May 27, 2020
By: Paula Villegas and Rachel Dixon
This article on Free Zones constitutes the first in a series of three that will deal with the general background to Free Zones, the entity types permitted in the Free Zones, how foreign investors and companies can benefit from establishing free zone entities and ultimately assessing various worked examples of corporate structuring using free zone entities in the United Arab Emirates (UAE).
Background/history to the concept of Free Zones
Free Zones are not a new concept. A free port is reported to have existed in the 3rd century before the Christian era in the Greek island of Delos, and by the 19th century, Free Zones had spread globally. However, it was not until the latter half of the 20th century that the organization and administration of Free Zones resemble those currently existing.
Nowadays there are numerous Free Zones around the world (it is estimated that there are now more than 3,000 Free Zones operating in about 120 countries), and the MENA region has its fair share, from the United Arab Emirates Free Zones, through Egypt’s Gulf of Suez all the way to the Tangier Free Zone in Morocco.
Free Zones were introduced to stimulate commerce and to deal with re-exporting processes, whereby goods are imported tax-free into a Free Zone and then exported out again tax-free. For this reason, they are often geographically located beside a water port or airport.
Although the general concept of a Free Zone is uniform in nature, there are several different types of Free Zones in different countries which vary according to national characteristics, goals set by the local governments and features of their legal jurisdictions.
The history of trading in what now constitutes the UAE predates its formal formation. Even prior to its formation in 1971, the UAE was a strategic trading nation with dhows berthing at its creek to unload cargo and then sent out toward several destinations.
The main objective of Free Zones in the UAE was to enhance the global market presence of the UAE by attracting new business and foreign investment. In order to stimulate trade and commerce, and incentivize external corporates to engage in business in the UAE, Free Zones provided an environment where no duties were levied on imports and re-exports, and full foreign ownership was possible.
The first Free Zone officially established in the UAE was Jebel Ali Free Zone (JAFZA) in 1985. The history behind the establishment of JAFZA dates back to the 1970s when the construction of Jebel Ali Port was initiated and ultimately completed in 1979. The port, the largest manmade harbour at the time, then became one of the world’s busiest ports, and the biggest and by far the busiest port in the Middle East.
Jebel Ali Port became a Free Zone in 1980 after a year of operation, at which point, the only characteristic of JAFZA was as a “customs free” zone for re-exports, i.e. where customs duties were exempted for goods altered in JAFZA and immediately re-exported.
By the early 2000s the trend towards more specialized Free Zones started to emerge. These specialized Free Zones were initially limited to companies, the business plan of which was in line with the Free Zone’s title theme, be it media, internet, or whatever.
Entrepreneurs considered the specialization of the Free Zone industry as an incentive to them, since access to a hub of specialized knowledge was provided, and therefore encouraging them to develop additional creativity and innovation. The concentration of such entrepreneurs in the same geographical area enhanced the cross-pollination of ideas amongst individuals working within a similar sector and, as a result, the UAE experienced additional economic prosperity and development.
Overview in the UAE
There are currently over 40 Free Zones located in the UAE, of which around 75% are in Dubai.
The general regulatory rule in the UAE, both in Free Zones and elsewhere, is that companies operate under a license which specifies prescribed activities that the company may undertake.
There are several license types to choose from in the UAE, the most common licenses including commercial licenses (trading activities), industrial licenses (industrial and manufacturing activities), and professional services (such as consultancy services).
Corporate structures permitted in Free Zones
In terms of the entity types that can be established in the Free Zones, the two main entities are generally as follows:
- subsidiaries, i.e. Free Zone Company, with two or more individual/corporate shareholders, or in some free zones, Free Zone Establishments denote entities with a sole individual/corporate shareholder; and
- Branches.
However, there are other types permitted in certain Free Zones which, in our experience, are rarely used, including: Public Listed Companies (PLCs), which may offer its shares to the public in accordance with the markets law of the relevant stock market; and civil companies (civil partnership) set up under the rules of the UAE Civil Transactions Law (Federal Law No. 5 of 1985).
A branch office is not a separate legal entity of the parent company, it is instead an “emanation” of the parent company. Hence any liability of the branch entity becomes a liability of the parent company and is therefore unlimited as to the parent company.
The main reasons why a company may wish to open a branch instead of a subsidiary (where the liability of the entity is limited to the share capital of said subsidiary), include a greater level of control to the parent company , easier administrative processes and auditing (no requirement of submission of audited accounts) and possibly, they may be cost effective (e.g. no share capital requirements involved).
Now that the general background to Free Zones has been provided, the next article in this series will discuss the benefits provided by Free Zones to overseas investors/companies wishing to enter the UAE market.
