UAE VAT: Out-of-Scope Supplies in Mainland, Free Zones & Offshore

Out of Scope Supplies in Mainland, Free Zones, Designated Free Zones, and Offshore Companies under UAE VAT Law: A Comprehensive Guide

Understanding the nuances of Value Added Tax (VAT) in the UAE is crucial for businesses operating within its diverse economic landscape. One area that often causes confusion is the concept of "Out-of-Scope Supplies." This article provides a comprehensive overview of out-of-scope supplies in mainland UAE, free zones, designated free zones, and offshore companies, as defined by UAE VAT law. We will explore specific regulations, provide practical examples, and clarify frequently asked questions to help businesses navigate this complex aspect of VAT compliance.

Introduction to UAE VAT and Its Territorial Scope

The UAE implemented VAT at a standard rate of 5% on January 1, 2018. The tax applies to most goods and services, with certain exceptions for zero-rated and exempt supplies. A crucial aspect of VAT law is determining the scope of the tax, meaning which transactions fall within its purview. Supplies that fall outside the scope of UAE VAT are termed "out-of-scope supplies." Understanding these supplies is essential for accurate VAT accounting and compliance.

Key Concepts: Zero-Rated vs. Exempt vs. Out-of-Scope Supplies

• Zero-Rated Supplies: These are taxable supplies subject to a 0% VAT rate. Businesses can recover input VAT on such transactions.
• Exempt Supplies: These are supplies that are not subject to VAT, but input VAT recovery is restricted.
• Out-of-Scope Supplies: These transactions are entirely outside the VAT system. No VAT is charged, and no input tax can be recovered.

What Are Out-of-Scope Supplies?

Out-of-scope supplies are transactions that, for various reasons defined in UAE VAT law, are not subject to VAT. These transactions fall entirely outside the VAT system, meaning:

• No VAT is charged.
• No input tax can be recovered.
• They are distinct from zero-rated or exempt supplies, which remain within the VAT system but with specific treatments.

Key Reasons for Out-of-Scope Supplies

Several factors can lead a supply to be considered out of scope, including:

1. Nature of the Supply and Its Place of Supply: The primary determinant of whether a transaction is out of scope is the place of supply rules. If the place of supply is outside the UAE, the supply is generally out of scope.

• Goods: The place of supply is typically where the goods are located at the time of supply.
• Services: The place of supply depends on the nature of the service and the location of the customer.

1. Specific Exclusions by Law: Certain transactions are explicitly excluded from the scope of VAT by UAE VAT law (e.g., certain financial services).
2. Lack of a Taxable Person (With Exceptions): While VAT typically applies only to taxable persons, even transactions involving non-registered persons can still be subject to VAT if the place of supply rules apply.
3. Transactions with Government Bodies: Supplies to government entities may or may not be out of scope, depending on whether the government body is acting in a business or non-business capacity.

Out-of-Scope Supplies in Different Business Zones

The UAE’s diverse economic zones – mainland, free zones, designated free zones, and offshore companies – have specific regulations that impact VAT application and the concept of out-of-scope supplies.

1. Mainland UAE

In mainland UAE, VAT applies under standard rules. Out-of-scope supplies are limited to specific cases where:

• The place of supply is outside the UAE.
• The transaction falls under specific exclusions in UAE VAT law.

Examples:

• A mainland company provides consulting services to a client outside the UAE. If the place of supply is determined to be outside the UAE, it is an out-of-scope supply.
• A mainland company sells goods to a customer in another GCC country (if the place of supply is outside the UAE).

2. Free Zones

Free zones in the UAE are categorized into designated zones and non-designated zones, which significantly impacts VAT treatment.

Non-Designated Free Zones:

• Supplies between mainland businesses and businesses in non-designated free zones follow standard VAT rules.
• The VAT treatment depends on the nature of the supply:
• Goods: Subject to 5% VAT when supplied to or from the mainland.
• Services: Subject to VAT if the place of supply is determined to be within the UAE.

Designated Free Zones:

Designated free zones are treated as being outside the UAE for VAT purposes when it comes to the supply of goods.

• Goods: Supplies of goods between designated free zones are outside the scope of VAT.
• Services: The place of supply determines VAT applicability. Services provided from a designated free zone are not automatically out of scope and may still be subject to VAT if the place of supply is deemed to be within the UAE.
• Goods supplied from a designated free zone to the mainland are subject to import VAT.

Examples:

• A designated free zone company sells goods to another designated free zone company → Out of scope.
• A designated free zone company supplies consulting services to a mainland business → VAT applies if the place of supply is within the mainland.
• Goods imported from outside the UAE to a designated free zone are out of scope while in the zone but become taxable when moved to the mainland.

3. Offshore Companies

Offshore companies are not considered as established in the UAE for VAT purposes, but their transactions can still have VAT implications depending on the place of supply.

Examples:

• An offshore company provides consulting services to a mainland company → The mainland company must apply reverse charge VAT, as the place of supply is in the UAE.
• An offshore company sells goods to a UAE mainland company → The transaction is out of scope if the goods are located outside the UAE at the time of supply.

Supply of Services and Out-of-Scope Considerations

For services, VAT treatment depends on place of supply rules rather than the location of the supplier. The supply of services is generally not automatically out of scope unless the place of supply is determined to be outside the UAE.

Examples:

• A mainland company provides digital marketing services to a client in Saudi Arabia → If the place of supply is Saudi Arabia, the service is out of scope.
• A designated free zone company provides IT support to a mainland company → If the place of supply is deemed in the mainland, VAT applies.
• International transportation services provided to non-residents may also be out of scope.

Practical Implications and Compliance Considerations

1. Accurate Record-Keeping

• Maintain detailed records indicating why a supply is classified as out of scope.
• Proper documentation is crucial for VAT audits and compliance.

2. Tax Invoices

• Though VAT is not charged, issuing an invoice stating "out of scope of UAE VAT" is recommended but not legally required.

3. VAT Registration and Compliance

• Businesses in free zones should carefully assess whether their transactions fall under designated free zone rules.
• Understanding the treatment of goods moving between the mainland and designated zones is critical.
• Consulting a VAT expert is advised due to complex regulations.

Frequently Asked Questions (FAQs)

What is the difference between an out-of-scope supply and a zero-rated supply?

• Out-of-scope supplies are entirely outside the VAT system, meaning no VAT is charged or recoverable. Zero-rated supplies are taxable but at a 0% rate, and businesses can recover input VAT on such transactions.

Are all transactions with offshore companies out of scope?

• Not necessarily. The place of supply rules determine VAT applicability. For example, services provided by an offshore company to a UAE mainland business may require the mainland business to account for VAT under the reverse charge mechanism.

Do I need to include out-of-scope supplies in my VAT return?

• No, out-of-scope supplies are not reported in the VAT return. However, businesses must maintain proper records to justify the classification.

What is the VAT treatment of goods imported from outside the UAE to a designated free zone?

• Goods imported into a designated free zone are generally out of scope while they remain within the zone. However, if the goods are moved to the mainland, import VAT may apply.

What is the VAT treatment of goods supplied from a designated free zone to a non-designated free zone?

• Supplies of goods from a designated free zone to a non-designated free zone are subject to VAT, as non-designated free zones are treated as part of the UAE for VAT purposes.

Are services provided within a designated free zone out of scope?

• Not automatically. Services provided within a designated free zone are subject to VAT if the place of supply is deemed to be within the UAE. For example, services provided to a mainland business are taxable.

What is the VAT treatment of international transportation services?

• International transportation services are generally out of scope if the place of supply is outside the UAE. However, domestic transportation services within the UAE are subject to VAT.

Can input VAT be recovered on out-of-scope supplies?

• No, since out-of-scope supplies are outside the VAT system, input VAT related to such supplies cannot be recovered.

What is the reverse charge mechanism, and when does it apply?

• The reverse charge mechanism shifts the responsibility of VAT payment from the supplier to the recipient. It often applies to services provided by non-resident or offshore companies to UAE businesses. The UAE business must account for VAT on its VAT return.

Are supplies between two designated free zones out of scope?

• Yes, supplies of goods between two designated free zones are out of scope for VAT purposes. However, services between designated free zones may still be subject to VAT if the place of supply is within the UAE.

hat is the VAT treatment of goods stored in a designated free zone but sold to a customer outside the UAE?

• If the goods are exported directly from the designated free zone to a customer outside the UAE, the supply may be out of scope or zero-rated, depending on the specific circumstances.

Are there any penalties for misclassifying a supply as out of scope?

• Yes, misclassification can lead to penalties during a VAT audit. Businesses must ensure proper documentation and justification for classifying a supply as out of scope.

How do I determine the place of supply for services?

• The place of supply for services depends on the nature of the service and the location of the customer. For example: Services related to real estate are based on the location of the property. B2B services are generally based on the location of the customer. B2C services are based on the location of the supplier.

Are supplies to government entities out of scope?

• It depends on whether the government entity is acting in a business or non-business capacity. Supplies to government entities in a non-business capacity may be out of scope, while those in a business capacity are subject to VAT.

What is the VAT treatment of goods moved from a designated free zone to another GCC country?

• If the goods are moved directly from a designated free zone to another GCC country, the supply may be out of scope or zero-rated, depending on the GCC VAT framework and the specific transaction.

Can a business voluntarily register for VAT if it only makes out-of-scope supplies?

• No, a business that only makes out-of-scope supplies is not eligible for VAT registration, as these supplies are outside the VAT system.

What documentation is required to prove a supply is out of scope?

• Businesses should maintain records such as contracts, invoices, shipping documents, and evidence of the place of supply to justify the out-of-scope classification.

Are financial services out of scope?

• Certain financial services, such as interest on loans, are explicitly exempt from VAT. However, others may be taxable or out of scope depending on the place of supply and specific VAT provisions.

What is the VAT treatment of goods temporarily imported into the UAE?

• Goods temporarily imported into the UAE for specific purposes (e.g., exhibitions) may be out of scope if they are not intended for use or consumption in the UAE.

How does VAT apply to e-commerce transactions?

• For e-commerce transactions, the place of supply rules determine VAT applicability. Sales to customers outside the UAE may be out of scope, while sales to UAE customers are subject to VAT.

Conclusion

Understanding out-of-scope supplies is critical for businesses to ensure compliance with UAE VAT law. For specific cases, always consult the Federal Tax Authority (FTA) or a tax professional like ProAct.

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