If you are curious or concerned about Value Added Tax (VAT) VAT treatment for your free zone company, then consider the following two facts:
- Some UAE free zones are called “designated zones,” and from a tax point of view, they are considered outside the country.
- However, some companies in designated zones may still need to register for VAT, collect and pay tax, and comply with VAT regulations.
Are you confused? Many people are! So, we researched extensively on VAT regulations for free zones/designated zones and found the simple and easy rules that will help you zero-in on the compliance rules for your business.
In this guide, we will give you a simple formula to determine whether your company will need to register for VAT. Moreover, we will break down the rules and examine them from all possible compliance angles.
Table of Content
- Chapter 1: The difference between a designated zone and a free zone in the UAE
- Chapter 2: Key VAT concepts every business manager should be savvy about
- Chapter 3: What does being in a Designated Zone mean, VAT wise?
- Chapter 4: Buying and selling services
- Chapter 5: Buying and selling goods within designated zones
- Chapter 6: Buying goods from and selling goods to mainland companies
- Chapter 7: Buying goods from and selling goods to companies outside the UAE
- Chapter 8: How to determine if your company should register for VAT
- Final Thoughts
Chapter 1: The difference between a designated zone and a free zone in the UAE
If you are wondering what the difference is between a free zone and a designated zone, then here is the simple answer:
All designated zones are free zones but not all free zones are designated zones.
What is the difference between a VAT designated and free zone
Now, of the 45 free zones in the UAE, here’s a list of the 20 designated zones:
These free zones became designated zones by the UAE Cabinet Decision no. 59 issued in December 2017.
What should you do if you are in a free zone and not in a designated zone? Simple – just follow through the VAT rules applicable to mainland companies in the UAE.
If you are in a designated zone, then read the rest of this post.
Designated zone vs. Free zone: Key distinguishers
Now the real question is, what makes a designated zone different from a free zone?
According to the regulations, a free zone maybe called a designated zone if it fulfils these conditions:
- it’s a fenced geographic zone
- it has security and custom controls in place to monitor the movement of goods from the area as well as the entry and exit of individuals
- it must have internal procedures with respect to keeping, storing, and processing of the goods
- the operator these designated zones must comply with the regulations outlined by the Federal Tax Authority (FTA)
Chapter 2: Key VAT concepts every business manager should be savvy about
Don’t worry, this is not going to be complicated and boring: we have just curated and deconstructed some industry concepts and jargon to make VAT compliance easier for you.
After all, as a business leader you need to have all the important bits at your fingertips to streamline the compliance process.
Ready to get started?
Many business people think of supplies as general purpose consumables such as stationary.
But, in the context of VAT, “supplies” are either a) the goods and services that you sell to customers or b) goods and services you purchase in order to provide your own goods or services.
For instance, if you produce windows, then your supplies are “windows.” The purchases you may need to produce your supplies, such as glass panes and wood panels are also called supplies.
So, the next time you hear the word “supplies” in the context of VAT, just mentally replace them with “goods and services.”
Input and Output VAT
It’s super easy to understand how VAT works.
When you provide your goods and services (or supplies) as a business owner, you will need to collect tax, whose rate depends on the type of the supplies. This is known as output VAT.
Now, when you purchase goods or services to produce your goods and services, you’ll need to cough up tax to pay your suppliers. This is known as input VAT.
This tax collection has to account for something right?
So, at regular intervals, you’ll have to determine the tax you owe to the government, or your due tax.
Tax due = output tax – input tax
This would ideally be an outgoing amount, but if you’re one of those lucky business entities who collect less than they pay in taxes, you’re eligible for a tax credit.
You will need to know what tax category your supplies fall under in order to determine the applicable tax rate.
There are three tax categories
- Exempt: No VAT is applicable
- Zero rate: VAT is applicable, but at the rate of 0%
- Standard rate: Standard VAT is applicable (currently 5%)
This diagram shows which supplies fall under the zero-rated and exempt categories. Everything else is standard rated.
Check out this FTA issued document for more information about zero-rated and exempt supplies.
Now, you must be stumped why “exempt” and “zero rate” are separate categories since their net cash effect is zero.
While they may appear to be the same to the less seasoned, there are two key differences.
First, Input tax and output tax
Do you remember how we calculated due tax with this formula?
Tax due = output tax – input tax
In the case of zero-rated supplies, the output tax (the tax you collect from your customers) is zero. On the other hand, input tax (the tax you pay to your suppliers) may not be zero. You can claim back the input tax related to zero-rated supplies. However, you cannot claim back the input tax you paid to provide tax exempt supplies.
Let’s clear this up with a couple of examples.
For example, let’s assume you export garments that you buy from local suppliers. Exports are zero-rated, so no VAT will collected from your customers. However, you can claim the VAT you pay your suppliers.
On the other hand, if you sell life insurance (which is VAT exempt) then you cannot claim back the taxes you pay to provide such services, such as rent and office supplies.
The second difference between zero-rated and exempt supplies deals with registration threshold. Zero-rated supplies are part of your registration threshold (will explain in depth in Chapter 9) whereas tax exempt supplies don’t count.
Mainland (The State)
This is a straightforward concept but we wanted to mention it anyway. Basically, any company registered in the UAE and not in a designated zone is a mainland company.
Federal Tax Authority (FTA)
FTA is the government authority responsible for managing all taxation activities in the UAE. Needless to say, you will interact with the FTA for all your taxation-related exchanges. Thankfully, most of FTA’s services can be availed electronically (www.tax.gov.ae), including registration and filing.
Chapter 3: What does being in a Designated Zone mean, VAT wise?
The law states that designated zones are treated as being outside the tax law (but with some deviations).
A great way to stop getting anxious over these complications is to treat your company like any other UAE-based company but with few exceptions.
To help you sort out the rules and exceptions, we’ve gone ahead done the research so you don’t have to.
Essentially, we’re about to
- Help you break down the exceptions that apply to designated zone companies
- Highlight scenarios that call for VAT compliance for companies in designated zones (both sales and purchases)
- Walk you through formulae and conditions for determining whether you should register and therefore comply with VAT regulations.
Essentially, for each sale and purchase transaction, your VAT status will be one of the following:
- Out of scope: You don’t have to account for VAT at all as these transactions are out of scope of the UAE VAT laws.
- zero-rated: You’ll have to account for 0% VAT on supplies and ensure this reflects in your invoices. Pay attention to this one because an important factor in determining whether you should register for VAT.
- Taxable: You’ll have to pay and collect the applicable tax rate (either standard or zero-rated).
We understand that the sheer number of scenarios are frankly quite a lot and wrapping your head around each can get confusing.
However, for the best results, we suggest you keep it simple and break down your comprehension process in the following way:
- First determine the kind of transactions (buying or selling activities) your business does.
- Next, navigate to the specific chapter in this guide and check out the relevant scenarios.
- Lastly, just move on to the registration section to see if you meet the parameters.
Chapter 4: Buying and selling services
In this section, we’ll detail VAT collection and payment if your business is a services provider rather than a product seller or manufacturer. Let’s get all your doubts clarified, shall we?
Buying and selling services: Transactions with businesses within the UAE
You should know that services receive no special treatment in terms of VAT even within the designated zones.
This means that if you’re buying or selling services within the UAE (either in the designated zone or to mainland companies) you’ll have to both collect as well as pay VAT.
Essentially, the invoice by the service provider (either you or a company you’re buying services from) should reflect the VAT rate.
Let’s take a couple of examples to make this clearer.
For instance, if you’re buying health insurance from an insurer in the designated zone or mainland, expect the service provider (in this case, the insurer) to charge you the standard VAT amount.
Now, if you’re selling management consulting services to a designated zone or mainland company, you’re required to charge VAT for your services, which must reflect on the invoice (provided you’ve registered for VAT, which we’ll cover in Chapter 8).
Buying and selling services: Transactions with businesses outside the UAE
If you are exporting services to businesses outside the UAE, then the VAT applicable is zero percent (zero-rated supplies).
What about the services you purchase from companies outside the UAE?
Well, almost similar rules apply
If the service takes place in the designated zone, then it is considered as imported service, and you will have to account for the applicable VAT rate. If the service takes place outside the UAE, then the purchase is out of the scope of VAT.
But wait, are we saying that if you purchase a service from a foreign company you should account for VAT? Now how can that happen if the foreign company is not registered for VAT?
There is an accounting mechanism to account for imported services where the service provider, or the goods seller, is outside the country. It is called “reverse charge.” We aren’t getting into details here, but your accountant or tax agent will definitely know about it. The main point here is that imported services are taxable.
Chapter 5: Buying and selling goods within designated zones
According to FTA regulations, companies in the designated zone are outside the UAE for taxation purposes.
This means, as a rule of thumb, goods traded between designated zone companies are not within the purview of UAE tax regulations. Basically, you don’t have to account for VAT in such cases.
But wait —there’s a catch: You have to consider the consumption factor.
The consumption factor here is a game changer. If goods sold within a certain zone are consumed within that zone, then the seller will have to charge the applicable VAT rate for the good.
However, if the goods will be “incorporated into, attached to or otherwise form part of or will be used in the production or sale of another good located in the same designated zone which itself is not consumed” then taxing them is out of scope of the set regulations. Simply, no VAT.
Let’s look at how VAT may be applicable for two businesses, both in the designated zones, based on the consumption of goods they produce.
Big Timber Co. FZE sells wood to Great Furniture Co. FZE for producing furniture which the latter will export or send over to their mainland distributor.
Note, two things happen here: Big Timber Co. FZE’s goods form a part of Great Furniture Co. FZE’s production process and the final goods are not consumed within the designated zone.
This means both companies have no tax implications for their transactions.
Tasty Sandwich Cafeteria operates within a designated zone and sells sandwiches and soft drinks to its patrons who consume it within the designated zone.
This means Tasty Sandwich Cafeteria should charge and collect VAT from their paying customers.
Here’s a quick recap of what we just discussed:
- VAT is out of scope if the goods produced are not consumed within a designated zone or form a part of the production process of goods which finally wouldn’t be consumed within the designated zone.
- Standard VAT rates are applicable if goods produced by a business in the designated zone are consumed within that designated zone.
Chapter 6: Buying goods from and selling goods to mainland companies
What the VAT implication of supplying good and services from a designated zone to mainland companies?
Now that we have VAT for goods and services sorted with respect to the designated zones, let’s look at VAT specifications when dealing with mainland companies.
Sourcing goods from mainland companies
If your business buys goods from a mainland company, you’re likely to be charged the standard VAT rate on most goods (5%).
For example, if you have a restaurant in the designated zone and source your food stuff from a mainland company, expect to pay the standard VAT rate.
Now, if you’re operating in the designated zone and your consumers are buying your food in that zone, you can recover this VAT from them.
Selling goods to mainland companies
When you sell goods to a mainland company, your transaction is counted as an export and the mainland company thus becomes the importer. You are not expected to account for VAT in your invoice and the burden of tax in this case falls on the “importer of record,” who pays both the VAT as well as custom duties.
For example, when Great Furniture Co. FZE sell chairs from their designated zone to their mainland distributor Nice Furniture importer LLC, they will issue an invoice without VAT as Nice Furniture importer LLC in this case is the importer and responsible for paying VAT.
Chapter 7: Buying goods from and selling goods to companies outside the UAE
What the VAT implication of supplying goods and services services from a designated zone company to a foreign company?
Although the movement of goods from the mainland to a designated zone will attract VAT, getting goods from companies outside the UAE to designated zones is outside the scope of VAT.
However, there’s one catch — if imported goods are consumed within the designated zones will be considered as imports and abide by tax regulations applicable for imports.
Again, goods exported outside the UAE from a designated zone are out of scope of VAT. Now, this also implies you can’t claim VAT on these goods if they were purchased from the mainland.
Chapter 8: How to determine if your company should register for VAT
How to determine if your company designated zone should register for VAT?
This is what was playing all along in your mind, isn’t it? Follow these steps:
Step 1: Make a list of the types of sales and purchases of goods or services your company made over the past 12 months
Step 2: Remove all sales and purchases that qualify as exempt supplies
Read Chapter 2 to find out what supplies (goods and services) are VAT exempt. Next, compare your lists to the types of transactions described in chapters 4-7 to determine if they are out of scope.
Step 3: Add up your sales over the past 12 months from the following
- Sales of standard-rated goods and services
- Sales of zero-rated goods and services
The total will give you your taxable sales.
Step 4: Find the total value of your import of standard-rated and zero-rated goods and services over the past 12 months.
Step 5: Add the value of sales and imports from Step 3 and Step 4.
This should give you your “taxable turnover.”
Step #6: Compare your taxable turnover against the registration threshold.
- If your “taxable turnover” exceeds 375,000 dirhams over the past 12 month period then you have to register.
- If it falls between 187,500 and 375,000 dirhams a year, then you can register voluntarily.
- If it’s less than 187,500, then you cannot register.
Great Garment Importer Exporter FZE imports garments from Thailand and exports them to Nigeria. In this case, since both import and export are out of the scope of VAT regulations, the company doesn’t have to account for VAT and doesn’t have to register for VAT compliance.
Tasty Food Restaurant FZE buys raw materials from a mainland supplier and sells food and beverage to customers within the designated zone. Now, if Tasty Food Restaurant FZE’s annual turnover is greater than Dh375,000, they will have to prepare for VAT compliance.
The most important question for business owners and managers of companies operating in designated zones is whether or not VAT regulations applies to their companies.
To determine whether you need to register, first you should analyse your business transactions, determine which taxable turnover are taxable, then check if you have crossed the registration threshold. If you do, then they go ahead and register to abide by VAT regulations.
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