The treatment of intellectual property (IP) by multinational groups is a key issue in the OECD’s initiative on tax base erosion and profit shifting.
Before this, IP ownership was often centralised in low-tax jurisdictions, with group subsidiaries paying royalties to the entity that held the intangible. Actions 8–10 of the OECD’s Base Erosion and Profit Shifting (BEPS) project introduced the principle that transfer pricing outcomes should align with value creation and specified that entitlement to returns from IP depends on the owning entity performing and controlling economically significant functions and risks.
Passive IP holding structures have been effectively outlawed
BEPS Action 5, meanwhile, introduced the ‘modified nexus approach’ for preferential IP regimes, which requires tax benefits to be proportionate to qualifying R&D expenditure incurred in the jurisdiction that grants the benefit.
Transfer pricing
The introduction of corporate tax in 2023 was a significant moment for the UAE. In the years running up to then, the groundwork was laid to ensure the UAE remained aligned with OECD objectives.
In 2020, the UAE published its economic substance requirements regulations, which specified that entities conducting ‘IP business’ must satisfy three key conditions:
- conduct their core income-generating activities in the UAE
- maintain adequate employees, expenditure and physical assets in the UAE
- demonstrate that strategic decisions are taken in the UAE
While the regulations did not impose a tax charge, they introduced compliance obligations that effectively outlawed passive IP holding structures, aligning the UAE with international transparency practices.
Preferential tax treatment is for non-marketing intangibles
When the UAE passed the federal law introducing corporate tax in 2022, article 34 specified that related party transactions should be consistent with the arm’s length principle. In practice, this means that royalty arrangements should reflect functional analysis and risk allocation in accordance with UAE transfer pricing rules. In other words, the corporate tax regime in the UAE reinforces the principle of substance.
Free zones
An important provision of the corporate tax law also is a provision that qualifying free zone persons (QFZPs) can benefit from a 0% corporate tax rate on ‘qualifying income’ (QI). There are strict rules around access to this incentive that link QI to research and development that is carried out in the UAE.
QFZPs can access the 0% corporate tax rate on QI, provided that:
- it derives QI in the relevant tax period
- revenue that does not meet the definition of QI remains within the prescribed de-minimis threshold
- the QFZP maintains adequate substance in the free zone
- it complies with the arm’s length principle and UAE transfer pricing documentation requirements
- it prepares audited financial statements
- it does not elect to be taxed at the standard UAE corporate rate of 9%
- it satisfies any additional conditions prescribed by the Ministry of Finance.
In 2023, qualifying intellectual property – which includes patents, copyrighted software and legally protected rights that are functionally equivalent to patents – was established in UAE as a specific category of QI. IP relating to marketing, such as trademarks, brands and similar intangibles, are expressly excluded. This is consistent with the OECD’s modified nexus approach, which limits preferential treatment to non-marketing intangibles associated with technical innovation.
QI derived from qualifying IP is calculated as follows:
QI = (qualifying expenditure + uplift expenditure) ÷ overall expenditure × overall IP income
This formula ensures the tax benefit is in proportion to economic activity undertaken in UAE.
Practical considerations
If a QFZP wants to benefit from qualifying IP and access the 0% corporate tax rate, it is important to carefully assess the following:
- documentation of ‘qualifying expenditure’ related to R&D costs
- cost allocation systems that support nexus calculations
- compliance with the transfer pricing requirements in article 34
- that the entity meets the eligibility criteria for a QFZP.
Multinational groups should also consider the potential interaction with global minimum tax rules under Pillar Two of BEPS.
Valuation
While the UAE’s qualifying IP regime is driven mainly by legal classification and expenditure analysis, there are times when IP’s economic valuation comes into play. For example, when IP such as internally developed software is licensed or transferred within a group, pricing must be established in accordance with the arm’s length principle. This is particularly relevant when internally developed software is the main driver of the business, or when IP is licensed between related entities within a group, or when a group is restructured or IP migration occurs.
Qualifying IP income must be shown to be economically supportable
In these cases, valuation analysis may be needed to support the determination of royalty rates, profit split and income attribution under the arm’s length principle. And taxpayers who benefit from the qualifying IP treatment will need to demonstrate that the income attributed to the IP is economically supportable.
International integration
The UAE’s treatment of IP is built on a foundation of policy continuity and international integration. From economic substance requirements to the nexus-based qualifying IP regime, the country has adopted a structured, OECD-aligned approach that incentivises innovation and R&D activity within the jurisdiction while preserving compliance with global tax standards.
For businesses operating in UAE and DIFC in particular, the implications are clear: IP strategy must be aligned with operational reality.
