Why VAT exemption matters for your UAE business

The United Arab Emirates implemented Value Added Tax (VAT) in January 2018 and fixed the standard VAT rate at 5%. This is an indirect, consumption tax, which can either be 0%, 5% or exempt.

Since then, understanding exemptions under VAT has become imperative for any business, as the characterization of supply has a direct relation to compliance and operational costs. Mistakes in the categorization of supplies lead to lost recoveries of input VAT or incorrect tax reporting.

This article outlines the Federal Tax Authority’s regulations on types of VAT-exempt supplies in the UAE, implications for free zone entities and mixed supplies, and finally, registration exceptions accorded to businesses that deal in zero-rated supplies.

What is VAT exemption in the UAE?

When goods and services are exempt under VAT in the UAE, two things happen:

1. Businesses cannot charge VAT on their sales invoice.
2. VAT paid on related costs is not recoverable.

This means that purchase VAT is an expense absorbed by the business and not an amount refundable to it.

According to the Federal Tax Authority (FTA), an exempt transaction means that no VAT has been levied on it, and VAT on related purchases cannot be claimed. Examples include specific financial services and bare land.

Zero-rated supplies are different from VAT-exempt supplies. The main difference is the recoverability of the input VAT.

Why does the classification of goods and services based on Value Added Tax (VAT) treatment matter?

The incorrect categorization of standard-rated or zero-rated goods and services as exempt and recovering input VAT incorrectly can result in penalties.

Zero-rated vs Exempt supplies: A comparison

Category	VAT Rate	Input VAT Recovery?	Typical examples of goods and services in this category	Business/Cash‑Flow Impact
Zero‑Rated	0%	Yes	Exports of goods/services outside the Gulf Cooperation Council (GCC), international transport, first supply of new residential building (within 3 yrs), and certain healthcare services	Allows input VAT recovery, improves cash flow, and mandates registration and filing of VAT returns
Exempt	N.A.	No	Bare land, resale of residential property after first supply, and certain financial services	Disallows input VAT recovery, but no registration is required if you only deal in exempt goods and services

Common VAT exempt goods and services: Four main supply categories for VAT exemption in the UAE

The FTA regulates the VAT exemption list in the UAE. Everything outside these exempt categories is usually either standard-rated at 5% or zero-rated, depending on the FTA rules.

Under the UAE VAT law, certain supplies that are exempt from VAT are:

1. Financial services

Financial services are exempt from VAT when the consideration is implicit (for example, interest or a margin) and there is no separate, explicit fee or commission. Examples include issues of equity or debt instruments and life insurance. Advisory or brokerage fees charged by businesses usually attract the standard 5% VAT rate.

2. Residential properties

Zero rating can apply to the first sale or lease of newly constructed residential properties within three years of completion. Later sales or leases are exempt.

Example: A unit completed in January 2023 and sold in February 2025 would be zero-rated. If the buyer later leases the unit to a tenant, those lease payments are exempt from VAT.

Commercial properties, such as hotels or properties listed via Airbnb, must, in all cases, pay the 5% tax.

3. Bare land

Transactions involving undeveloped lots are not subject to VAT. This rule applies regardless of the owner’s intention for future development.

Once the land is developed and a building is constructed, future supplies of that property are treated under the normal residential and commercial VAT rules.

4. Local passenger transport services

Services exempt from VAT include the domestic passenger transport services, such as the Dubai Metro. By contrast, international transportation of passengers or goods is generally zero-rated.

Exploring VAT exemption in UAE free zones

Here, we discuss the VAT treatment of transactions involving free zone and designated zone entities.

1. Designated zone companies

Designated zones are special free zones treated as outside the UAE for VAT treatment of many goods. Essentially, goods can move within or between designated zones without VAT in some cases. However, once goods are consumed in designated zones or transported to the mainland UAE, the standard 5% VAT normally applies.

In contrast, services in designated zones are treated just as services performed in the mainland UAE.

2. Free zone to free zone

Any movement of goods under customs control and directly between free zones that are designated zones is outside the scope of UAE VAT. However, if either of the free zones is not a designated zone, the supplies generally attract the standard 5% VAT.

Services supplied by one free zone entity to another are subject to normal VAT rules.

3. Free zone to mainland

Goods moving from designated zones to the mainland are treated as imports, requiring the mainland buyer to pay 5% VAT (usually via reverse charge). Goods and services from a normal free zone to the mainland are treated as standard-rated supplies.

The following tables cover a more comprehensive set of VAT treatment scenarios involving free zone and designated zone entities:

How does VAT apply when goods move from or to free zones? 

Supplier location	Customer location	VAT treatment
Designated zone	Mainland	Transaction treated as an import 5% import VAT applicable Mainland customer accounts for VAT (reverse charge in VAT return if registered, or at customs if not registered)
Mainland	Designated zone	Treated as a normal domestic supply from a mainland supplier to a UAE customer 5% VAT is charged unless zero-rating or exemption applies
Designated zone A	Designated zone B	Outside the scope of VAT if conditions in Article 51 are met (direct movement, proper control, not released into mainland) Otherwise, treated as a taxable supply (Assuming goods move under customs control)
Anywhere in the UAE (Mainland, any free zone, or designated zone)	Customer outside UAE & GCC	Treated as export and hence, zero-rated, provided that certain conditions are met, such as the supplier holding proper export evidence

How does VAT apply when services are performed by or for free zone entities? 

Supplier location	Customer location	VAT treatment
Mainland	Designated zone	Treated as services performed within the UAE 5% VAT is charged unless zero-rating or exemption applies
Designated zone	Mainland	Normal VAT rules apply since the place of supply is in the UAE
Anywhere in the UAE (Mainland, any free zone, or designated zone)	Customer outside UAE & GCC (non-resident)	Treated as a service export 0% VAT applies if Article 31 conditions are met Otherwise, standard 5% VAT applies

Partial VAT exemption: Input tax recovery guide for businesses with mixed supplies

Many businesses make both taxable (standard‑rated or zero‑rated) and exempt goods and services. When that happens, overhead costs and general inputs are used for both activities. This triggers the partial exemption regime. Understanding this is critical for companies such as hospitals, banks, educational institutions, mixed‑use real‑estate groups, or crypto/financial services firms.

Such companies need to classify their expenses into the following groups:

• Input tax = VAT paid on purchases
• Fully recoverable input tax = VAT on costs directly related to taxable/zero‑rated supplies
• Wholly non-recoverable input tax = VAT on costs directly related to exempt supplies (or non-business use)
• Residual input tax = VAT on costs that support both taxable and exempt supplies (overheads, general admin)

Standard method to apportion input tax

Unless you have an approved special method or Specified Recovery Percentage (SRP), businesses with mixed supplies can use the following method to calculate input tax recovery:

1. Identify input tax quantities
   Fully recoverable input VAT = a
   Fully non‑recoverable input VAT = b
   Residual input VAT = c
2. Calculate the recovery percentage
   Recovery percentage = a ÷ (a + b)
   Note: The recovery percentage must be rounded to the nearest whole number.
3. Apply the recovery percentage to the residual input tax:
   Recoverable portion of residual input tax = c × Recovery percentage
   Total recoverable input VAT = Fully recoverable + Recoverable portion of residual
4. Year-end adjustment
   At the end of the tax period, you must:
   • Recalculate the recovery percentage as if the entire year were a single period
   • Adjust for under-recovery or over-recovery accordingly
5. Actual use adjustment
   If the difference between:
   • Recovery using the actual-use method, and
   • Recovery using the standard method
   exceeds AED 250,000; the actual-use method must be used as the basis for the year-end adjustment.
   If your tax year is less than 12 months, you must prorate the AED 250,000 threshold accordingly.

Example: Partial VAT Recovery – Hospital with Pharmacy

Input Type	Amount (AED)	Recovery Status	Calculation
Input VAT attributable to pharmacy (taxable supply)	50,000	Fully recoverable	–
Input VAT attributable to hospital services (exempt supply)	30,000	Non-recoverable	–
Shared overhead input VAT	20,000	Partially recoverable (residual input)	–
Recovery percentage	–	–	50,000 ÷ (50,000 + 30,000) = 62.5% Adjusted to 63%
Recoverable portion of overhead input VAT			20,000 × 63% = 12,600
Total Recoverable Input VAT			50,000 + 12,600 = AED 62,600

Why should you learn the standard apportionment method?

• You cannot calculate input recovery simply based on revenue figures. Instead, you need to consider the proportion of input VAT attributable to taxable and exempt supplies.
• Crypto, financial services, and real‑estate groups are particularly at risk of getting this wrong.
• Special methods offer more predictability, but FTA approval may not arrive in time for filing VAT returns.

UAE VAT registration and exemptions: How to get a VAT exemption certificate in the UAE

Check the following thresholds to understand whether you need to or if you can voluntarily register for VAT in the UAE via the EmaraTax platform:

1. Mandatory registration threshold

A business must register for VAT when:

• The total value of its taxable supplies (and/or imports) in the last 12 months is more than AED 375,000, or
• It expects its taxable supplies to cross AED 375,000 in the coming 30 days

Note: You must complete registration within 30 days of hitting the mandatory registration thresholds.

2. Voluntary registration threshold

A business may choose to register for VAT early when either its taxable supplies or expenses are more than AED 187,500 over 12 months.

3. VAT registration exemption

If the company supplies only exempted supplies, no registration is required since their supplies are not part of the VAT system.

Getting a VAT Administrative Exception in UAE

Most VAT exemptions apply automatically if transactions fall within the four main categories determined by the FTA.

However, certain VAT treatments, such as special apportionment methods, partial input tax recovery mechanisms, and specific regulatory exceptions, require formal applications and FTA approval.

Similarly, to have VAT-related procedural or reporting obligations waived, you must apply for a VAT Administrative Exception in the UAE. While you can apply online easily through EmaraTax, approval often requires detailed justifications, supporting calculations, and, in some cases, professional advisory support. In this application, you may need to attach supporting documents such as:

• Reason for application
• A supporting letter that details the legal requirements you are unable to meet and provides the necessary background and factual context
• Sample invoices, contracts, payment slips, or any other relevant documents that can serve as evidence for your arguments

Compliance, record keeping, and penalties: Practical tips for businesses

Traditionally, in the UAE, tracking VAT compliance for an FTA audit has been a manual-heavy process that required VAT-registered businesses to keep records of all tax invoices, receipts, and contracts for at least 5 years.

But let’s be honest, for most company owners, navigating the ins and outs of UAE VAT exemptions and changing VAT regulations can be time-consuming.

Thankfully, in today’s AI-centric world, the process has become much simpler. With modern solutions like skrooge.ai, you can avoid compliance headaches and reduce the risk of indirect penalties, such as the AED 10,000 penalty for failure to maintain the required records (first offense).

Working with us makes it easy to:

• Track taxable and exempt supplies separately
• Effectively run partial exemption reviews
• Adequately prepare for periodic FTA audits
• Know how to reclaim input VAT on your zero-rated supplies
• File tax returns on time

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