How Does VAT Work in Free Zone in the UAE?

With its progressive leadership, world-class infrastructure, and stable economic policies, the United Arab Emirates (UAE) has become one of the most business-friendly destinations. The presence of free zones across the country is an important growth driver for the UAE's economy. 

With a relaxed regulatory framework as compared to the mainland, these zones offer various tax benefits and are emerging as attractive destinations for global corporations. 

The introduction of VAT for Free Zone companies in the UAE has added a layer of complexity for businesses operating here. Understanding VAT rules in the UAE can help ensure that your free zone company operates smoothly and remains compliant with FTA (Federal Tax Authority) regulations. This blog covers how VAT works for companies operating from the UAE's Free Zones and Designated Zones, exploring its impact on various transactions.

What is VAT?

Value Added Tax (VAT) is a consumption tax applied to the supply of most goods and services in the UAE. It is charged at each step of the 'value-added' process, i.e., whenever value is added to the products or services.

• The standard rate of VAT in the UAE is 5%, one of the lowest in the world. This rate applies to most goods and services in the country unless they are zero-rated or exempt.
• Zero-rated supplies are taxable but at a 0% rate. This means you do not charge VAT from customers but can claim input credit for any VAT paid on your costs. Examples of zero-rated supplies in the UAE include preventive healthcare services, the export of goods and services outside the GCC, and various others.
• Exempt supplies do not come under the purview of VAT, and you cannot claim input credit for any VAT paid on the costs. Specific financial services, the first sale or lease of residential buildings, and the supply of bare land are some examples of exempt supplies in the UAE.

You can register for VAT within 30 days of your annual taxable turnover crossing the mandatory threshold of AED 375,000 or if your taxable supplies for a year cross AED 187,500 (Voluntary registration). 

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What are free zones in UAE?

Free Zones in the UAE are special economic areas established to boost the economy and attract international investors to the country. Here, businesses can trade goods and sell services under a taxation framework that is different from the mainland UAE. Moreover, different Free Zones can have different rules governing the companies and employees working in respective zones. 

Here are some key features of Free Zones:

• 100% Foreign Ownership: You can enjoy full business control without needing local sponsorship.
• 100% Repatriation of Capital and Profits: You may transfer the profits from the business back to your home country without any restrictions.
• 100% Import and Export Tax Exemption: International trade becomes more profitable as you do not need to pay any import or export tax in the Free Zones.
• Exemption from Income and Corporate Taxes: It can improve your cash flow by reducing tax liabilities and freeing additional funds for other important business expenses.
• Global Connectivity: The strategic location of these Free Zones provides easy access to international markets.

However, Free Zone companies are not entirely exempt from VAT. The UAE government implements a 5% VAT on goods and services, with specific considerations for Free Zone entities classified as 'Designated Zones'. 

What are designated zones in the UAE?

Designated Zones are specific fenced areas within Free Zones with special tax treatment under the UAE VAT system. While these zones are a part of the UAE territory, they are considered outside the UAE for VAT purposes. This unique status offers several benefits and incentives for enterprises operating in these zones.

Here are some key advantages of Designated Zones you might find beneficial:

• Tax Breaks: Enterprises in Designated Zones can enjoy significant tax advantages, including exemptions from certain VAT obligations. For instance, goods transferred between different Designated Zones like the Free Trade Zone of Khalifa Port, Umm Al Quwain Free Trade Zone in Ahmed Bin Rashid Port, and others are not subject to VAT, which can significantly reduce your tax liabilities.
• Simplified Customs Procedures: Customs procedures can be complex and time-consuming for mainland businesses, but these processes are simplified in Designated Zones. For instance, there are fewer restrictions on the movement of goods between different Designated Zones, making it easier for businesses to import and export goods.
• No Customs Duties: Goods transferred between Designated Zones are not subject to customs duties, making trade more cost-effective. For instance, trading goods from the Dubai Airport Free Zone to the Khalifa Industrial Zone in Abu Dhabi will not attract customs duties.
• Streamlined Business Regulations: The regulatory environment in Designated Zones is business-friendly, with streamlined rules that can facilitate ease of doing business.

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VAT for designated zone companies in the UAE

As discussed above, Designated Zones are considered to be outside the territory of the UAE for specific supplies of goods. This means your company within a designated zone might be exempt from VAT on specific transactions, such as when 

• Supplies are used to make other goods (as input).
• Supplies are combined with other goods (as a package).
• Any other type of usage that makes the supplies a part of other goods.

However, if the goods supplied within a designated zone are intended for non-business-related use, your company must pay the standard 5% VAT.  

Let's consider an example here. Your company operates in a designated zone and imports raw materials for manufacturing. In this case, importing raw materials into the Designated Zone would not be subject to VAT as the area is considered outside the UAE territory.

Now, you use these raw materials to manufacture goods within the Designated Zone. The consumption of these raw materials in the manufacturing process would also not be subject to VAT. However, if you sell these goods to a customer in the mainland UAE, then this supply would be subject to the standard 5% VAT. 

Special regulations are applicable to transactions conducted in Designated Zones. However, companies located in these zones might still be required to register if they fulfil the necessary VAT registration criteria.

Freezone to freezone VAT

Here are some important aspects of VAT implementation on transactions between different Freezone entities in the UAE:

• VAT on Goods: The general rule is that these transactions are not subject to VAT when goods are transferred from one Free Zone to another. This exemption creates a viable ecosystem for Business-to-Business (B2B) transactions, making it cost-effective for companies to trade goods within these zones.

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• VAT on Services:  Services provided by businesses operating in Free Zones can be either standard-rated, zero-rated, or exempt from VAT, depending on the specific nature of the service. For instance, a consultancy service provided by a Free Zone company to a client in another Free Zone would typically be subject to the standard 5% VAT. In contrast, IT maintenance services from one zone to another could potentially be zero-rated.

Conditions for VAT exemption 

Freezone VAT rules offer significant tax benefits for businesses. However, for VAT exemptions, Freezone-to-Freezone transactions should meet the following conditions: 

• For thesupply of goods between Designated Zones to be outside the scope of the UAE VAT law, the goods should not be used or altered during the transfer. 
• The transfer must happen as per the customs duty suspension rules under the GCC Common Customs Law.
• The recipient must be authorised to receive goods in a Designated Zone.

Understanding the UAE tax laws for free zone companies and how they apply to your enterprise can facilitate FTA compliance and optimise your tax liabilities.

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Freezone to mainland VAT

When goods or services are supplied from a Free Zone to the mainland, the following VAT implications apply. 

• Supply of Goods: The supply of goods from the Designated Zone to a supplier located on the mainland is considered an import. This means that the supplier who is buying goods from the Designated Zone will have to pay VAT on a reverse charge basis, like the import of goods from other countries.
• Supply of Services: If you are a service company operating from a Designated Zone, then services supplied to the mainland are taxable at 5%.
• VAT Compliance: While Designated Zones offer exemptions for certain good supplies, businesses operating there are still considered ‘onshore’ for VAT purposes. This means they have the same VAT compliance obligations as any other company in the UAE. You will have to:some text
  • Register for VAT
  • Account for VAT on your transactions
  • File VAT returns
  • Pay any VAT due

Other Considerations:

• VAT Grouping: You can also be eligible to join a VAT group with other UAE businesses. This allows for simplified VAT treatment within the group. Your company should meet all the conditions for forming a VAT group.
• Input VAT Recovery: You are also subject to the standard rules for input VAT recovery on your taxable expenses.

Conclusion

VAT rules for Free Zone companies in the UAE can involve some complexities, especially when dealing with mainland transactions. It is good to stay up-to-date with the most recent VAT regulations and ensure adherence to avoid penalties. 

Meanwhile, if you want to automate your VAT calculation and streamline operations, try Alaan. With Alaan’s corporate card and spend management solution, you can

• Eliminate manual errors 
• Identify tax-deductible expenses 
• Keep track of your expenses in realtime 
• Ensure policy compliance throughout the company 

To connect, please fill out the form, and we will get back to you. 

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