Is VAT Applicable in Freezone?

The UAE introduced Value Added Tax (VAT) on January 1, 2018, to diversify government revenue and align with global tax standards. The Federal Tax Authority (FTA) administers VAT at a standard rate of 5% and ensures that businesses comply with the law. VAT covers most transactions across the UAE, including mainland companies and free zone businesses.

This raises a common question: “Does VAT apply to free zone operations?” The answer is yes, but VAT for free zone companies in the UAE follows specific rules. The tax treatment depends on whether the business supplies goods or services within the UAE mainland, inside the free zone, or internationally. Understanding these distinctions is essential to avoid penalties and ensure smooth operations.

VAT applies to most supplies of goods and services. Businesses collect VAT from customers on behalf of the government and reclaim VAT paid on business expenses. This system ensures that the tax ultimately falls on the end consumer, not the business. By following these rules carefully, free zone companies can remain fully compliant and avoid legal complications.

This guide clarifies the VAT in the free zone UAE landscape, offering a clear path to compliance and supporting a successful Freezone Business Setup in the UAE.  

Why VAT in Free Zones Causes Confusion?

Free zones are economic areas that attract businesses with incentives such as:

• 100% foreign ownership
• Full profit repatriation
• Customs duty exemptions  

These benefits often lead to the misconception that free zones are entirely exempt from taxes, including VAT. This assumption is incorrect.

VAT and corporate tax in UAE operate under separate systems:

• Corporate Tax: Free zone companies can enjoy a 0% tax rate on qualifying income, subject to certain conditions.
• VAT: Most free zone businesses must comply with VAT rules, unless specific exemptions apply in officially designated zones.

Therefore, setting up a business in a Dubai free zone requires a clear understanding of these distinct tax systems to ensure compliance and optimize operations.

VAT rules for free zones depend on their official classification. The UAE Cabinet and the FTA categorize free zones as either “Designated Zones” or “Non-Designated Free Zones.” Businesses operating in these zones face very different VAT obligations.

Designated Zones

A Designated Zone is a specific, fenced-off free zone that the UAE Cabinet has legally declared. A Designated Zone must meet strict criteria.

• It must have a clearly defined, secured geographic boundary.
• It must enforce customs controls over the movement of goods and people.
• It must have internal regulations that govern the storage and processing of goods within its borders.

The FTA publishes a definitive list of these zones. Prominent examples in Dubai include Jebel Ali Free Zone (JAFZA) and Dubai Airport Free Zone (DAFZA). Businesses must verify their zone’s status on the official list to confirm its classification.

When are Goods/Services Inside Designated Zones VAT-Exempt?

Transactions involving goods within a Designated Zone receive special VAT treatment. This unique treatment comes from the legal perspective that a Designated Zone is outside the UAE for VAT purposes.

• Movement of Goods: The transfer of goods from one Designated Zone to another is not subject to VAT. This treatment is often referred to as being “outside the scope of VAT.”
• Imports: Companies do not pay VAT on goods imported from outside the UAE directly into a Designated Zone. This applies as long as the goods remain within the zone.
• Exports: Exports of goods from a Designated Zone to a location outside the UAE are zero-rated. A zero-rated supply means the business charges 0% VAT but can still reclaim the input tax it paid.
• Services in the Zone: Services provided within a Designated Zone are not exempt. Companies must charge 5% VAT on these services.

Non-Designated Free Zones

Any free zone that does not appear on the official Cabinet-approved list is a Non-Designated Free Zone. These zones do not have the same special VAT treatment as Designated Zones. Standard UAE VAT rules apply to businesses in these zones, just as they do on the mainland.

• 5% VAT on Supplies: Businesses in Non-Designated Free Zones must charge 5% VAT on most goods and services they supply.
• Mainland Transactions: A transaction between a Non-Designated Free Zone company and a mainland company is a standard domestic supply. VAT applies at the standard 5% rate.
• Inter-Zone Transactions: Sales between Non-Designated Free Zones, or from a Non-Designated to a Designated Zone, are also subject to standard VAT rules.

Key Distinctions and Examples of Freezones

Understanding the difference between zones is critical for compliance. Here is a simple table to illustrate the different freezone VAT implications in the UAE.

VAT rules can vary significantly based on the type of transaction and the parties involved.

Moving Goods Into/Out of Free Zones

This is one of the most common and complex areas for VAT for free zone companies in the UAE.

• Imports from Abroad: When a company imports goods from a foreign country directly into a Designated Zone, it generally does not pay VAT. However, if that company moves the goods from the Designated Zone to the mainland, the transaction is a “deemed import,” and import VAT becomes payable. For Non-Designated Free Zones, import VAT is due at the point of entry into the UAE.
• Sales to Mainland UAE: A supply of goods from a free zone to a mainland customer is a domestic supply. The free zone company must charge and collect 5% VAT from its mainland customers.
• Exports Outside UAE: Businesses exporting goods from any UAE free zone (Designated or Non-Designated) can apply a zero-rate on the supply. The business must hold the required customs and export documentation as proof.

Services Provided Under Freezones

VAT on services often depends on the recipient’s location, rather than the service provider’s.

• Services within a Free Zone: A company supplying services to another company within the same free zone must charge 5% VAT. This applies to both Designated and Non-Designated Free Zones.
• Cross-Border Services: A free zone company can zero-rate a service supply if the service recipient is a non-resident of the UAE. The company must obtain specific evidence to prove this.
• Digital Services (2025 Updates): The FTA has issued new guidance on digital services for 2025. VAT in Dubai Freezone for SaaS, e-learning, and streaming platforms now has clearer rules. Business-to-business (B2B) digital services provided to a UAE-based company are subject to the Reverse Charge Mechanism. The recipient, not the supplier, accounts for the VAT.

VAT Registration in the UAE is mandatory for any business that meets the registration threshold. The location of the business, whether on the mainland or in a free zone, does not change this requirement.

• Mandatory Registration: A business must register for VAT if its annual taxable turnover exceeds AED 375,000. This includes both taxable supplies and imports.
• Voluntary Registration: Companies can voluntarily register if their taxable turnover or expenses exceed AED 187,500. This is a strategic move for many businesses, as it allows them to reclaim input VAT.

Compliance duties remain the same for free zone and mainland companies. They must:

• Issue VAT-compliant tax invoices.
• File VAT returns with the FTA on a regular basis (quarterly for most).
• Maintain all business records for a minimum of five years.

These concepts are often confused, but are fundamentally different.

• Zero-Rated Supplies: The tax rate is 0%. A business charges no VAT to the customer but can still recover the input tax on related expenses. This category applies to exports, international transportation, and certain education and healthcare services.
• Exempt Supplies: These supplies are not subject to VAT. A business cannot charge VAT to the customer, and also cannot recover any input tax. Examples include residential property leases and certain financial services.

For a business with VAT for free zone companies in the UAE, exports are a key zero-rated category. This applies whether the company is in a Designated Zone or not.

VAT-registered businesses that make zero-rated supplies often have more reclaimable input tax than output tax. In this situation, they can apply for a VAT refund.

• Eligibility: A business with a net VAT credit (more input tax than output tax) can submit a refund claim.
• Process: Companies file refund claims through the FTA’s online portal. They must provide supporting documents, such as tax invoices, customs declarations, and proof of export. The FTA typically processes these claims within 20 business days.

The UAE tax landscape continues to mature. Businesses must stay updated to ensure full compliance. Key updates in 2025 include:

• E-Invoicing Mandate: The FTA is moving towards a mandatory e-invoicing system. While a full mandate for all VAT-registered businesses is set for July 2026, the FTA is running pilot programs in late 2025. Businesses should begin preparing their systems for this transition. They must be ready to issue and process invoices in a specific digital format (PINT-UAE).
• Updated Corporate Tax Rules: On September 3, 2025, the UAE Ministry of Finance (MoF) issued Ministerial Decisions No. 229 and 230 of 2025. These decisions clarify how corporate tax rules apply to Free Zone businesses. While a separate tax from VAT, these updates are crucial. They expand the definition of “Qualifying Activities” for the zero-rate Corporate Tax. They also provide clear pricing standards. Businesses in free zones must ensure their activities qualify to benefit from the tax relief.
• Refined Documentation: The FTA has tightened documentation requirements for zero-rating cross-border services. Businesses must provide stronger proof of the recipient’s non-resident status to justify the zero-rate.

VAT is unequivocally applicable in the UAE free zones. The key to successful compliance lies in understanding the distinction between Designated and Non-Designated Zones. Businesses must proactively assess their operations, register for VAT if required, and maintain meticulous records. 

By staying informed on recent changes and adhering to FTA guidelines, companies in free zones can ensure compliance and maximize their tax efficiency. This careful approach is essential for any successful Free Zone Business Setup in the UAE.