As the value-added tax (VAT) regime comes into effects, an important piece of the puzzle was made public recently, which is the Cabinet’s Decision No. 52 (the “Decision”) on Executive Regulations of the Federal Law-Decree No. (8) on Value Added Tax (the “Tax Law”).

For years now, the concept of free zones has been attracting international companies and home-grown start-ups looking to get a foothold in the country’s burgeoning economy. These zones offer members a plethora of advantages that enables such companies to thrive, including a tax-free environment and 100 per cent foreign ownership.

Although the Decision sheds some light on the VAT treatment for transfer of goods by free zone companies, one piece is still missing, namely the list of free zones to which the Decision and the Tax Law will apply. This is expected to be issued by the Cabinet upon recommendation of the Minister of Finance.

In the Decision, free zones are named “designated zones”. Paragraph 1 of article 51 of the Decision states that designated zones are treated as being outside the UAE and those GCC countries who are signatories of the Common VAT Agreement if such a designated zone:

• is a specific, fenced, geographic area with security measures and custom controls in place to monitor entry and exit of individuals and movement of goods to and from the area;

• has internal procedures regulating how to keep, store and process goods within the area; and

• complies with the procedures set by the Federal Tax Authority.

Notwithstanding the above, paragraph 9 of the very same article 51 of the Decision specifies that companies established and registered in a designated zone are deemed to be resident in the UAE for the purposes of the Tax Law.

It is hard to identify free zones in the UAE that would meet — or be willing — to meet such requirements. Aside from the obvious investment of fencing the area and establishing security and monitoring systems for goods and individuals circulating in and out of the zone, many of the most popular free zones rely on a successful retail segment with end consumers enjoying unrestricted circulation to and from the zone.

Complying with said requirements might certainly have an impact on such business.

In any event, what would be the effect for companies established in a free zone that qualifies (or not) as a Designated Zone, according to the Decision? For businesses established and operating in free zones that do not qualify as designated zones, the answer is simple: such businesses will be fully subject to the VAT regime, effective from January 1, 2018.

For businesses established and operating in free zones that do qualify as designated zones, the applicability of the VAT regime is summarised below.

Tax Registration

In light of the specification under paragraph 9 of article 51 of the Decision, it is fair to say that businesses will have to register with the Federal Tax Authority if they reach the turnover threshold of Dh375,000 and may do so voluntarily if their turnover is Dh187,500.

Taxable Supplies

The supply of goods and services in the UAE mainland by designated zone businesses is not contemplated by the Decision and the Tax Law, for the simple reason that free zones companies are generally restricted to do business outside of the free zone areas. All other main situations would seem to work as follows:

• Transfer or supply of goods from the UAE mainland into the designated zone will not be considered as an export of goods. Therefore the supplier will charge VAT to the designated zone recipient of goods, subject to applicable exemption or rate (5 or 0 per cent).

• Supply of goods from abroad into the designated zone will not be considered import of goods in the UAE. Therefore the invoice received will only reflect any VAT if and how applicable to the foreign supplier, without triggering any reverse charge requirement.

• Supply of goods among businesses in designated zones will not be subject to VAT, on condition that the goods are kept in their original status during the transfer and the transfer is made in compliance with applicable customs rules.

• Supplies of goods and services made by designated zones’ businesses abroad remain VAT exempt.

• Supplies of services made within a designated zone will be considered as being made in the UAE. Therefore, such supplies would seem to trigger VAT, subject to applicable exemption or rate (5 or 0 per cent), although this scenario is not clear.

Overall, there appears to be limited benefits for free zones from qualifying as designated zones. It remains to be seen which free zone will follow that path and be listed by the expected Cabinet’s list of designated zones. Clearly, the legislator has kicked the ball of the ultimate decision into the field of free zone operators.

The writer is Partner at Galadari Advocates & Legal Consultants.