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The Rise Of The Free Zone

Global Incorporation Guide [GIG] Editorial

January 18, 2016

The factors that must be taken into consideration when deciding which jurisdiction is most suitable to incorporate a company are legion. Depending on the nature of the business, the sort of things that enter into the equation include set-up costs, the simplicity or otherwise of the legal and regulatory framework, political and economic stability, infrastructure, labor issues, taxes... the list could go on quite considerably. Thankfully, some countries are making the incorporation and running of a company much easier for foreign investors with the establishment of free zones.


The Proliferation Of The Free Zones

Free zones have spread rapidly across the globe over the last three decades or so, to the extent that there are now more countries with such delineated fiscally privileged areas as there are without them. According to the World Atlas of Free Zones, in 2010 there were 1,735 free zones in 133 countries. By 2015, the number of free zones had increased to 3,500 supporting approximately 70m jobs, according to the World Free Zones Organization (World FZO).


What Is A Free Zone?

Loosely, a free zone can be described as a geographical area within which companies are granted significant fiscal and regulatory privileges not available to firms operating in the "normal" economy. Sometimes, there are strings attached, and companies have to meet certain criteria, such as hiring a certain number of local staff, to qualify for free zone legal and tax treatment. Many free zones are semi-autonomous from government and administered by private sector organizations, and many of them could justifiably be described as "offshore" territories in a legal sense, but without being labeled as "tax havens" and carrying all the negative baggage that attaches to this phrase.


Where Are You Most Likely To Find Free Zones?

The only place you won’t find any free zones is the European Union, except for in those member states which are relatively new the EU, where in most cases tax incentives have been considerably watered down as a condition of their membership. This is because the state aid rules, which seek to prevent governments from granting certain companies or geographical areas with "selective advantage" over their competitors, won’t allow them.

You will however find free zones in just about every other part of the world, from Asia to the Middle East, Africa and the Americas. Indeed, as the World FZO’s figures suggest, the number of jurisdictions with free zones now significantly outnumbers those which have not legislated for these fiscally-privileged regimes.

Examples of notable free zones, some well-established, others relatively new, are summarized below:


United Arab Emirates

We start in the United Arab Emirates, and particularly Dubai, which has shown the world how spectacularly successful free zones can be at transforming an economy.

Companies in Dubai's free zones, of which there are now over 20, with several more under construction, are granted are number of fiscal and regulatory benefits, including freedom from corporate taxation for a period of 50 years, a concession which is renewable, exemption from all import duties, 100 percent repatriation of capital and profits and 100 percent foreign ownership.

The results of this generous legal regime speak for themselves. The 19 companies which set up in Jebel Ali, Dubai's first free zone adjacent to the region's largest port, 30 years ago have grown in number to over 7,100. And this growth shows no sign of abating. In 2014, 679 new companies were registered in the JAFZ, an increase of 17 percent on 2013. Asia Pacific firms accounted for 29 percent of the new companies formed. The Americas and Europe together accounted for 27 percent. 14 percent of the new companies came from India, six percent from China, and eight percent were from either the United States or the United Kingdom. Company revenues grew by 10 percent, and profits were up more than 13 percent to AED1.18bn (USD321m). Last year, these companies generated trade worth an estimated AED370bn (USD100bn). The JAFZ now accounts for about 25 percent of Dubai's gross domestic product.

Meanwhile, the Dubai International Financial Centre (DIFC), reported in September 2015 that the number of active companies registered at the Centre grew 8.3 percent in the first half of this year compared with the end of 2014, totaling 1,327. In the period from January to June, the number of people employed within the free zone increased by 4.8 percent to more than 18,521.

The number of active companies registered at the DIFC by the end of June was up 19.2 percent compared with the end of June last year. During the first six months of this year, 140 new companies were licensed, including 36 financial services firms, 91 non-financial services companies, and 13 retailers. Most of the new financial firms originate from the Middle East (53 percent), followed by Europe (19 percent), North America (8 percent) and Asia (6 percent), with the rest of the world accounting for 14 percent.

Essa Kazim, Governor of the DIFC and Chairman of the DIFC Authority, said that the strong growth rates show that the free zone is on the right track to achieving its goal of trebling its operations by 2024. "With a growing portfolio of active registered firms and an ever expanding and vibrant workforce, we are maximizing the opportunities for investment into and trade with the emerging markets of the MEASA region," he said.


Central America – Panama and Belize

Some of the most well-established free zones are to be found in Latin America, notably Panama, where the Colon Free Zone (CFZ) was established in 1948. CFZ companies obtain fiscal benefits including: exemption from sales tax, production tax and income tax on foreign income; no capital gains tax on assets held for more than two years; no capital investment tax; no municipal taxes; no tax on shipments sent to or from the CFZ. Companies in the zone can also reduce their taxable income by employing a certain number of local workers. More than 1,700 companies are established in the CFZ, shipping more than USD9bn of goods annually.

Another example in this region is Belize, where the Commercial Free Zone at Corozal was created in 1994 to attract foreign investment after the collapse of the sugar refining industry in the country's northern region. Benefits and exemptions available to companies in the Commercial Free Zone include: no restrictions on foreign exchange including the sale of foreign currency; no government charges and taxes on the use of foreign currency within the zone; all merchandise, articles, or goods entering the zone for commercial purposes are exempt from duties; most imports and exports of the zone are exempt from all custom duties, consumption taxes, excise taxes, and export duties.

Commercial Free Zone businesses pay income tax at rate between 2 percent and 8 percent, depending on their level of income. A tax credit is also available if a minimum of 10 Belizeans are employed by a CFZ company. During the first ten years of its operation, a Commercial Free Zone business is exempt from income tax or capital gains tax or any new corporate tax levied by the Government of Belize, and any dividends paid by a Commercial Free Zone business are exempt from tax for the first twenty years of its operation.

There are now over 300 companies in the Commercial Free Zone engaged in various activities including manufacturing, processing, packaging, warehousing, and distribution of goods and services.


Africa – Kenya and South Africa

African governments have also been waking up to the potential economic benefits of free zones, and the World Free Zone Atlas counts 17 countries with free zones of varying description across the continent. One of the earliest of these was Kenya's Export Processing Zones program, which was brought about by legislation in 1990.

Tax benefits of Kenyan EPZs include: a 10 year corporate income tax holiday and a 25 percent tax rate for a further 10 years thereafter; a 10 year withholding tax holiday on dividends and other remittances to non-resident parties; perpetual exemption from VAT and customs import duty on inputs and local purchases of goods and services; perpetual exemption from payment of stamp duty on legal instruments; and 100 percent investment deduction on new investment in EPZ buildings and machinery, over 20 years. By 2006 there were 39 zones employing over 35,000 Kenyans.

South Africa, meanwhile, has placed much faith in its Industrial Development Zones (IDZs) to provide the catalyst needed to drive investment and growth in the manufacturing sector. As well as attracting foreign investors, these incentives are designed to encourage investment in industrial undertakings and to boost levels of employment among the previously economically disenfranchised black population.

One of the most significant incentives is the Automotive Investment Scheme (AIS), which is designed to grow and develop the automotive sector through investment in the building of new cars and components. The AIS provides for a taxable cash grant of 20 percent of the value of qualifying investment in productive assets as approved by the Department of Trade and Industry (DTI). An additional taxable cash grant of 5 percent or 10 percent may be available to projects that maintain their base year employment figure throughout the incentive period, and achieve at least two of the following economic requirements: tooling; research and development in South Africa; employment creation; strengthening of the automotive value chain; and value addition.

The "Section 12I" tax incentive is designed to support "greenfield investments" (new industrial projects that utilize only new and unused manufacturing assets), as well as "brownfield investments" (expansions or upgrades of existing industrial projects). Under this scheme, brownfield projects are entitled to deduct an additional 75 percent of the cost of manufacturing assets (up to a maximum of ZAR550m (USD40,700), and greenfield projects can deduct an additional 100 percent (up to a maximum of ZAR900m). An additional training allowance of ZAR36,000 per employee can also be deducted from taxable income.

There are also Special Economic Zones (SEZs), which are geographically designated areas of a country set aside for specifically targeted economic activities, supported through special arrangements. The Government's 2014/15 to 2016/17 Industrial Policy Action Plan identifies SEZs as key contributors to economic development, and the SEZ Act of 2014 will create a special 15 percent corporate tax (the regular South African corporate tax rate is 28 percent). SEZ companies will also be entitled to existing industrial tax incentives such as a building allowance and the "Section 12I" tax allowance.


China

In what is seen as an essential step towards upgrading China's economy through the liberalization of services and trade, with an eventual roll-out nationwide in other chosen areas, Shanghai has built the free trade zone (FTZ), launched on September 29, 2013, around its existing comprehensive bonded zones at Waigaoqiao, Yangshan and Pudong Airport, which are reported to have serviced total trade of more than USD100bn in 2012.

The Shanghai FTZ (or, as it has been more aptly called, the "free-market area") goes beyond a further liberalization of trade to be significantly more advantageous for financial services and investment. For example, the FTZ strengthens Shanghai's role in financial services, as foreign-funded banks and joint venture banks are allowed to be set up in the zone and banks are permitted to act within a foreign exchange settlement center for international trade. While the State Council's plan did not commit to full convertibility of the RMB or interest rate liberalization, measures have been introduced in that respect, with the Shanghai FTZ being used to try out these reforms ahead of other parts of China.

Given the port and airport location of the FTZ, there are policies to abolish the capital requirements for single aircraft or single vessel company subsidiaries set up by financial leasing companies (FLCs); to relax the existing limits on foreign investment shareholdings in joint venture international shipping companies; and to allow for wholly foreign-owned international ship management companies.

There is already a tax exemption on business income and revenues arising from international shipping, transporting, warehousing, and shipping insurance for companies registered in the FTZ port areas, and FLCs can now also benefit from preferential tax rates on the import of planes with a net weight of above 25 tonnes.

The FTZ also offers further tax incentives for investment and trade. Zero customs duties and import taxes continue to apply to goods transferring between the FTZ and overseas destinations. But with domestic merchandise entering the FTZ being regarded as having been exported, exporters enjoy an immediate tax rebate. Tax exemptions are also available to companies registered in the zone on their imports of machines and productive equipment.

In addition, in order to promote investment in the FTZ, companies and individuals are able to pay income taxes by installments over a five-year period for revaluations arising from asset restructuring.

In April 2015, the FTZ concept was extended to Guangdong, Tianjin, and Fujian. And judging by figures from the Government the three new FTZs have been phenomenally successful: by the end of May 2015, the Guangdong FTZ had received FDI worth RMB7.77bn (USD1.25bn), the Tianjin FTZ had attracted investment worth RMB11.71bn, and the Fujian FTZ had absorbed RMB3.15bn. This was despite investors being precluded from undertaking projects in 49 industries.


New Free Zones

The list of the world’s free zones is being added to on a regular basis. Indeed, the World FZO granted membership to an additional 44 FTZs during the second meeting of the Organization's Board of Directors this year towards the end of 2015.

One recent entrant to the free zone club was the Abu Dhabi Global Market (ADGM), which began accepting license applications on June 15, 2015. ADGM aims to become a major financial services center, which will focus on asset management, private banking, and wealth management during the first phase of its establishment. It will provide firms with a number of benefits, including exemption from taxes guaranteed for 50 years; relaxed rules on the repatriation of profits; and an allowance for 100 percent foreign ownership.

The Mauritian Government is also aiming to expand investment opportunities across Africa in 2016 by developing a number of special economic zones that will provide favorable conditions, including tax concessions. Ghana, Madagascar, Senegal, and Zambia have all expressed an interest in collaborating with Mauritius to develop these economic zones. The Government of Mauritius said the zones will open up new opportunities for domestic businesses.

Each planned SEZ will have a distinct focus depending on the local economic opportunities. For example, the SEZ in Ghana will be targeted towards technology companies, while the SEZs in Madagascar and Senegal will be focused on cargo logistics.

Dubai's DP World also recognizes the economic potential of Africa, having signed a memorandum of understanding with the Government of Senegal to set up a logistics free zone in the vicinity of the new Blaise Diagne International Airport in the outskirts of Senegal's capital city Dakar.

Ahmed bin Sulayem, Chairman of DP World and Chairman of Ports, Customs and Free Zone Corporation (PCFC) said that the new free zone will use state-of-the-art equipment and technology to operate and manage the zone. The project will also add new jobs for the Senegalese workforce, he said.

In 2015, Mexican President Enrique Peña Nieto looking to free zones to drive investment to the south of the country, and he introduced draft legislation last year for the creation of special economic zones in the southern states of Mexico.

The proposed SEZs would be set up in the Isthmus of Tehuantepec and the ports of Chiapas and Lázaro Cárdenas. These three areas are located in the states of Oaxaca, Chiapas, and Michoacán, respectively. These SEZs are being created to attract investment, through tax benefits and other business incentives. They are intended to stimulate economic growth southern Mexico, which is poorer than the rest of the country.

Earlier in 2015, Lourdes Medina Valdés, a member of the Finance Committee of Mexico's Chamber of Deputies, said that the country should focus on creating SEZs as a way of boosting economic growth and employment. According to her proposal, companies operating in the SEZs would benefit from zero-rated value-added tax and exemptions from trade taxes. In addition, the income tax rate for individuals would not exceed 12 percent, and companies would be subject to a rate of not more than 16 percent.

 

Tags: tax | investment | trade | Africa | services | business | Dubai | financial services | Senegal | Kenya | Belize | South Africa | China | manufacturing | Mexico | Europe | tax incentives | Ghana | legislation | United Arab Emirates | Madagascar

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