How VAT Impacts Businesses in Dubai’s Free Zones
The United Arab Emirates (UAE) has established itself as an international commerce hub, attracting businesses and investors from all over the world. Understanding the tax environment, especially the VAT system, is one of the most significant considerations when establishing a business in the UAE. The implementation of VAT in UAE in 2018 has consequences for businesses operating there, notably those in free zones.
In this blog, we’ll look at how VAT operates in UAE-free zones and what business owners should know to comply with tax laws.
What is VAT?
A consumption tax known as the Value Added Tax (VAT) is imposed on the value that is added to products and services at each step of production or distribution. The final consumer is responsible for paying for it. The implementation of VAT in UAE represented a substantial change in the country’s tax structure. VAT is a typical form of indirect tax utilized in many nations throughout the world.
VAT in UAE
VAT in UAE is set at 5% and applies to the majority of products and services, with a few exceptions such as basic food items, healthcare, and certain financial services. This tax revenue is critical to the UAE’s infrastructure, public services, and economic diversification.
However, VAT is not applied uniformly throughout the country. The UAE has designated specific areas, particularly in free zones, with unique VAT regulations. These areas, known as “Designated Zones,” have distinct VAT implications for businesses operating within them. In this guide, we’ll delve into what Designated Zones are, how to identify them, and what this means for businesses within these zones.
What is a Designated Zone?
A Designated Zone, as defined by UAE tax laws, is an area considered to be outside the UAE territory for VAT purposes. This means that supplies made from inside or outside a Designated Zone are generally free from VAT, with some exceptions. Designated Zones are subject to strict criteria to maintain their status, including being fenced areas with security measures, well-defined regulations for goods storage, and compliance with all relevant rules and regulations.
Identifying a Designated Zone
Not all free zones automatically qualify as Designated Zones. Designated Zones must meet specific criteria outlined in the Federal Decree-Law on VAT and Executive Regulations. These criteria include:
- Fenced Area: The zone must be a fenced area.
- Security Measures: It should have its security measures and customs control unit for monitoring the movement of individuals and goods.
- Compliance: The operator of the zone must comply with all rules and regulations set forth by the UAE’s Federal Tax Authority (FTA).
- Regulations: There must be well-defined regulations for the storage, retrieval, and processing of goods within the zone.
List of Designated Zones in the UAE
Cabinet decision No. 59 lists several free zones across the UAE as Designated Zones. These include zones in Abu Dhabi, Dubai, Sharjah, Ajman, Umm Al Quwain, Ras Al Khaimah, and Fujairah. Businesses need to verify the current list of Designated Zones to ensure compliance with VAT regulations.
Supply of Services within Designated Zones
A supply of services within a Designated Zone is regarded to take place in the UAE under standard VAT laws. This means that most services provided within Designated Zones are subject to ordinary VAT rates. However, services exported outside of the GCC may be zero-rated.
Supply of Goods within Designated Zones
A supply of goods within a Designated Zone is generally not subject to VAT, as the place of supply is considered outside the UAE territory. This standard rule changes when the goods are intended for private use within the UAE, in which case VAT applies.
If goods purchased within a Designated Zone are attached to other goods within the same zone, forming part of a final product, the supply is considered outside the scope of VAT.
Transfer of Goods
- From Outside the UAE into Designated Zones: VAT is not levied on such supplies.
- From Mainland UAE into Designated Zones: This is not considered an export but a local movement and is subject to VAT.
- Between Different Designated Zones: It’s outside the scope of VAT if specific conditions are met.
- Import of Goods from Designated Zones: The import of goods from a Designated Zone to the mainland UAE is considered an import of goods and is subject to import VAT. If VAT was already paid on these goods within the Designated Zone, it can be recovered during import, provided the goods are identical.
Supplies of Water, Energy, and Real Estate
Supplies of water and energy within Designated Zones are typically outside the scope of VAT, except for personal consumption. Sales and leases of real estate in Designated Zones are treated as supplies of goods and are not subject to VAT. However, real estate services are subject to VAT.
Tax Groups and Branches
Businesses in Designated Zones can form tax groups with onshore companies or entities in different Designated Zones. The tax group becomes liable for import VAT if goods are transferred among group members, resulting in imports from a Designated Zone into the mainland UAE.
VAT Recovery in Designated Zones
Businesses registered in Designated Zones can recover input VAT for taxable supplies. However, if an expense covers both recoverable and non-recoverable supplies, the VAT must be divided accordingly.
VAT in Free Zones
Free zones in the UAE offer a range of incentives to attract foreign businesses, including 100% ownership, tax exemptions, and customs benefits. However, when it comes to VAT, free zones have specific rules and regulations that businesses need to follow:
1. VAT Registration:
Threshold: Businesses operating in free zones are required to register for VAT if their taxable supplies and imports exceed the mandatory threshold, which is currently AED 375,000.
Voluntary Registration: Even if a business does not meet the mandatory threshold, it can choose to register voluntarily for VAT.
2. Supply of Goods and Services:
VAT on Supplies: Businesses in free zones must charge VAT at the standard rate (5%) on the supply of most goods and services to other VAT-registered businesses.
Imported Goods: When goods are imported into a free zone, VAT is typically not paid at the point of entry, but it becomes due when the goods are released into the local market.
3. Designated Zones:
Certain free zones have been designated as “Designated Zones” for VAT purposes. Goods transferred between these zones are not subject to VAT.
Businesses in free zones are required to maintain accurate records of their financial transactions for VAT purposes.
5. VAT Returns and Payments:
VAT-registered businesses in free zones must submit regular VAT returns to the Federal Tax Authority (FTA) and settle any VAT liabilities within the specified timeframe.
6. Penalties for Non-Compliance:
Non-compliance with VAT regulations, such as late or incorrect filing, can result in penalties and fines.
How BizDaddy Can Help
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Are you ready to establish your business in a UAE-free zone while staying VAT-compliant? Contact BizDaddy today for expert guidance and support on all your business setup needs.
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