VAT Rules for Free Zone Companies in UAE: The Definitive 2026 Guide
The UAE Freezones are the primary driver of international trade by offering 100% foreign ownership and special regulatory environments. But with the introduction of Value Added Tax (VAT) in 2018, a more complex legal framework. In 2026, the Federal Tax Authority has increased their focus on compliance, and now it is vital for the Free Zone entities to distinguish between "Designated" and "Non-Designated" zones.
A common misunderstanding among business owners is that a Free Zone license offers a "tax-free" pass for VAT. But in reality, some of the transactions are fall under the Out of Scope category. However, the majority of service-based transactions and mainland-focused activities are subject to standard-rated VAT rules. This blog details the applicability of VAT for free zone companies in the UAE, explaining the rules, the nuances of Designated zones, and the compliance requirements.
1. The Core Distinction: Designated Zones vs. Non-Designated Zones
The most crucial factor while determining the VAT applicability is the correct classification of your Free Zone. FTA divided Free Zones into two distinct categories for VAT purposes.
Designated Zones (The "Out-of-Scope" Areas)
A Designated Zone (DZ) is a specific area of Free Zone that is bounded by its own customs controls and security procedures. Under Cabinet Decision No. (59) of 2017, these zones are considered "outside the UAE" for VAT on goods.
· Key Benefit: The movement of goods within a DZ or between two DZs is generally considered out-of-scope for UAE VAT, provided the goods are not consumed or used.
· Examples: Jebel Ali Free Zone (JAFZA), Dubai Airport Free Zone (DAFZA), and Khalifa Port Free Trade Zone.
Non-Designated Free Zones
If your Free Zone is not listed on the official FTA "Designated Zone" list, then it is treated as a Non-Designated freezone, and VAT will be applicable exactly as in the UAE Mainland
· VAT Applicability: All supplies of goods and provision of services will fall under the standard 5% VAT rate.
· Examples: Dubai Media City, DMCC (non-fenced areas) and many other northern emirate free zones.
2. VAT Treatment of Goods: The "Fenced" Logic
In 2026, in order to get the tax advantages as designated Zones, the primary area to focus on is the movement of goods. The logic behind this is very simple: as long as goods stay within the "fenced" customs-controlled area, VAT will be out of scope.
· Import into a DZ: When goods are imported from outside the UAE directly into a Designated Zone, no VAT is applicable at the point of entry
· Transfers Between DZs: Where the goods are moving from JAFZA to DAFZA is VAT-free, provided the goods do not reach the mainland and are transported under conditions prescribed by the customs.
· Supply to Mainland: When goods move from a DZ to a mainland customer (e.g, from DAFZA to a warehouse in Al Quoz), it is treated as an Import into UAE. On these transactions, the buyer will be responsible for VAT under the Reverse Charge Mechanism (RCM).
· Supply from Mainland to DZ: This transaction will be treated as a standard-rated local supply. A mainland supplier selling goods to a DZ company must charge VAT at 5%.
3. The Service Trap: Why Services Are Different
One of the most frequent compliance errors assumed by the business owners is that for services, VAT is not applicable under Designated Zone status. But in reality It is not.
Under UAE VAT law, the place of supply for services is always considered as within the UAE, irrespective of whether the provider is in a Designated Zone or on the mainland.
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Services Within a Designated Zone:
When a company established in a Designated Zone, such as DAFZA, provides IT services to another company located in a different Designated Zone, such as JAFZA, the standard VAT rate of 5% generally applies to the service provided. -
Services from a Designated Zone to the Mainland:
If a management consultancy firm based in a Designated Zone supplies services to a mainland business, the transaction is typically subject to the standard VAT rate of 5%. -
Services Supplied Overseas:
Services provided to customers outside the UAE are commonly treated as zero-rated, meaning VAT is applied at 0%, subject to meeting the required conditions for export of services.
Please note that the recipient is truly outside the UAE and the other conditions of Article 31 of the Executive Regulations are met.
Important Note: Supply of water and energy (electricity DEWA) within a Designated Zone is treated as a supply of services and always attracts VAT at 5%.
4. Free Zone VAT Registration UAE: Thresholds and Deadlines
Whether you are registered in a Designated or Non-Designated freezone, the thresholds for VAT registration remain the same as those applicable for mainland businesses.
· Mandatory Registration: under this, you need to register for VAT if your taxable supplies and imports exceed AED 375,000 in the last 12 months or are expected to exceed in the next 30 days.
· Voluntary Registration: Possible to go for registration if taxable supplies or taxable expenses exceed AED 187,500.
Is VAT applicable in Dubai free zones for startups?
Yes. Even if you have no revenue, you can voluntarily register for VAT once your taxable expenses (incorporation costs, legal fees and equipment) cross AED 187,500. This enables you to reclaim the 5% VAT you’ve paid to suppliers, which can significantly boost your initial cash flow.
5. Compliance Checklist for Free Zone Companies
To stay compliant with VAT Laws for free zone companies, your business must focus on managing the following requirements
1. Verify Zone Status: Regularly keep an eye on the updated FTA list of freezone zones to see if your zone’s status as “ Designated” has changed or not.
2. Separate Goods and Services: Ensure that your accounting system can correctly distinguish between the sale of goods (which may be out-of-scope) and services (which are taxable).
3. Customs Documentation: For transactions between DZ’s, maintain all customs declarations and transport documents. The FTA may categorize the transaction as taxable at 5% in the absence of adequate proof of movement
4. Invoicing: Always ensure to issue invoices as per the provisions of VAT law. For zero-rated or out-of-scope supplies, the invoice must clearly state the reason for the tax treatment (e.g., "Export of services" or "Intra-DZ supply of goods").
5. Reverse Charge Accounting: If you are importing services or goods from outside the UAE, ensure that you are reporting for VAT correctly on the return under the RCM columns.
6. How Flying Colour Tax Consultant Can Help
At Flying Colour Tax Consultant, we ensure your Free Zone entity operates in compliance with the VAT laws and optimise tax efficiency.
Our specialised services include:
· VAT Health Checks for Free Zones: We deeply analyse your accounting records to ensure that you are correctly distinguishing between goods and services and applying the right tax rates.
· Designated Zone Advisory: We provide expert advisory on the complex documentation required for transfers within the DZ’s and exports, thereby minimising your risk of audit flags.
· FTA Registration & EmaraTax Management: We will assist with your mandatory or voluntary VAT registration, with your detailed business flowchart and financial data to avoid rejection or resubmission.
· Bookkeeping & Return Filing: Our accountants provide FTA-compliant bookkeeping, ensuring every VAT return is accurate and filed well before the deadline.
· VAT Grouping Strategy: We help in grouping multiple Free Zone and mainland entities of the same business owners under a single TRN, This will simplify your reporting and eliminate VAT on inter-company transactions.
Frequently Asked Questions (FAQs)
1. Is my company in a "Designated Zone" automatically exempt from VAT?
No. Exemption is only applicable to specific supplies of goods within the designated zone. All services provided within the zone and all sales of goods to UAE mainland are subject to VAT at 5%. You should register for VAT upon reaching the thresholds.
2. Do I need to charge VAT if I provide services from a Free Zone to a mainland company?
Yes. Services provided from a freezone entity to mainland UAE entities are always attract 5% VAT. The only exception on the above is the export of services is (services provided to a recipient outside the UAE).
3. Can a Free Zone company recover VAT paid on business expenses?
Yes, if the company is VAT-registered. You can reclaim "Input VAT" paid on business expenses like rent, utilities and professional fees, as long as they are used to make taxable supplies (at 5% or 0%).
4. What are the penalties for late VAT registration for a Free Zone entity?
The FTA imposes a fixed administrative penalty of AED 10,000 for late VAT registration. In 2026, the FTA has also strengthened its power to deny input tax claims if documentation is not maintained according to the new standards.
5. How has the 2026 RCM update affected Free Zone businesses?
From January 2026 onwards, you are not required to create "self-invoices" for imports. However, you must be more vigilant with VAT compliance for free zone companies by keeping records for all vendor invoices and customs declarations digitally to substantiate your Reverse Charge entries on the tax return.
To learn more about VAT Rules for Free Zone Companies in UAE, book a free consultation with one of the Flyingcolour team advisors.
Disclaimer: The information provided in this blog is based on our understanding of current tax laws and regulations. It is intended for general informational purposes only and does not constitute professional tax advice, consultation, or representation. The author and publisher are not responsible for any errors or omissions, or for any actions taken based on the information contained in this blog.