Many people think that the first and most important decision they will make in starting a business in UAE is about what to sell or whom to hire. In reality, the first decision they make is where the company will be legally registered. The choice of business location in the UAE is a fundamental one, as it has a significant impact on the scope of business activities, the tax treatment of the business, the location of the business and who can own it; mainland or inside one of the many free zones offered by the country. There are significant savings in terms of costs and restructuring if the decision is made tactically. This article clarifies it in simple terms and outlines an approach to considering the pathway that is appropriate for a specific company.
The Two Routes: Mainland and Free Zone
Mainland and free zone are two kinds of legal environment one can choose. Both are based in the UAE but with the difference being who licenses the company and what the regulations are that govern the company's operation.
i. A mainland company is licensed by the economic department of the emirate where it operates, for example, Department of Economy and Tourism of Dubai or Department of Economic Development of Abu Dhabi. It is an onshore UAE business that can trade throughout the UAE, interact directly with customers within the UAE and can bid for UAE government work.
ii. Free Zone means a specified zone of an economy having its own registration authorities and its own internal regulations. It is located within a specific emirate, but operates to a certain degree autonomously from the onshore licensing system. The UAE has over forty free zones, most of which are based on a particular sector, like media, commodities, tech, healthcare, logistics or financing. A free zone company is registered with the authority of that zone instead of the economic department of the Emirate.
It is pertinent to note that free zones are not tax havens in the sense of offshore, nor are they beyond the boundaries of UAE law. In most ways they are part of the UAE and bound by federal law, and in some commercial and legal aspects, and in some instances, there are benefits that are given to them by the zone. This is in addition to the offshore vs onshore issue which were a different topic than the onshore vs free zone they are talking about in this instance, as offshore companies cannot trade in the UAE at all, and they are used primarily for the holding of assets.
The Legal and Regulatory Framework
The main law governing companies in the UAE is the UAE Commercial Companies Law, which specifies the recognised types of companies (including the limited liability company), the ownership and management of the companies, and the obligations of shareholders and directors of companies on the mainland. Licensing is performed at emirate level via the economic department of the emirate and sector regulators are built on top of that when the sector needs it. Banks are accountable to the Central Bank, for example, and healthcare providers to the local health authority. Free zones have their own laws and regulations, and are governed by the power of each free zone. There is still a larger federal legal system of which most of the free zones are part. They are two different types in an essential way. The Dubai International Financial Centre (DIFC) and the Abu Dhabi Global Market (ADGM) are financial free zones with distinct legal regimes, largely based on common law and have their own courts, independent of the UAE onshore civil-law system. Whether a company is incorporated in DIFC or ADGM has an important difference: day to day, a company incorporated in either of these centres is subject to the company law of the respective centre, as opposed to the federal Commercial Companies Law which is the law applicable to a company incorporated in the UAE. Ownership and much of the old advice lie in one of the areas where the most change has taken place. Until recently, a UAE national had to acquire a controlling stake (at least 51 per cent) in a mainland L.L.C. This position was altered through the Commercial Companies Law which now allows 100 per cent foreign participation in mainland commercial activities. Eligibility is activity based, however, which is the key qualification. As there are lists specific for each economic department and some activities may not have been recognized as strategic impact activities, they may still be subject to ownership conditions or need additional approvals. Yes, but for some activities, it is best to check with the concerned department prior to taking on the activity as this depends on the activity and the emirate. One of the key characteristics of free zone companies has historically been the 100 per cent foreign ownership. Nowadays, this is less of an issue as there are no restrictions on the ownership of the company for the mainland, and it is not a question of who owns the business, but rather where the business has to operate and what tax will apply. There is a need for a straightforward term for tax, as it is often misunderstood. UAE has introduced a federal corporate tax, with a 0% rate on profits below a threshold and a 9% rate on profits above the threshold for financial years that start from 1 June 2023. While some tax exemptions are given to free zone businesses, this is not automatic, but depends on the company meeting certain substance and activity requirements as stipulated in the corporate tax regulations. Most mainland and free zone businesses have standard 5 per cent VAT and the tax position of any specific business should not be assumed but should be determined in accordance with applicable tax rules or with the help of a tax adviser, given the detail of the qualifying free zone conditions, which have been further qualified by additional cabinet decisions.
How UAE Company Formation Works in Practice
Whichever route is taken, the journey to company formation in the UAE is essentially the same, with only a few differences in terms of authority and paperwork. But the basic procedure is the following.
Choose the business activity: The activity will dictate the types of licences and approvals that are required and on the mainland, the availability of full foreign ownership. Getting this right, avoids rework later.
Select jurisdiction / legal structure: This is the mainland/free zone choice in addition to the company type. In most small and medium businesses, this would equate to a limited liability company (LLC), or a free zone limited liability company (FZ-LLC), FZE or FZCO depending on the free zone.
Secure trade name and get initial approval: The registering authority makes sure that the name is available and satisfies the requirements and issues a preliminary consent to proceed.
A tenancy is registered by a mainland company (in Dubai, by means of the Ejari system) and a free zone will be able to provide their own office and desk packages or warehouse packages. On many occasions, the space used will help decide how many residence visas the company can sponsor.
Prepare the constitutional documents: For an L.L.C. this would be a memorandum of association that documents ownership and management. For partners, this would be a shareholders agreement.
With the documents and approvals in place, the authority will issue the licence, the actual document which will allow the business to operate.
The post-licence procedures; which usually involve an establishment card, residence visa paperwork for owners and employees and opening a company bank account.
The place where the two routes really differ is with regard to reach. A mainland company is able to sell directly to customers and other companies throughout UAE and even participate in government contracts without having to rely on an intermediary. A free zone company normally is established to conduct business within its free zone and abroad, in order to sell to the general UAE market, it will typically require a distributor or agent in the mainland, or the establishment of a branch in the mainland. There are a few exceptions (dual licensing in Dubai is one), but generally a company that relies heavily on being able to service customers in the UAE directly will gravitate to the mainland, whereas a company that exports, trades internationally or services clients remotely will gravitate to a free zone.
Common Mistakes and Key Risks
Some mistakes tend to repeat themselves, and most are easily prevented with a little planning.
“Local trade is allowed with a free zone licence.” Typically, it does not. Businesses in the mainland market that are operating from a free zone without proper structure can be subject to fines and the loss of contracts.
Selecting an inappropriate activity or a licence that is too specific. The late addition of activities may result in extra licences and extra fees, and a too-generous licence may bring on extra costs and regulatory scrutiny. At the beginning, it is important to carefully consider the activity list.
aking a 0 percent corporate tax rate in the free zone for granted. It is conditional. A business that takes it for granted that it qualifies without verifying the rules of substance and qualifying income may be subject to an unexpected tax bill.
Underestimating the running costs: The headliner's setup fee is not the only factor. True cost of ownership includes annual licence renewal, rent of office, cost of visa, audits that are required in certain zones, and corporate tax registration.
Overlooking sector approvals: These include financial services, healthcare, legal, education and food, which generally require specialist regulatory clearance in addition to the trade licence and impact both the time and cost.
Banking as an after-thought: A Corporate Bank Account is not something one can open up right away, and requires well-documented business, owners and source of funds, it is best planned for and not assumed.
The cost and time will vary significantly depending on the Emirate, Free Zone and Activity in which the company is being established and should be obtained from the relevant authority at the time of company establishment and not relied upon from general sources.
