UAE VAT Implications on Designated Zones: A Comprehensive Guide

As the UAE continues to enhance its position as a global business and investment hub, understanding the intricacies of Value Added Tax (VAT) is crucial for companies operating within its borders. One of the key components of the VAT framework is the concept of Designated Zones. These zones offer unique VAT treatment that can significantly impact businesses engaged in the movement of goods and services. This blog provides a comprehensive overview of Designated Zones for VAT purposes, outlining their criteria, implications for supplies, and how businesses can navigate the associated regulations effectively.

1. Understanding Designated Zones for VAT Purposes

Free Zones, also referred to as Free Trade Zones, are specific geographic areas within the United Arab Emirates (UAE) that provide a distinct set of regulatory, tax, and commercial advantages aimed at encouraging foreign investment and fostering economic diversification. Each Free Zone is managed by its own regulatory authority and the provisions of the UAE Commercial Companies Law do not apply.

As per Article 51(1) of the Executive Regulations, a Designated Zone may be treated as outside the UAE for VAT purposes, while all other Free Zones are treated as being within the mainland UAE and subject to standard VAT provisions.

A Designated Zone can be treated as outside the UAE for VAT purposes, while all other Free Zones that are not designated are treated as being within the mainland UAE, and the normal VAT provisions apply to them.
Criteria for classification as a Designated Zone under Article 51(1) of the Executive Regulations include:

It must be a specific fenced geographic area.
It must have security measures and Customs controls to monitor movement.
It must maintain internal procedures for storing, keeping, and processing goods.
It must comply with Federal Tax Authority (FTA) regulations.

If a Designated Zone fails to meet these conditions or changes its operations, it will be treated as being within the territory of the UAE.

2. VAT Registration for Entities in Designated Zones

Contrary to a potential misconception, businesses within Designated Zones are not exempt from VAT registration if they meet the mandatory registration threshold. As per Article 13 of the Decree Law, any person carrying on a business activity in the UAE and making taxable supplies exceeding the mandatory threshold must register for VAT. 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 apply to register for VAT purposes.
Businesses operating in Designated Zones are considered to be established ‘onshore’ in the UAE for VAT purposes and have a place of residence in the UAE. This means they have the same obligations as non-Designated Zone businesses regarding registration, reporting, and accounting for VAT under the normal rules. They are also eligible to join a tax group (VAT group) if they meet the required conditions.

3. Application of VAT Within Designated Zones

The treatment of VAT within a Designated Zone depends on whether the supply is of services or goods.

a. Supply of Services
Article 51(6) of the Executive Regulations explicitly states that the place of supply of services is considered to be inside the State if the place of supply is in the Designated Zone. This overrides the normal place of supply rule for services, which is generally the place of residence of the supplier. Therefore, in all circumstances, the supply of services within a Designated Zone is treated as being in the UAE, and VAT will apply accordingly. Most services will be liable to VAT at the standard rate, similar to services performed elsewhere in the UAE. However, export of services (supplied to persons resident and located outside the GCC Implementing States) may be zero-rated.
b. Supply of Goods
Article 51 (3), (4), and (5) of the VAT law govern the supply of goods within Designated Zones. Generally, the place of supply for goods follows the location of the goods. However, a supply of goods within a Designated Zone is treated as made outside the UAE and is not subject to UAE VAT, provided certain conditions are met.
The key condition is that the goods supplied within a Designated Zone are not intended to be consumed by the recipient or another person. If the goods are consumed, VAT will be applicable under the normal rules. The term “consumed” should be interpreted broadly to include any utilisation, application, employment, deployment, or exploitation of the goods. However, the resale of purchased goods is not treated as consumption.

Furthermore, there are exceptions where the supply can still be treated as outside the scope of VAT even if the goods are technically “used” by the purchaser:

When the purchased goods are incorporated into, attached to, or otherwise form part of another good located in the same Designated Zone, and that other good is not consumed.
When the purchased goods are used in the production of another good located in the same Designated Zone, and that other good is not consumed. There must be a direct connection between the purchased goods and the production process. For instance, tools and equipment used to manufacture goods generally fall under this exception, whereas a computer used for designing goods is usually not considered to have a direct enough connection.

Examples of VAT Treatment for Supply of Goods within a Designated Zone:

A business buys trading stock for resale within the Designated Zone: Out of scope.
An oil equipment manufacturer buys steel used in the production of equipment, which is then sold: Out of scope.
A manufacturer buys work tools used in manufacturing goods, which are then sold: Out of scope.
A business buys an office computer, food, stationery, and a company car for general business running: Taxable (Within the scope of UAE VAT)
A manufacturer buys a computer to create designs for goods to be manufactured: Taxable (Within the scope of UAE VAT).
An individual buys goods for private purposes: Taxable (Within the scope of UAE VAT).

The supplier bears the responsibility for correctly treating a supply for VAT purposes. Unless satisfied that there is no risk of the goods being used for non-qualifying purposes, suppliers should generally not treat supplies of goods as outside the scope of UAE VAT. A written statement from the recipient confirming that the goods will not be consumed is usually sufficient in arm’s-length transactions. The context of the purchase can also provide clarity on the intended use.

4. Application of VAT – Transfer of Goods Into a Designated Zone

The VAT treatment of transferring goods into a Designated Zone depends on the origin of the goods.

a. Supply of Goods from Outside the UAE to a Designated Zone

Since Designated Zones are treated as outside the UAE for VAT purposes, the supply of goods into a Designated Zone from outside the UAE is considered to take place outside the UAE. Therefore, such supplies are out of scope of UAE VAT.
b. Supply of Goods from Mainland UAE to a Designated Zone
A movement of own goods or a supply of goods from mainland UAE to a Designated Zone is not considered an export of goods from the UAE. Consequently, these movements and supplies are treated as local movements/supplies and are subject to normal VAT rules, meaning they are taxable.
c. Supplies Between Two Designated Zones
A transfer of goods (either a sale or movement of own goods) between two Designated Zones is generally treated as outside the scope of VAT, provided two conditions are met:

The goods, in whole or in part, are not released into circulation, used, or altered in any way during the transfer.
The transfer is undertaken in accordance with the rules for Customs suspension as per the GCC Common Customs Law.

The FTA may require the owner of the goods to provide a financial guarantee for the payment of VAT if the conditions for the movement are not met.

5. Application of VAT – Transfer of Goods From a Designated Zone

The VAT treatment of transferring goods from a Designated Zone depends on the destination.

a. Supply of Goods from a Designated Zone to UAE Mainland
The movement of goods from a Designated Zone into the mainland UAE is treated as an import of goods into the UAE. Therefore, import VAT is payable by the importer. However, VAT registered persons who incurred VAT on the purchase of the same goods within the Designated Zone and are now importing them into the mainland can recover the import VAT in full on their VAT return, irrespective of their normal input tax recovery percentage. This recovery is conditional on the same goods being subject to VAT upon purchase in the Designated Zone and no intervening transactions occurring between the purchase and import. Evidence of VAT incurred on both purchase and import must be retained. Subsequent sales of these imported goods within the mainland may also be subject to VAT.
b. Supplies of Goods from a Designated Zone to Outside UAE
Since Designated Zones are considered outside the UAE for VAT purposes, the supply of goods from a Designated Zone to a destination outside the UAE is treated as taking place outside the UAE. Therefore, such supplies are out of scope of UAE VAT.

6. Special Cases

Certain types of supplies within Designated Zones have specific VAT treatments.
a. Supplies of Water and Energy
Supplies of water and energy are considered supplies of goods. While they might generally be treated as outside the scope of UAE VAT under the rules for goods within Designated Zones, an override applies when water or energy is supplied for consumption (e.g., by a water and electricity authority). In such cases, the place of supply reverts to being within the UAE, and the supply is subject to normal VAT treatment. This override applies even if the water or energy is used in the production of other goods within the Designated Zone. Suppliers of water and energy must charge VAT without needing to distinguish the potential uses. However, supplies of oil, gas, and similar goods traded by businesses within Designated Zones may still be outside the scope of UAE VAT if the necessary conditions for goods are met.
b. Supplies of Real Estate
Supplies of real estate, including the sale and lease, are treated as supplies of goods, with the place of supply being where the real estate is located. Importantly, real estate is not considered consumed when sold or leased within a Designated Zone. Therefore, these supplies are outside the scope of VAT. Consequently, raw materials purchased within a Designated Zone for constructing real estate in the same zone are also outside the scope of VAT, as they are used in the production of another good (the real estate) that is not consumed.
However, services related to real estate (e.g., granting a right to use, licences to occupy) are treated as supplies of services. As the place of supply of all services within a Designated Zone is deemed to be in the UAE, these services related to real estate will be taxable even if supplied within a Designated Zone.

7. Tax Groups (VAT Groups) and Branches

Businesses established in Designated Zones are considered UAE residents for VAT purposes and may form a Tax Group with mainland or other Designated Zone entities, subject to control requirements. While supplies between Tax Group members are disregarded for VAT, the movement of goods from a Designated Zone to the mainland still triggers import VAT.

Similarly, transactions between a head office and its branch (e.g., mainland and Designated Zone) are not treated as supplies. However, goods transferred from a Designated Zone to the mainland are considered imports, and import VAT applies accordingly.

8. VAT Recovery

Businesses operating in Designated Zones are subject to the normal VAT rules for input tax recovery under Article 54 of the VAT Law, which specifies that recoverable Input Tax for any Tax Period includes the total Input Tax paid for Goods and Services used or intended to be used for making any of the following:

Taxable Supplies.
Supplies made outside the UAE that would have been taxable had they been made in the UAE.
Supplies specified in the Executive Regulations of the Decree-Law that are made outside the UAE but would have been exempt had they been made inside the UAE.
Input VAT is fully recoverable if only taxable supplies are made.
Input VAT is not recoverable if only exempt supplies are made.
Proportional recovery applies if both taxable and exempt supplies are made.

9. Identified Designated Zones

A Designated Zone is an area specifically identified as such by a Cabinet Decision. The List of Designated Zones provides a comprehensive list of these zones across various Emirates:

List of Designated Zones:
Emirate of Abu Dhabi: