VAT on Free zones in the UAE

UAE free zones are special economic zones which are free from many official government laws, including the Federal law and the Labour ministry laws. However, some of the laws, including the UAE criminal law are applicable in the free-zone regions. The clarification about the application of the new VAT system in such free zones has not yet been made by the government. The UAE VAT Law, under the article 50 to 52, covers these free zones, and the decision regarding the implementation of VAT in these zones is pending for the fourth quarter of 2017.

The concept of free zones has been very successful and popular in the country. Many new zones are being developed under the same mechanism to promote the growth and digitization in the UAE. These free zones are completely exempted from import and export taxes, income taxes, corporate taxes, etc., and have many other facilities like full repartition of capital and profits.

Since the authorities have not yet made any decision about VAT in these free zones, let’s try to understand how it may affect the economy.

Let’s assume that the free UAE zones are exempt from the VAT. Then, the cost of things will be slightly cheaper in these zones as compared to the normal regions of the country. This will largely impact those areas that are situated on the border or near the border of these free zones. People living near free zones in the UAE might see a difference in the prices of various things due to VAT in the remaining areas of the country.

The most significant effect will be on the prices of valuable entities like commercial properties. People will see a noticeable difference in the price of a property located in the free zone area and a property located just a few meters away in the normal area. This might further promote the growth of the onshore commercial environment.

However, it is being estimated that neither the free zones nor the businesses outside the free zones will be exempt from the VAT. There might be a special tax rate for the businesses situated in these free zones, as compared to the normal VAT rate of 5%. Some specific services and commodities, including duty-free goods, will be VAT free in bonded free zones. A bonded free zone is allowed to hold goods before duties are paid on them.

After the implementation of VAT in the country, many small and medium businesses might face a dip in the cash flow due to increase in tax liability. Although there is a provision of tax refund on inputs, there is no clarity on how long it might take for such refunds to process. Even if some businesses do not see the immediate effect on their cash flows, it will impact everyone sooner or later.

It is normal for refunds to be delayed when a new tax system is launched in a country. The government and the authorities are mostly busy in auditing the returns before they begin the refunding process. This is what delays the release of refunds to the involved businesses, which in turn, affects the cash flow in the market.

While the standard UAE VAT rate of 5% is lower as compared to many other economies in the world, the difference in tax liability within the country, such as special relaxation for businesses in the free zones, will impact the economy.

The new UAE VAT law mentions the concept of designated zones, but it is still not clarified whether the free zones will be kept under these Designated Zones or not. Therefore, it is also not clear how these free zones will be treated after the implementation of VAT in the country. If free zones are kept under designated zones, they will be free of any VAT liability, as designated zones will be not covered under the VAT system. As per the UAE VATLaw, there will be no tax on the transfer of goods from one designated zone to another. However, the government might define some special conditions under which the businesses situated in a designated zone will still be liable to pay VAT.

It is being estimated that more information regarding this might be released by the fourth quarter of this year.