The United Arab Emirates (UAE) has established itself as a leading global hub for trade, logistics, and international business. One of the reasons behind this success is the Free Zone system, which offers businesses incentives like tax benefits, simplified customs procedures, and ease of ownership.
However, when it comes to Value Added Tax (VAT), not all Free Zones are treated the same. The UAE VAT Law introduced the concept of Designated Free Zones (DFZs), which are subject to special rules, particularly in relation to the supply of goods.
In this article, we’ll explain the difference between Free Zones and Designated Free Zones and how VAT applies to goods in each case.
What is a Free Zone?
A Free Zone is a specific economic area within the UAE where businesses enjoy benefits such as:
- 100% foreign ownership.
- Zero customs duties on imports and exports.
- Simplified business setup processes.
From a VAT perspective, Free Zones are generally considered within the UAE VAT system. This means that supplies of goods and services in Free Zones are subject to the standard VAT rules (5% VAT applies, unless an exemption or zero-rating applies).
What is a Designated Free Zone (DFZ)?
A Designated Free Zone is a special category of Free Zones that are treated as outside the UAE for VAT purposes—but only in relation to the supply of goods (not services).
The UAE Cabinet has identified specific Free Zones as DFZs because of their strict customs control and security measures, particularly around goods movement. Examples include major logistics hubs and ports.
VAT Treatment on Goods
Here’s how VAT applies to goods in Free Zones vs Designated Free Zones:
1. Supplies of Goods Within a Free Zone (Non-Designated)
- Treated as supplies within the UAE.
- 5% VAT applies on most transactions, unless zero-rated (e.g., export).
- Businesses registered for VAT can claim input tax credits on eligible purchases.
2. Supplies of Goods Within a Designated Free Zone
- Considered as taking place outside the UAE for VAT purposes.
- No VAT is charged on goods supplied between entities located in the same DFZ.
- Import/export rules apply when goods move into the UAE mainland or outside the UAE.
3. Movement of Goods Between DFZs
- Goods transferred between two different DFZs are also outside the scope of UAE VAT, provided conditions are met (proper documentation, customs supervision).
4. Supplies of Goods from DFZ to Mainland
- When goods leave a DFZ and enter the UAE mainland, they are treated as imports, and VAT becomes payable at customs.
VAT Treatment on Services
It’s important to note that the DFZ special VAT treatment only applies to goods.
- Services provided within a DFZ are treated the same as in the mainland or other Free Zones.
- The standard 5% VAT applies unless an exemption or zero-rating applies (such as international transport services).
Why This Distinction Matters for Businesses
Understanding the difference between Free Zones and Designated Free Zones is crucial for:
Final Thoughts
The UAE’s Free Zones continue to provide excellent opportunities for businesses, but when it comes to VAT, not all Free Zones are equal.
- Free Zones (Non-Designated): Treated as part of the UAE VAT system (5% VAT applies on goods).
- Designated Free Zones: Treated as outside the UAE for VAT purposes on goods, giving businesses tax advantages when trading internationally.
For companies engaged in import/export or trading, setting up in a Designated Free Zone can provide significant VAT benefits—especially when dealing with high-volume goods transactions.