The United Arab Emirates (UAE) has positioned itself as a business-friendly environment by offering various operational models such as mainland and free zone structures. Free zones offer tax incentives, simplified setup procedures, and 100% foreign ownership. However, with the implementation of Value Added Tax (VAT) on January 1, 2018, it has become critical for free zone businesses—especially those that supply goods or services to the UAE mainland—to understand the VAT implications of such transactions.
This blog provides a detailed exploration of the VAT rules for free zone companies supplying to the mainland, including VAT registration requirements, Designated Zone distinctions, tax invoicing, reverse charge mechanisms, and compliance risks.
Understanding Free Zones vs Mainland in the UAE
Free zones in the UAE are special economic areas where businesses can operate under separate regulatory frameworks, often with incentives such as exemption from import duties and corporate tax holidays. In contrast, mainland companies operate under the UAE Commercial Companies Law and can trade freely across the UAE without restrictions.
From a VAT perspective, all areas within the UAE, including free zones, fall within the scope of VAT. However, a subset of free zones designated as “Designated Zones” are treated as being outside the UAE for the purpose of certain goods transactions.
What Are Designated Zones?
Designated Zones are specific free zones listed under Cabinet Decision No. 59 of 2017. These zones must meet criteria such as:
- Fenced geographic area with controlled entry and exit
- Customs supervision over goods movement
- FTA-approved procedures to monitor goods transfer
Examples of Designated Zones include Jebel Ali Free Zone (JAFZA), Dubai Airport Free Zone (DAFZA), Hamriyah Free Zone, and others. Only certain types of supplies in these zones are treated differently for VAT purposes.
VAT Registration for Free Zone Companies Supplying to the Mainland
Any free zone company—whether located in a Designated or Non-Designated Zone—must register for VAT if its taxable supplies and imports exceed AED 375,000 in the past 12 months or are expected to exceed that threshold in the next 30 days. Voluntary registration is allowed above AED 187,500.
VAT registration is mandatory if the free zone company supplies goods or services to mainland customers, regardless of location. Once registered, the company must charge VAT at 5% on applicable transactions.
VAT on Goods Supplied to the Mainland
The VAT treatment of goods supplied by a free zone company to the mainland depends on the location and nature of the transaction:
1. From Non-Designated Free Zone
If a company in a Non-Designated Zone supplies goods to a mainland customer, the transaction is subject to 5% VAT. The supplier must issue a valid VAT invoice, collect VAT, and report it in the VAT return.
2. From Designated Zone
When goods are moved from a Designated Zone to the mainland, it is treated as an import into the UAE. The recipient in the mainland may be required to account for VAT under the reverse charge mechanism or pay import VAT at customs, depending on their VAT registration status.
If the supplier arranges delivery into the mainland, the Designated Zone company must charge 5% VAT and act as the importer of record.
VAT on Services Supplied by Free Zone Companies
Unlike goods, all services supplied by free zone entities are considered to be supplied within the UAE and are subject to VAT at the standard rate of 5%, regardless of whether the free zone is Designated or Non-Designated.
This includes services such as:
- Consulting and advisory
- Software and IT services
- Management and administrative support
- Leasing of commercial space
If a free zone company supplies services to a VAT-registered mainland customer, the reverse charge mechanism may apply if agreed and documented properly.
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Reverse Charge Mechanism Explained
The reverse charge mechanism (RCM) shifts the obligation to account for VAT from the supplier to the recipient. This applies when:
- A mainland VAT-registered business receives goods or services from a free zone or foreign supplier
- The supply is eligible under UAE VAT Law to be treated under RCM
For example, if a free zone IT company provides software support to a VAT-registered company in Dubai mainland, the mainland company may account for VAT under the reverse charge, reporting both input and output VAT in its return (net effect is zero if fully recoverable).
VAT Invoicing and Documentation Requirements
Free zone companies must issue VAT-compliant invoices when supplying goods or services to the mainland. These invoices must include:
- Supplier and recipient details
- Tax Registration Number (TRN)
- Date of supply and invoice
- Details of goods/services supplied
- VAT rate (usually 5%) and amount charged
- Total invoice value inclusive of VAT
Non-compliant invoices can lead to disallowed input VAT for the recipient and fines imposed by the FTA.
FTA Compliance and Penalties
The Federal Tax Authority may audit free zone companies supplying to the mainland to verify:
- Correct classification of transactions
- Proper application of VAT and reverse charge rules
- Timely submission of VAT returns and payments
- Accurate documentation and record-keeping
Penalties may include fines for late filing (AED 1,000 for first offense), incorrect tax treatment, and failure to register when required. PEAK BCS can assist in preparing your business for FTA audits.
VAT on Imports and Customs Declarations
When free zone companies import goods into the mainland, VAT is payable at the point of import, unless the importer is VAT-registered and accounts under the reverse charge mechanism. Proper coordination with customs authorities and accurate declarations are necessary to ensure VAT is applied correctly.
Summary of Key Rules
| Scenario | VAT Treatment |
|---|---|
| Free zone company (Non-Designated) supplies goods to mainland | Charge 5% VAT, issue tax invoice |
| Designated Zone company supplies goods to mainland | Subject to import VAT or reverse charge depending on importer |
| Free zone company provides services to mainland | Charge 5% VAT or use reverse charge if applicable |
| Free zone company imports goods into mainland | Pay import VAT or account under reverse charge if VAT-registered |
Conclusion
Free zone companies in the UAE engaging in trade or service provision with the mainland must be aware of their VAT obligations. Whether located in a Designated or Non-Designated Zone, supplying to the mainland triggers VAT registration, invoicing, and compliance requirements. Proper understanding of supply classification, reverse charge applicability, and documentation rules is critical to avoid penalties and ensure smooth business operations.
PEAK Business Consultancy Services is your reliable partner for VAT compliance in the UAE. Whether you operate from a free zone or the mainland, we provide expert guidance on cross-border VAT treatment, filings, and structuring. Visit www.peakbcs.com to schedule a VAT strategy session today.
