A free zone company wins a mainland customer. It feels like a simple sale. It is actually two separate tax questions with two different answers, and the corporate tax one can cost far more than the VAT one — because it can cost you the 0% rate on your entire qualifying income.
Two regimes, one transaction
Keep them apart in your head. VAT asks where the supply happened. Corporate tax asks whether your income still qualifies for the free zone rate. They do not move together, and a transaction can be perfectly clean for one and damaging for the other.
The VAT position
Everything turns on whether your zone is a designated zone for VAT purposes. Most free zones are not. The designated list is specific, short, and concerned with fenced, customs-controlled areas — see designated zones and VAT.
| Your zone | Goods to mainland | Services to mainland |
|---|---|---|
| Not a designated zone | Ordinary domestic supply, 5% | Ordinary domestic supply, 5% |
| Designated zone | Treated as an import into the UAE. VAT due, usually accounted for by the mainland recipient on import | Generally treated as supplied onshore, 5% |
Two things people get wrong here. First, services do not get the designated zone treatment — the special rules are essentially about goods. A consultancy in a designated zone billing a mainland client is making an ordinary 5% supply. Second, the mainland customer often needs to handle import VAT, which means your paperwork has to let them.
Being in a free zone has never been a VAT exemption. If you are registered, you charge VAT on mainland supplies in the normal way.
The corporate tax position, which is the expensive one
A Qualifying Free Zone Person pays 0% on qualifying income and 9% on everything else. Income from mainland customers is, as a general rule, not qualifying income.
That by itself is manageable — 9% on that slice. The danger is the de minimis test.
Non-qualifying revenue must stay within the lower of 5% of total revenue or AED 5,000,000. Breach it, and you lose QFZP status — not just for the mainland income, but for all your income, for that tax period and the following four.
That is the cliff edge. A free zone company with AED 20m of revenue has a de minimis ceiling of AED 1m, because 5% of 20m is lower than the AED 5m cap. One mainland contract worth AED 1.2m does not cost 9% on AED 1.2m. It costs 9% on AED 20m, this year and for four more.
What to do about it
Four options, in rough order of how often they are the right answer.
- Track non-qualifying revenue monthly against the ceiling. Not annually. The number you need is a running total, because the decision to accept or decline a contract has to be made before you sign it, not after the year end.
- Decline or defer the contract where it would breach. This sounds drastic until you do the arithmetic above. Deferring revenue into the next period is sometimes worth more than the contract.
- Open a mainland entity and route mainland business through it. Two entities, two returns, more cost — and complete protection of the free zone company’s status. See mainland company formation.
- Accept the loss of QFZP status deliberately, where mainland business is genuinely the strategy. Paying 9% on everything is a legitimate outcome if you chose it with the numbers in front of you. It is only a disaster when it happens by accident.
If you are already structurally mainland-facing, the honest question is whether the free zone licence is still the right vehicle at all. Mainland versus free zone goes through the trade-off properly.
The branch route
A free zone company can register a mainland branch. The branch is not a separate legal entity, so income attributable to it is non-qualifying income of the free zone company — it counts towards the de minimis rather than sitting outside it.
That makes a branch useful for licensing and customer access, and useless as a de minimis shelter. People routinely assume the opposite. See branch versus subsidiary.
What your records have to show
Both regimes rest on evidence you either kept or did not.
- Revenue split by customer type — free zone, mainland, export — as a reporting dimension in the ledger, not a spreadsheet someone builds in March
- Customer location evidence, because the classification has to be defensible
- Audited financial statements, which QFZP status requires in any case
- Transfer pricing documentation where you transact with related parties — QFZPs must meet the arm’s length principle. See transfer pricing
The practical failure we see most often is a chart of accounts that cannot produce the split. The information exists in the invoices; it has never been coded, so nobody can answer the question without a manual exercise — and by the time anyone asks, the year is over and the decision has already been made for you.
Frequently asked questions
Yes. A free zone licence is not a VAT exemption. If your zone is not a designated zone, supplies to mainland customers are ordinary domestic supplies at 5%. If it is a designated zone, goods moving into the mainland are treated as an import with VAT accounted for on import, but services are generally treated as supplied onshore at 5% regardless.
No. The designated zone rules are essentially about goods. A business in a designated zone supplying services to a mainland client is making an ordinary standard-rated supply, and assuming otherwise is one of the commonest VAT errors among free zone companies.
Non-qualifying revenue must stay within the lower of 5% of total revenue or AED 5,000,000. Note which way round that is: a company with AED 20m of revenue has a ceiling of AED 1m, not AED 5m, because 5% of 20m is the lower figure.
You lose Qualifying Free Zone Person status entirely, for that tax period and the following four. The 9% rate then applies to all of your income, not only the mainland portion. This is the single most expensive mistake available to a free zone company.
No. A branch is not a separate legal entity, so income attributable to it is non-qualifying income of the free zone company and counts towards the de minimis. A branch is useful for licensing and market access and useless as a shelter. A separate mainland company is the structure that actually works.
Code revenue by customer type in the ledger so a running total of non-qualifying revenue is available monthly. The decision to accept a contract has to be made before signing, and an annual review tells you about a breach several months after you could have prevented it.