Historically, Free Zones have been excluded from the territorial scope of the UAE. And because the consumption tax, namely VAT, applies to only those goods and services that are supplied within the territorial area of the UAE, free zone entities don’t have to pay VAT until they are trading within the free zones. For VAT purposes, this is not the case as a matter of course. Only those Free Zones that are classified in a Cabinet Decision are eligible for special VAT treatment and that special VAT treatment has certain limitations. These nominated Free Zones are known as Designated Zones for VAT purposes.
In simple terms, Free Zone jurisdictions in the UAE don’t impose taxes on the entities conducting business from here but certain free zones are considered to be outside the state for the purpose of VAT and defined as VAT Designated Zones. These Designated Zones have to comply with special rules for trading products within those Designated Zones in line with the FTA-published Cabinet Decision No. 56 of 2017 on Medications and Medical Equipment, and Cabinet Decision No. 59 of 2017 on Designated Zones for the purposes of the Federal Decree-Law No. (8) of 2017 on Value Added Tax (VAT). In order to qualify for the tax benefits offered by the government, one VAT designated free zone should do business with another VAT designated free zone which means any supplies between designated zones will not attract VAT at 5%. Say, ABC, located in Khalifa Industrial Zone, can supply goods to XYZ, situated in Dubai Textile City, without being subject to 5% VAT. While special rules are applicable to supplies made in the designated zones, the companies set up in such zones may still need to register their business on the UAE VAT system provided the registration criteria is met.
Supplies of goods and services in the UAE territory started attracting 5% VAT after 1 January 2018 except free zones. These are the regions considered omitted from the UAE territory and excluded from VAT. However not all of them. Certain regions that are treated to be outside the UAE for VAT reasons and have special restricted regulations for VAT are the free zones termed as Designated Free Zones. You may find them in the Cabinet Decision document.
Designated Zones and Free Zones have special considerations under UAE tax laws. Let’s take a look at the ways how these two regions differ from one another:
Any area specified by a decision of the Cabinet upon the recommendation of the Minister, as a Designated Zone for the purpose of the Decree-Law.
Free zones are geographically bounded areas within the UAE (not all of them are fenced or gated tho) allowing 100% foreign ownership and are by and large, committed to a particular industry.
FTA-listed free zones that are assigned to be outside the UAE territory for VAT purposes despite being physically located inside.
Free zones are not considered outside the territory in any circumstances.
If a Free Zone is not a Designated Zone, it is treated like any other part of the UAE. Businesses in the free zones, which are not specified as designated zones by FTA, will be taxed at the usual VAT rates.
Those Free Zones which are nominated as Designated Zones are treated as being outside of the territory of the UAE for VAT purposes for specific supplies of goods. In addition, there are special VAT rules in respect of VAT treatment of certain supplies made within Designated Zones. The effect of these rules is that certain supplies of goods made within Designated Zones are not subject to UAE VAT. In contrast, supplies of services made within Designated Zones are treated in the same way as supplies of services in the rest of the UAE. Supplies made from inside or outside a Designated Zone are free of VAT (with some exceptions).
VAT is a general consumption tax imposed on most supplies of goods and services in the UAE. By default, it is chargeable on supplies of goods and services throughout the territorial area of the UAE. This territorial area will also include those areas currently defined as both fenced and unfenced Free Zones. For VAT purposes, both fenced and unfenced Free Zones are considered to be within the territorial scope of the UAE – and therefore subject to the normal UAE VAT rules – unless they fulfill the criteria to be treated as a “Designated Zone” as defined by the Federal Decree-Law on VAT and Executive Regulations.
How to Determine a Designated Zone?
A Designated Zone is an area classified by a Cabinet Decision as being a “Designated Zone”. You may refer to the list of Designated Zones in the UAE published under the Legislation tab on the FTA website in order to identify whether a free zone is a Designated Zone. Although an area might be identified as a Designated Zone, it is not automatically addressed as being outside the UAE for VAT purposes until it meets certain criteria. In order for a Designated Zone to be considered as outside the UAE for VAT objectives, the Designated Zone must:
Be a specific fenced geographic area.
Have security measures and Customs controls in place to keep track of the entry and exit of individuals and movement of goods to and from the Designated Zone.
Have internal procedures regarding the method of keeping, storing and processing of goods within the Designated Zone.
Ensure that the operator adheres to the procedures set out by the Federal Tax Authority. This implies that where a Designated Zone has regions that fulfil the above requirements, and areas that do not fulfil the requirements, it will be treated as being outside the UAE only to the extent that the requirements are met. Furthermore, should a Designated Zone modify the manner of its operation or no longer meet any of the conditions imposed on it which led to it being specified as a Designated Zone by way of the Cabinet Decision, it shall be treated as though it is located within the territory of the UAE.
Companies within a Designated Zone
Free Zones meeting the criteria have been specifically identified by way of a Cabinet Decision as Designated Zones. Those entities which are set up, registered or which have a place of residence within the Designated Zone are deemed to have a place of residence in the UAE for VAT objectives. The effect of this is that where a business is operating in a Designated Zone, it itself will be onshore for VAT purposes, even though some of its supplies of goods may be outside the scope of UAE VAT.
VAT Registration of Designated Zone Entities
Designated Zone businesses are seen as established ‘onshore’ in the UAE for VAT purposes. This means that they have the same obligations as non-Designated Zone businesses and have to register, report and account for VAT under the normal rules. It also means they can join a tax group (VAT group) provided they meet the required conditions. Any entity performing a business activity in the UAE and making taxable supplies more than the mandatory VAT registration threshold (i.e., a taxable person) must register for VAT purposes. Any other person that is making taxable supplies or incurring expenses (which are subject to VAT), in excess of the voluntary VAT registration threshold may register for VAT purposes.