vary according to the specific activity, but mainly consist of the significant functions that drive the business value for each activity carried out — and they are not exclusively or mostly support activities.

That last clause is the operative one. Accounting, administration, HR, IT support and general management are support functions. A free zone entity whose UAE presence consists of back-office and administration, while the decisions and the value-driving work happen elsewhere, does not have its CIGA in the zone — however many people it employs there and however real the office is.

The practical question to ask of each activity is not "do we have staff here" but "if this function stopped, would the income stop?" Functions that answer yes are the ones the rule is about.

Employees: qualified, full-time, and in the zone

The wording is an adequate number of qualified full-time employees in a Free Zone or Designated Zone. Three separate constraints sit in that phrase, and each of them excludes an arrangement that is common in practice.

• Qualified — the people have to be capable of performing the activity in question, which links headcount to the nature of the work rather than to a number.
• Full-time — part-time or fractional arrangements do not obviously satisfy a full-time requirement.
• In a Free Zone or Designated Zone — physically located where the activity is required to be conducted, not employed by the entity while working elsewhere.

Outsourcing is allowed, but the boundary is tight

Article 8(2) permits core income-generating activities to be outsourced to another Person in a Free Zone or Designated Zone — again depending on where the activity is required to be conducted — provided the Qualifying Free Zone Person has adequate supervision of the outsourced activity.

Two limits follow directly from that sentence. The provider has to be in a Free Zone or Designated Zone, which rules out outsourcing core activity to a mainland provider or offshore. And supervision is a condition, not a formality: an outsourcing arrangement the company cannot show it directs and monitors does not preserve substance simply because a contract exists.

Why this condition is harder to fix than the others

Most Qualifying Free Zone Person conditions can be corrected once identified. An audit can be arranged. A revenue mix can be managed. A filing can be made. Substance is different: it describes where a business is genuinely run, and moving that is an operational decision with cost, people and timing attached, not a compliance step.

It is also the condition least likely to be raised by anyone inside the business, because nothing about it feels like tax. A decision to have a regional team manage a product line from another country, or to consolidate a function into a group service centre, is an ordinary operating decision that can quietly move CIGA out of the zone.

What a defensible position looks like

1. List the activities the entity carries on, separately. The test runs per activity, so the analysis has to as well.
2. For each one, identify the functions that drive its value — and be honest about which are support.
3. Record where those functions are performed and by whom, with employment and location evidence for the people concerned.
4. Check the proportionality against the income claimed from that activity, and re-check it when revenue moves materially.
5. For any outsourced core activity, confirm the provider is in a Free Zone or Designated Zone — unless it is Qualifying IP work — and document how supervision is exercised in practice.

Cabinet Decision No. 100 of 2023 was issued on 25 October 2023 and takes effect from 1 June 2023; it repealed Cabinet Decision No. 55 of 2023. Confirm the position for your own facts before relying on it.