UAE Free Zones and Designated Zones: Corporate Tax, VAT and Excise Tax Explained

UAE Free Zones & Designated Zones: Tax Rules Explained

In the UAE, there are a large number of free zones that offer businesses various commercial and operational benefits. However, being licensed in a UAE free zone does not mean that a business automatically gets the same tax treatment for Corporate Tax, VAT and Excise Tax.

One of the important points to take care of by businesses is that the definition of a Free Zone or Designated Zone can differ depending on the applicable tax law. For example, a location that qualifies as a Designated Zone under VAT may not automatically qualify as a Designated Zone for Corporate Tax purposes.

It is therefore required for businesses to check their status separately under each relevant tax law. The Federal Tax Authority (FTA) has issued a Public Clarification detailing these differences and the requirements businesses should consider while determining the applicability of Corporate Tax, VAT and Excise Tax laws.

This blog explains the key differences and what businesses operating in UAE free zones should consider.

What Is a Free Zone or Designated Zone?

The terms Free Zone and Designated Zone are not interchangeable for all UAE tax purposes.

The relevant classification includes:

• Free Zone for purposes of corporate tax
• Designated Zone for Corporate Tax
• Designated Zone for Excise Tax
• Designated Zone for VAT

This classification is particularly important for businesses that are relying on the 0% Corporate Tax benefits as Qualifying Free Zone Persons (QFZPs) or businesses that use Designated Zones for VAT or Excise Tax purposes.

Free Zone for UAE Corporate Tax

For Corporate Tax purposes, a Free Zone is a designated and defined geographical area in the UAE specified by a cabinet decision.

A VAT Designated Zone Is Not Automatically a Corporate Tax Designated Zone

It is not possible for a business to assume that its free zone is on the VAT Designated Zone list; it automatically qualifies as a Designated Zone for Corporate Tax.

For Corporate Tax purposes, the relevant zone should meet the requirements under the Corporate Tax framework as well.

It has been advised by the FTA to businesses to confirm their location and status with the relevant free zone authority.

Why Is the Corporate Tax Free Zone Status Important?

The treatment of Corporate Tax free zones is particularly important for businesses because the Qualifying Free Zone Person (QFZP) can get the benefit of 0% Corporate Tax rate on Qualifying Income, provided the conditions specified under the Corporate Tax Law and relevant Cabinet and Ministerial Decisions are met.

In short, just incorporating a company in a free zone is not enough.

The company must meet the prescribed conditions to qualify as a QFZP and must continue to satisfy those conditions.

Distribution Activities and Designated Zones

One example is the qualifying activity of distribution of goods or materials in or from a Designated Zone.

Although a QFZP must generally be incorporated or registered in a Corporate Tax Free Zone and should operate from a Free Zone, a business conducting the qualifying distribution activity must carry out that activity in or from a Corporate Tax Designated Zone to get the benefit of 0% Corporate tax.

This is a major consideration for free zone companies engaged in distribution, wholesale trading and logistics business.

What Happens If a QFZP Does Not Meet the Conditions?

If a Qualifying Free Zone Person fails to meet the applicable conditions during a Tax Period, the Public Clarification requires that the entity ceases to be a QFZP from the beginning of the relevant Tax Period and for the four subsequent Tax Periods.

For the businesses to maintain their status, they should regularly review:

• Their business activities
• Income source
• Customers and vendors
• Location from which activities are being conducted
• Qualifying and excluded activities
• Supporting documents
• Compliance with QFZP conditions

Designated Zone for Excise Tax Purposes

The Designated Zone concept is also different under Excise Tax.

A designated Zone for excise tax is a specific free zone or geographical area that meets the conditions mentioned under Excise Tax Law and Executive Regulation.

To qualify as a designated Zone for excise tax, the following are the requirements:

• There should be proper security checks restricting the entry and exit of people and the movement of Excise Goods
• Supervision and control of the Customs Department
• There should be a Warehouse Keeper in the fenced free zone

Businesses should confirm their status with the relevant free zone authority.

Designated Zone for UAE VAT

There is again a different treatment for Designated Zone under VAT.

A Designated Zone under VAT is a specific geographical area fenced by customs and included in the List of Designated Zones under Cabinet Decision No. 59 of 2017 and its amendments.

The following are the conditions:

• Should be a geographical area fenced by customs
• Adequate Security measures must be there
• Control measures from customs
• Strict monitoring of entry and exit of people and goods
• Internal measures for keeping, storing and processing goods
• Compliance requirements for the zone operator should align with the procedures established by FTA

How Can a Business Check Whether Its Location Is a VAT Designated Zone?

Businesses cannot simply rely only on the name of the free zone.

As per the FTA clarification, companies should:

1. Review the List of VAT Designated Zones published by the FTA
2. Check the concerned location where the company operates.
3. Confirm with the relevant free zone authority that the applicable conditions under Article 51(1) are satisfied.

This is more important for businesses having warehouses, logistics transactions or goods stored within a free zone.

Corporate Tax vs VAT vs Excise Tax: Why the Difference Matters

Therefore, a business cannot follow a single statement as "We are operating in a free zone, hence we are outside the scope of VAT" or "We are in a designated zone, so we automatically qualify for 0% Corporate Tax."

The relevant tax law must be considered separately.

Practical Example

XYZ Trading LLC operates in a UAE free zone and imports goods for further distribution.

Based on its location, the company assumed that because it is a designated zone for VAT, it automatically qualifies as a Designated Zone for Corporate tax as well.

This assumption may be wrong.

For Corporate Tax purposes, the company should confirm with its free zone authority whether the location qualifies as a Corporate Tax Free Zone and whether it is recognised as a Corporate Tax Designated Zone relevant to its qualifying activity.

For VAT purposes, the company should separately check with FTA the List of Designated Zones for VAT and the applicable conditions.

If the company also deals with excise goods, it should separately check whether the location qualifies as an Excise Tax Designated Zone.

Therefore, the same physical location requires three separate tax analyses.

Common Mistakes UAE Free Zone Businesses Should Avoid

1. Assuming all free zones have the same tax status

Each free zone has different status and treatment under each tax law

2. Assuming VAT Designated Zone status means Corporate Tax Designated Zone status

It is specifically mentioned in the FTA guidelines that a Designated Zone for VAT is not automatically qualify as a Corporate Tax Designated Zone.

3. Assuming free zone incorporation automatically gives 0% Corporate Tax

Not just holding a free zone license makes you eligible for QFZP benefits; eligibility depends on meeting the applicable conditions.

4. Ignoring the location from which activities are conducted

To get the tax benefits for certain qualifying activities, the location of the activity also needs to be considered.

5. Failing to review status after business changes

Moving office locations, changing warehouses, adding new activities or making changes in the nature of transactions may also affect the relevant tax applicability.

What Should UAE Free Zone Businesses Do?

Businesses operating from UAE free zones should follow the below steps:

• Confirm their exact free zone and location.
• Check their free zone status.
• Determine whether the location qualifies as a Designated Zone for Corporate tax or VAT
• For Corporate tax purposes, review their QFZP eligibility and qualifying activities.
• For VAT, check FTA's VAT Designated Zone list.
• Confirm conditions for designated free zones with the relevant free zone authority.
• If dealing with Excise Goods, confirm status with Excise Tax Designated Zone.
• Review contracts, invoices and accounting treatment.
• Maintain evidence supporting the treatment of tax
• Review the tax position whenever there is a change in business activity or location where it is operating.

How Flying Colour Tax Consultant Can Help

Flying Colour Tax Consultant assists UAE businesses with:

• Corporate Tax registration and related compliance
• Complete advisory on QFZP
• VAT registration and compliance
• Tax advisory on VAT Designated Zone
• Excise Tax registration and compliance
• Analysis and review of tax positions
• Support with FTA audit
• Transfer Pricing documentation
• International tax advisory

If you have a business in a UAE free zone and are unsure about the treatment for Corporate Tax, VAT or Excise Tax, a tax review can help you to identify applicable rules and compliance requirements before they become an issue.

Frequently Asked Questions

1. Is every UAE free zone a Corporate Tax Free Zone?

Not all. A Corporate Tax Free Zone is an area specified under the Corporate Tax framework. Businesses should confirm their status with the relevant free zone authority.

2. Is a VAT Designated Zone automatically a Corporate Tax Designated Zone?

No. The FTA specifically clarifies that a Designated Zone for VAT does not automatically qualify as a Corporate Tax Designated Zone. The location must satisfy the relevant conditions as well.

3. Does being incorporated in a free zone automatically mean 0% Corporate Tax?

No. To get the benefit of 0% Corporate tax as a QFZP, a company must satisfy the prescribed conditions.

4. How can a business check whether it is in a VAT Designated Zone?

To check for a VAT designated free zone, the business should review the List of VAT Designated Zones published by FTA and check the applicable conditions with the relevant free zone authority.

5. What is an Excise Tax Designated Zone?

It is a specific free zone or geographical area that satisfies the requirements under Excise Tax Law and Executive Regulation. Requirements includes security measures, customs control and appointment of a Warehouse Keeper.

6. Why should a free zone company check its status under different tax laws?

Because the definitions and conditions for Free Zones and Designated Zones differ between Corporate Tax, VAT and Excise Tax. A business should check  its status separately under each relevant tax law.

To learn more about UAE Free Zones and Designated Zones: Corporate Tax, VAT and Excise Tax Explained, 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.