The UAE is home to numerous free zones designed to attract foreign investment and promote business-friendly policies. With the introduction of Value Added Tax (VAT) in 2018, questions quickly arose about how VAT applies within these zones. To clarify the treatment, the UAE Federal Tax Authority (FTA) introduced the concept of “Designated Zones”—specific free zones with special VAT rules. In contrast, Non-Designated Zones follow the standard VAT framework applicable across the mainland.
This blog provides a detailed guide on the VAT implications in UAE Free Zones, highlighting the differences between Designated and Non-Designated Zones, registration requirements, treatment of goods and services, and compliance responsibilities.
Understanding Free Zones in the UAE
Free zones in the UAE are geographically defined areas with their own regulations and administrative authorities. They offer incentives such as 100% foreign ownership, full repatriation of profits, and tax holidays. However, from a VAT perspective, the mere location of a business in a free zone does not automatically exempt it from VAT obligations.
The VAT treatment depends on whether the free zone is classified as a Designated Zone by the UAE Cabinet and FTA.
What is a Designated Zone?
According to Cabinet Decision No. (59) of 2017, a Designated Zone is a specific free zone that is treated as being outside the UAE for VAT purposes, but only for the supply of goods. These zones must meet certain conditions such as:
- Being fenced-off with controlled entry and exit
- Having internal procedures to monitor goods movement
- Meeting FTA-defined record-keeping and storage standards
A list of approved Designated Zones is published by the FTA and may be updated periodically.
Non-Designated Zones Explained
All other free zones that are not classified as Designated Zones are considered Non-Designated Zones. These are treated like any other UAE territory for VAT purposes. Businesses operating here must adhere to all standard VAT obligations without any special treatment for supplies made or received.
Key VAT Differences Between Designated and Non-Designated Zones
| Aspect | Designated Zone | Non-Designated Zone |
|---|---|---|
| VAT on Supply of Goods Within Zone | Generally out of scope if goods remain within the Designated Zone | Standard 5% VAT applies |
| VAT on Goods Supplied to Mainland | Standard 5% VAT applies | Standard 5% VAT applies |
| VAT on Imported Goods | No VAT at import into Designated Zone, but payable if moved to mainland | VAT due on import as per UAE customs rules |
| VAT on Supply of Services | Standard 5% VAT applies | Standard 5% VAT applies |
| VAT Registration | Required if taxable turnover exceeds threshold | Required if taxable turnover exceeds threshold |
Supply of Goods Within Designated Zones
When goods are supplied from one entity to another within the same Designated Zone (or between two Designated Zones), the transaction may be outside the scope of VAT provided:
- The goods do not leave the Designated Zone
- The recipient is a VAT-registered business within another Designated Zone
- Proper documentation and records are maintained
If the goods are transferred to the mainland, VAT must be charged and accounted for by the importer.
Supply of Services in Designated Zones
Unlike goods, services supplied within Designated Zones are treated the same as in the mainland. This means:
- All service supplies are subject to 5% VAT
- Location of the service provider or recipient determines taxability
- There is no “out-of-scope” treatment for services
Businesses in Designated Zones must charge VAT on taxable services, file returns, and comply with all standard requirements.
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VAT Registration Obligations in Free Zones
Businesses operating in both Designated and Non-Designated Zones must register for VAT if their taxable supplies exceed AED 375,000 annually. This includes:
- Sales of goods and services (both domestic and international)
- Import of goods into mainland UAE
- Reverse charge services received from abroad
Even if a business is located in a Designated Zone and deals exclusively in out-of-scope goods supplies, it must still assess its eligibility for voluntary registration at AED 187,500 to reclaim input VAT.
Reverse Charge and Import Compliance
Businesses in Free Zones must apply the reverse charge mechanism for certain transactions, such as receiving services from abroad or importing goods into the mainland. Key points include:
- Reverse charge applies even in Designated Zones for imported services
- Goods moved from Designated Zones to the mainland are considered imports
- Import VAT must be paid or accounted for via VAT returns
Customs and FTA documentation must be aligned to avoid compliance penalties.
FTA Audit Readiness in Free Zones
FTA may audit businesses located in both Designated and Non-Designated Zones to ensure proper VAT treatment of supplies. Common audit areas include:
- Misclassification of goods and services
- Incorrect application of Designated Zone benefits
- Failure to charge VAT on local service transactions
- Improper invoicing or documentation
PEAK BCS can help prepare your business for FTA audits with internal VAT health checks and compliance reviews.
Conclusion
The VAT treatment in UAE Free Zones depends heavily on whether the entity is located in a Designated or Non-Designated Zone. While Designated Zones offer specific VAT relief for goods transactions, services and mainland-linked activities remain subject to standard VAT rules. Businesses must understand their obligations, keep accurate records, and ensure they are applying VAT rules correctly to avoid penalties and maintain compliance.
Let PEAK Business Consultancy Services be your trusted VAT partner. From registration to filing and audit support, our professionals offer end-to-end VAT solutions tailored for Free Zone operations. Visit www.peakbcs.com to schedule your VAT strategy session today.
