The United Arab Emirates and the Kingdom of Saudi Arabia were the only GCC states that have implemented Value Added Tax (VAT) with effect of 1 January 2018 as per the Unified GCC VAT Agreement from December 2015. The Implementation of VAT has been especially challenging in the UAE with regard to the treatment of free zones, some of which – so-called Designated Zones – are subject to special rules. This briefing gives an overview of practical cases of VAT application in Designated Zones.
Introduction / Legal Framework
While the legal framework for implementing VAT in the UAE has been gradually prepared for the past one and a half years, the relevant provisions regarding its application in free zones were only published in December 2017 (the Executive Regulations on
VAT Law, Cabinet Decision 52/2017, “ER”) and January 2018 (Cabinet Decision 59/2017 on Designated Zones) both of which came into effect on 1 January 2018. The following timeline shows the sequence of implementation of relevant tax legislation:
As a general rule, free zone companies are not excluded from the application of VAT in the UAE. However, certain specific rules apply if a free zone is classified as a Designated Zone. Prerequisites in order for free zones to be classified accordingly are a fenced geographical area with security measures and customs controls to monitor entry and exit of individuals and goods.
Since the Cabinet Decision 59/2017 on Designated Zones was only published on 11 January 2018, free zone companies registered in Designated Zones were facing a situation where VAT had already been introduced while the details with regard to its application in Designated Zones were unclear. This has now been clarified. Cabinet Decision 59/2017 declares the following free zones as Designated Zones:
Emirate: Designated Zone
It is important to understand that free zone companies are treated as “regular” mainland companies unless the respective free zone has been qualified as a so-called Designated Zone. Furthermore, it should be noted that a registration with the Federal Tax Authority is required (if the company reaches the respective turnover thresholds), irrespective of whether the company is in a free zone or Designated Zone. The main principles applied to Designated Zones are as follows:
In general, a Designated Zone will be considered as being outside the UAE (Article 51 para. 1 Cabinet Decision No. 52/2017). Therefore, specific rules apply when goods are transferred between Designated Zones. Those rules follow the Customs rules and require a financial guarantee to be given (Article 51 para. 3). On goods transferred from one Designated Zone to another Designated Zone no VAT is applicable.
Furthermore, when assessing VAT implications on Designated Zones, it is crucial to distinguish between goods and services.
If services are being rendered within a Designated Zone, standard VAT rate has to be applied – irrespective of the recipient (individual or company, Article 51 para. 6) The same applies if a free zone entity registered in a Designated Zone renders services in the mainland (whereby limitations of free zone licenses should, of course, be observed).
If goods are sold from an entity registered in a Designated Zone, three different cases have to be distinguished:
- No VAT is applicable if a good is sold to another company registered in a Designated Zone since the territory of the Designated Zone is considered as being outside the UAE (Art. 51 para. 1 – see above).
- If goods are sold from an entity registered in a Designated Zone to an individual, VAT is applicable.
- If goods are sold from an entity registered in a Designated Zone to a company registered in the mainland, VAT is applicable, however, the buyer is liable to account for VAT (reverse-charge-mechanism).
While the Cabinet Decisions 52/2017 and 59/2017 have finally clarified some major questions surrounding the application of VAT in free zones and especially in Designated Zones, some details remain open to interpretation. For example, it is not clear how cases of mixed supply of goods and services will be treated. This will likely depend on the application of said Cabinet Decisions by the Federal Tax Authority.
Companies registered in a Designated Zone and companies and individuals dealing with Designated Zone-companies should be aware of the details with regard to supplies (whether of services or goods) made by or to companies in Designated Zones. As is often the case with legal and tax matters, seemingly small distinctions can have a big impact on the end result.
SCHLÜTER GRAF Legal Consultants
Dubai / UAE
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Andrés Ring (email@example.com)
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