Manufacturing, Processing and Distribution in the Public Consultation Document



Art 3(2)(a) of the UAE Corporate Tax Law (CTL) provides for a 0 percent tax rate for Qualifying Income. Art 18(1)(b) of this Law vests the Cabinet with authority ‘to specify’ Qualifying Income. The Cabinet in Decision No. 55/2023 delegated to the UAE Minister of Finance (the MoF) power to list the Qualifying Activities, i.e. activities which generate Qualifying Income. On 1st June 2023, the MoF released Decision No. 139 with such list.
The MoF had launched a digital public consultation on its website as part of the UAE Corporate Tax’s Free Zone regulations. The consultation is open fr om 19th July to 2nd August 2023. The Public Consultation Document (PCD) “aims to gather feedback fr om free zone-based companies and other relevant parties before issuing further clarifications or executive decisions detailing the scope of these activities. The Ministry of Finance welcomes clear and concise comments, with examples and data (wh ere possible) or other information to support the views expressed in the responses to this consultation. The responses must be received by 2nd August 2023 and will remain confidential, and will not be published”.
We use this opportunity in the comments below to address some new issues in the proposed regulations. We will appreciate your comments on and your input regarding these issues. As the MoF has given us a chance to express our position and thereby affect subsecuent regulation, it would be a sin to miss this chance.


Bifurcating income from fully-fledged manufacturing

The big news in the PCD is the interpretation of “Manufacturing”. The PCD proposes:
  1. to distinguish fully-fledged manufacturing fr om contractual manufacturing,
  2. to tax whole profit of a contractual manufacturer fr om a free zone at 0%;
  3. to split the profit of a fully-fledged manufacturer in 2 parts:
  • profit from manufacturing which is subject to a 0% tax rate, and
  • profit from sale (distribution) which may be taxed with a 0% rate only if this sale is made from a designated zone for subsequent resale of this or processed products (i.e. profit from a sale to an end-user may never qualify).



General considerations of a fully-fledged manufacturing approach in the PCD

Decision No. 139/20239, which lists Qualifying (zero-tax rating) Activity, hasn’t given rise to such interpretation. ‘Manufacturing of goods or materials’ Paragraph (k) of Clause (1) of Article 2 of the MoF’s Decision No. 139/2023  and ‘Processing of goods or materials’ both qualify for a 0% Corporate Tax rate but under separate paragraphs. It was reasonable to assume that manufacturing is something that is not covered by the processing of goods and materials. How else may you distinguish them if not as follows:



  • ‘Processing’ concerns a sale of work on manufacturing ordered by the client (contract manufacturing with the processing of raw materials provided by the client or procured by the manufacturer itself);
  • ‘Manufacturing’ is something that is not covered by processing, i.e. a sale of goods rather than a sale of works.
The PCD gives different interpretation of this. The PCD treats as ‘manufacturing’ both contractual manufacturing (a sale of works) and the manufacturing of products for subsequent sale (a sale of goods).
The PCD does not explain how processing, which is covered by para (b), shall be distinguished from contractual manufacturing, which is covered by para (a) of Art. 2(1).
The only way to differentiate them is the content of the work described in the PCD
  • “Manufacturing of goods or materials includes the creation, production, improvement or assembly of products and materials from raw materials or components”
  • “Processing of goods or materials includes the preparation, treatment, transformation or conversion of goods or materials into another form of material or good for further commercial or industrial use or sale”.
The assembly of vehicles, for instance, doesn’t fit the definition of ‘processing’ but is specifically mentioned as ‘manufacturing’. Thus, there’s no option to choose between the two.
However, this is not a case wh ere any of the operations included in the definition of processing has taken place. For example, if a company converts raw oil into diesel or gasoline, webs into clothes, lumber into paper, etc., here, you have processes which fit both definitions, i.e. you may call them both processing and manufacturing. Fr om the PCD standpoint, you may conclude that paragraphs (a) and (b) of Art. 2(1) may be applied equally to contractual and full-fledged manufacturing. If so, there was no need for para ‘b’ of the Decision No. 139/2023 Processing qualifying by this paragraph is already covered by the ‘manufacturing’ covered by the previous paragraph.
The current addition of Decision No. 139 qualifies not only manufacturing but also an activity, which is ancillary thereto Paragraph (m) of Clause (1) of Article 2.. Moreover, the Cabinet in Decision No. 55 qualifies income incidental to manufacturing Clause (4) of Article 3.. Clearly, the sale of manufactured income is not ‘ancillary’. The price of such sale is not ‘incidental’ income. Such income is inherent rather than incidental. The sale itself is rather an integral part of the manufacturing business.
Shall this inherent/integral character disqualify activity/income? Of course not. An ancillary and incidental character qualifies as a sort of excuse. But activity which is integral to manufacturing and income inherent to it doesn’t need any excuse. It was a reason why integral activity and inherent income are not added to the list of qualifying activities/incomes. They are meant to already exist in the list under the term ‘manufacturing’.
The PCD doesn’t disclose a tool by which new rules will be introduced into the regulation. It’s dubious that inclusion in the MoF Explanatory Guide may serve as such a tool. The disqualification of profit attributed to sales from the total income of a fully-fledged manufacturer does not simply clarify the existing rule but modifies it substantially. Therefore, I think that the MoF needs to change Decision No. 139/2023 to disqualify this part.
There is no doubt that the MoF is vested with authority to amend its Decision. However, I can’t understand the economic rationale behind such solution. From the whole list of qualifying activities, manufacturing is the area which most of all deserves tax incentives. Why do all other activities not have to bifurcate income this way but manufacturing does?
We may see how the list of qualifying income presented in the PCD released in 2022 differs from what has actually been qualified by the Cabinet and the MoF. We may hope that the position on bifurcating manufacturing profit will be adjusted in line with the goals of development manufacturing in the UAE, which the Ministry of Industry and Advanced Technology (MoIAT) is pursuing.
Does packaging fall within the scope of manufacturing/processing?
Aggregating the product into a pack that is to be used to sell the product lies between the processes which are described in the PCD as manufacturing/processing and the subsequent distribution of a product. This may lead to a dispute if packaging is classed as manufacturing/processing. This is especially the case wh ere packaging is the only process which a legal entity conducts before a subsequent sale.
For instance, if drug pills produced by one entity are packed in blisters or in bottles by another legal entity, the packaging is a part of the manufacturing of the drug. However, it doesn’t fit the definition of processing because there’s no conversion into another form of goods. It may be treated as ‘production’ or ‘assembly’ mentioned in the definition of ‘manufacturing’. But, ‘production’ and ‘assembly’ are accompanied in the PCD with ‘of products and materials fr om raw materials or components’. There is no perfect match with this definition as packaging has not been actually assembled or produced out of components. However, maybe it is possible to refer in this way to pills, bottles and packs coming together to form a product?
The Federal Decree-Law No. 25/2022 concerning the Regulation and Development of Industry determines ‘Industrial Establishment’ as ‘every establishment whose primary purpose is to transform raw materials into fully manufactured or semi-manufactured products, or to convert semi-finished products into fully manufactured products, including mixing, separating, forming, assembling and packaging works, provided that all or most of these operations are carried out by mechanical force’. This could be used to contend that packaging is an integral part of the conversion (transformation) mentioned in the definition of ‘processing’ given in the PCD On the other hand, opponents may object that if packaging works have been included in the special definition of ‘industrial establishment’ in one law, but will not be included in the definition of processing and/or manufacturing in other (tax) regulations, this means that packaging is treated as part of manufacturing for the purpose of the first (non-tax) law and may not treated this way in taxation.
On balance, I believe it is reasonable to include packaging in the description of manufacturing and processing.


How to attribute profit of fully-fledged manufacturer to distribution?

Let’s return to fully-fledged manufacturing and the idea of bifurcating the gains earned. The PCD doesn’t give any clue on how to do this. There is no profit without a sale as the profit ensues from revenues received from the sale of the manufactured goods.
Probably the easiest way to attribute part of the profit to a sale is to:
  • calculate an internal mark-up as the difference between revenues earned from sale of manufactured products and the cost of sales (gross profit) reduced by distribution costs;
  • determine the ratio of this markup dividing it by the aggregate amount of costs of sales and distribution costs;
  • split the profit between manufacturing and distribution with this ratio (applying it to the relevant costs).
This method is simple because it doesn’t require any external comparable. The distribution costs are recommended to be presented in the report on profit and loss in the financial statements by para 103 of IAS 1 “Presentation of Financial Statements” This line is likely to be found in the P&L of companies applying the ‘function of expense’ or ‘cost of sales’ methods to present information. It is not a safe harbor, though. The standard warns that ‘this method can provide more relevant information to users than the classification of expenses by nature, but allocating costs to functions may require arbitrary allocations and involve considerable judgement. Wh ere a taxpayer has exercised considerable judgment, there the FTA may reconsider.
Moreover, another method of splitting profit between manufacturing and distribution may be chosen wh ere they secure a more accurate result. For example, the market level of a mark-up fr om the market:
  • for distribution activity may be applied to determine the non-qualifying income fr om distribution, or
  • for contractual manufacturing may determine the qualifying income from manufacturing.  
The comparable uncontrolled price (CUP) to attribute revenues to manufacturing or distribution may also happen to be applicable. It may be implemented as taking a comparable price for the contractual manufacturing (processing) job to establish part of the revenue related to the manufacturing and then reducing this revenue with the cost of sales and other costs except for the distribution costs. The latter should reduce the rest of the revenues to calculate the income attributed to distribution activity.
Nor should the resale method be excluded. The resale price is to be reduced by the “resale price margin” “representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit. What is left after subtracting the gross margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. customs duties), as an arm’s length price for the original transfer of property between the associated enterprises. This method is probably most useful wh ere it is applied to marketing operations”Para 2.27 of the OECD TP Guidelines (OECD, Committee on Fiscal Affairs. Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Paris: OECD, 2022).. After that, part of the total profit fr om the sale of the manufactured goods may be allocated to manufacturing according to the share in the ‘resale’ price of the internal ‘sale’ price determined in this way.
On balance, there are different methods, which may be applied to split profit between manufacturing and distribution. This exposes a taxpayer to disputes wh ere the FTA challenges the method applied by such taxpayer, proposing a different one which the auditors find more appropriate. Hence, in introducing such a split, the MoF is invited to bring some clarity to ensure certainty.
It is especially obvious now when we see all the work on Amount B, which the OECD’s Inclusive Framework is doing. This work has been triggered by the high risk of “transfer pricing disputes with respect to baseline marketing and distribution arrangements… Those disputes may arise”:
  • “in relation to the accurate delineation of the arrangement and often focus on whether the arrangement involves “baseline” distribution or whether it involves the performance of more complex activities, for instance, when the distributor develops intangible assets that are related to the products distributed”;

  • “with respect to the pricing considerations of marketing and distribution arrangements, focusing on areas such as the selection of the transfer pricing method, the appropriateness of the benchmarking analysis (especially the identification and selection of non-domestic comparables) or, wh ere necessary, how to make appropriate comparability adjustments”
    Para 2 of the Public Consultation Document (PCD) “Pillar One – Amount B (17 July 2023 – 1 September 2023)”.
To ensure certainty and to prevent tax disputes, the Inclusive Framework developed a ‘simplified and streamline approach’. In general, this approach recognizes the Transactional Net Margin Method as an “appropriate to price in-scope transactions” (base-line distribution) with “return on sales has been applied as the net profit indicator”. The OECD’s PCD gives “Pricing Matrix (return on sales %) derived fr om the global dataset” and some adjustments for specific groups of circumstances.
It seems reasonable to consider this approach being applied for profits to be attributed to distribution activity.


Which functions and risks are inherent to manufacturing and which to distribution?

The answer to these questions affects the calculations we considered in the previous section. For example, wh ere shall the revenues (and costs) be allocated to for assuming inventory risk As an inventory risk, I deem here the risk of a mismatch between the volume of a product produced and the actual demand. This is the case wh ere a product has been produced but hasn’t been sold, or, conversely, a case wh ere a product has been requested by the buyers in volumes which exceeded the volumes of the products actually produced.? Is it a part of the internal distribution activity or a part of internal manufacturing activity (relevant for fully-fledged manufacturing, of course)?
I think this risk is inherent to manufacturing. Para 1.84 of the OECD TP Guidelines names the risk associated with determining the volume of production as “significant risks associated with generating a return fr om the manufacturing activities”.
At first glance, the PCD from the MoF recognizes this, saying that “in the scenario of ‘fully fledged’ manufacturing, the Free Zone Person (Manufacturing Co) manufactures products in its own name and at its own risk”. On the other hand, it states that ‘the income (sales profit) that is attributable to the distribution (sale) of the manufactured products or materials would not be considered Qualifying Income from manufacturing, unless the distribution meets the conditions to be treated as a “qualifying distribution activity” …’. Moreover, “inventory management” is included in the description of distribution and not included in the list of manufacturing. All that may be interpreted as any risk related to sale (including inventory risk) shall be included in the calculation of income from distribution rather from manufacturing.
Therefore, it is worth taking the chance given by the Public Consultation and asking for clarity. Inventory risk may be specifically addressed as a case to be clarified. However, it is better for the regulations to disclose the whole (or a basic) set of functions/risks corresponding to manufacturing (or distribution). As best practices, the MoF may use for this the OECD’s work on Amount B. Look how the Inclusive Framework handled it in the already mentioned PCD
  • Core distribution functions … performed by baseline distributors … may include … identification of new customers and managing customers’ relationships, certain after-sales services, implementing promotional advertising or marketing activities, warehousing goods, processing orders or performing logistics, invoicing and collection…”.


  • Non-distribution activities are economic activities that are distinct from wholesale distribution, including, for example, manufacturing, research and development, procurement or financing that are non-incidental to a qualifying transaction…”.
What is also worth doing is to address non-baseline contributions in the distribution of a product. The Inclusive Framework defined them as “functions and assets that represent a key source of actual or potential economic benefits in the qualifying transaction and are contributions whose benefits are expected to exceed the actual or potential economic benefits typically derived from core distribution functions”. Such contributions may still be treated as distribution but those ones that are added to the core distribution functions exceed them.
The questions here are:
  1. For a fully-fledged manufacturer, shall such added functions be attributed to manufacturing or to distribution?
  2. For regular distribution (which is not the mere sale of a product by its manufacturer), shall remuneration received for a non-baseline contribution qualify for a 0% rate?

An example of such non-baseline contribution is given in para 25 of the OECD’s PCD Examples 1A and 1B.: “Assume Distributor Y, … supplies high-value capital equipment to customers... Distributor Y purchases the capital equipment from Supplier Z.... The capital equipment is distributed to independent manufacturers who use the equipment to manufacture information technology hardware products. The capital equipment requires extensive specialist advice to properly install, use, and maintain. Moreover, the customers require the provision of ongoing highly specialised and customer-specific technical engineering support functions that aim to customise the use of the equipment to new designs of the customers. In this case, as part of the qualifying transaction, these contributions are made by the distributor. The engineers of the distributor support the customers in utilising the engineers require specialist knowledge not only of engineering or their own product, but of the manufacturing processes, product designs and research objectives of their manufacturing customers. The same engineers consequently need to work in a highly collaborative manner with the engineers of the manufacturers on-site in order to adequately discharge their support functions”.

Para 26 of the PCD shows that this non-baseline contribution could be a part of distribution or a part of manufacturing. This is clear but in the case of fully-fledged manufacturing in a free zone of the UAE, an additional challenge is to bifurcate the manufacturer’s income. Should this non-baseline contribution be included in the manufacturing functions or does it belong to internal distribution? This is a question that needs to be specifically addressed (officially clarified).  

Storage and delivery to the 1
buyer. How should a fully-fledged manufacturer qualify this activity: manufacturing, distribution or logistics?

If it is part of the manufacturing (or activity ancillary thereto), a corresponding part of the income qualifies for a 0% rate. If it should be treated separately as an internal logistics service, the producer may enjoy a 0% rate even if it operates in a regular (not designated) free zone. However, if storage and delivery functions and risks feature distribution, a 0% rate is applicable only if these operations are conducted within a free zone or within and from a designated zone.  

The PCD released by the MoF states that:
  • “The Qualifying Activity of distributing goods or materials may include functions such as the importation, storage, inventory management, handling, transportation and exportation of those goods or materials”.


  • “Logistics services includes the storage and transportation of goods or materials on behalf of another Person without taking title to the good or material of that other Person, including cargo handling, warehousing, container storage, transport agency services, customs brokerage services, order and inventory management, freight forwarding and brokerage services, document preparation, packing and unpacking and other related services”.
The PCD offers to answer the question: “Is the distinction between ‘Distribution of goods and materials’ and ‘Logistics services’ clear based on the above-mentioned scope”. The answer “Yes” may be given in response to this wh ere the distributor and manufacturer are not one (single) person. In the case of fully-fledged manufacturing, this is not so. The criterion ‘without taking title to the good or material of that other Person’ does not work here as the division between manufacturing and other functions is a fiction (it is neither real nor formal/legal). This is what I would answer in reply to the question in para 3.12 of the PCD asking for further clarity.
Should marketing be distinguished fr om both manufacturing and distribution?
Distribution and marketing are often used together with “and” dividing them. This may raise the question of whether marketing should be treated as activity that is not covered by distribution. If so, a taxpayer needs to single out profit attributed to marketing because it is not in the list of Qualifying Activities.
I think that distribution and marketing should be treated as one activity (distribution). The OECD in the PCD “Pillar One – Amount B (17 July 2023 –1 September 2023)” includes in ‘core distribution functions … performed by baseline distributors … implementing promotional advertising or marketing activities. However, para 3.11 of the PCD from the MoF doesn’t include marketing and promotion in the list of a distributor’s functions. Thus, it makes sense to ask the MoF to include it because such marketing (promotion) is either inherent in or ancillary to distribution.
The tricky thing is that marketing and promotion also directly affects the income from manufacturing activity. Thus, both the distributor and manufacturer benefit form marketing and promotion. Therefore, I think it’s worth proposing to the MoF that it should link marketing and promotion functions to manufacturing (not to distribution) activity in the case of fully-fledged manufacturing.


Should Commercial Agency be treated as distribution?

The OECD in the PCD “Pillar One – Amount B (17 July 2023 –1 September 2023)” recognizes distribution in 2 forms:
  1. ‘Buy-sell marketing and distribution transactions wh ere the distributor purchases goods fr om one or more associated enterprises for wholesale distribution to unrelated parties; and
  2. Sales agency and commissionaire transactions wh ere the sales agent or commissionaire contributes to one or more associated enterprises’ wholesale distribution of goods to unrelated parties’.
The UAE’s Commercial Agency Code Federal Law No. 3/2022 Concerning the Regulation of Commercial Agencies also allows distribution in the form of commercial agency. The activity of a distributor that acts as an agent is to be rewarded by the agency fees to be paid by the principal.
There is no clarification in the PCD on whether such agency fee is to be treated as qualifying income. We believe that an agency fee of the distributor should qualify. The rationale for this is clear: there is no specific form of distributions singled out to qualify for a 0% rate in Decision No. 139/2023


Do KPI bonuses received by a distributor qualify for a 0% rate?

This question relates to para 3.11 of the PCD and Art. 2(1)(k) of Decision No. 139, i.e. to regular distribution from designated zones.

In practice, distribution contracts often provide for bonuses to a distributor when certain key performance indications (KPI) are met (e.g. volume of sales, market share covered, sales growth rate, customer satisfaction rating, inventory turnover rate, net profit margin percentage, etc.).

The PCD does not clarify whether such payments qualify. I think they do. They should be treated either as income from distribution or as incidental income. Both qualify if distribution is carried out from a designated zone.
However, there some tricky issues. One example is bonuses paid to a distributor for certain activity which is not ‘baseline’ distribution, or which does not fall within the distribution function list in para 3.11 of the PCD “The Qualifying Activity of distributing goods or materials may include functions such as the importation, storage, inventory management, handling, transportation and exportation of those goods or materials”.
What if the company pays a distributor a bonus for certain promotional activity to be performed to affect demand? What if a bonus is paid to encourage the activity of a distributor directed to raise demand from consumers? Should these bonuses qualify? I think it makes sense for them to qualify. However, the answer hinges on the position on the issue of marketing activity considered above.


Warning: Pursuant to MoF press-release issued 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.
The Ministry reminded that official sources of information on Federal Taxes in the UAE are MoF and FTA only. Therefore, analyses that are not based on official publications by MoF and FTA; or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law.

You should factor it in dealing with this article as well. It is not commissioned by MoF or FTA. Interpretation, conclusions, proposals, surmises, guesswork, etc. it comprises have status of the author’s opinion only. Like any human job, it may contain inaccuracy and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.




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