FTA publishes guide on the VAT treatment of Designated Zones

The United Arab Emirates (UAE) Federal Tax Authority (FTA) has published a guide on the Value Added Tax (VAT) treatment of Designated Zones. The issuance of this guide is important as it provides much more clarity on how to apply VAT to transactions with businesses established in Designated Zones, which has been a major area of concern for businesses since the introduction of VAT in the UAE.

What are Designated Zones?

Designated Zones are areas specified by the UAE Cabinet as being outside the state for the purposes of VAT in certain limited cases. It is important to note that not all Free Zones are automatically considered Designated Zones and not all Designated Zones will necessarily comply with the requirements for concessionary treatment in every case.

The guide sets out the specific criteria for Designated Zones to be treated outside the UAE for VAT purposes, such as required security measures and internal procedures. Only areas which meet all the requirements are treated as Designated Zones.

As per Article 51(9) of Cabinet Decision No. (52) of 2017 on the Executive Regulations of the Federal Decree-Law No (8) of 2017 on Value Added Tax, taxable persons which are established, registered, or have a place of residence within a Designated Zone are considered to have a place of residence in the UAE for VAT purposes. Thus, a business operating in a Designated Zone will be in the UAE for VAT purposes, while some of its supplies will be outside the scope of UAE VAT.

The VAT rules which apply to Designated Zone transactions are complex. It is critical that businesses within a Designated Zone, or which transact with businesses within Designated Zones, are fully aware of these rules and are in a position to comply with them.

General rules for Designated Zones

Supply of services

If the place of supply of a service is in a Designated Zone, it is treated as if the place of supply is in the mainland (i.e. in the UAE). Essentially, this means that no special rules exist to allow concessional treatment for the supply of services in Designated Zones, and they will be taxed according to the regular VAT rules applicable to them.

Supply of goods within a Designated Zone

A supply of goods made within a Designated Zone (i.e. where both the supplier and consumer are in the Designated Zone) will generally be out of scope of VAT.

However, an exception exists where the supply is to be consumed within the Designated Zone. In this case, the place of supply will be the mainland and regular VAT rules will apply. The concept of what is ‘consumed’ is going to be an important one, and is subject to interpretation, so is one where taxpayers need to be particularly careful. Further conditions and criteria for these situations are detailed in the guide.

Transfers of goods into a Designated Zone

The following general rules apply to transfers of goods into a Designated Zone:

• From outside the UAE into a Designated Zone: out of scope of UAE VAT, as the supply is considered to be moving from outside the UAE to outside the UAE.
• From the mainland UAE to a Designated Zone: treated as a local movement/supply and taxed as such, and not considered an export from the UAE.
• Transfer of goods between Designated Zones: treated as out of scope of UAE VAT, as long as the goods are not released into circulation, used, or altered in any way during the transfer between the Designated Zones, and the transfer is undertaken in accordance with the rules for Customs suspension per the GCC Common Customs Law.

Import of goods from Designated Zones

A movement of goods from a Designated Zone to the mainland is considered an import of goods into the UAE, and is thus taxed as an import.

Tax groups

Because the place of residence of businesses established in Designated Zones is the UAE, businesses in Designated Zones can form a tax group with mainland companies or other Designated Zone companies. The regular rules for tax grouping will apply to these arrangements. This is an area where we foresee that there is considerable potential for risk if not dealt with appropriately.

Potential complexities and action to take

There are many complexities and exceptions which apply to transactions with or among businesses established within Designated Zones. Only a few of these have been identified above. Taxable persons should be aware that the general rules described above apply only if certain conditions are satisfied, and in other cases, the mainland VAT rules may apply. For example, specific rules apply to supplies of water and energy, and supplies of real estate and these should be adhered to carefully.

For businesses newly entering into transactions with entities in Designated Zones, operations should be reviewed immediately to identify potential impacts of these new transactions. This may mean that you should review the transaction mapping to ensure the correct VAT treatment is applied.

Deloitte is well placed to provide guidance on these rules, and we have extensive experience in advising businesses which are established in or transact with businesses in Designated Zones.