As explained in the Federal Decree Law No. 8 of 2017 on Value Added Tax (“VAT Law”), VAT is imposed on payments that are in return of taxable supplies of goods or service. As per the VAT Law, the term “taxable supplies” refers to supplies of goods or services inside the state that are not including exempt supplies.
This means, that in order to charge VAT on a payment received, the payee must supply in return to the payer goods or services worth of what the payee received. If no supply of goods nor services is made in return to the payment received by the payee, then the payee is not permitted to charge VAT on the payment amount received.
In order for the payer to understand of the payment they are making must include VAT or not, they must analyze if they are receiving any good or service in exchange of what they are paying.
Below, we have included a number of examples that a payment may or may not be made in exchange of a good or service. Tax payers must understand that the below examples are not the only cases of such arguments, there are many other cases, and tax analysis must depend on case-by-case analysis when the subject is “compensation-type payment”1. A contractual payment to compensate for loss
An example of compensation payments is “liquidated damages”. Liquidated damages amount is an amount that parties of the contract have agreed on, in which the injured party will receive the amount to compensate the breach that has occurred. For example,
The purpose of such payments is not to provide another good or service, but they are just to compensate any damages that have occurred because of the occurred incident, and therefore, such payments are outside the scope of VAT.2. A payment to settle a dispute
Where a dispute is settled, and an amount is paid to one party, it is necessary to understand the nature behind the payment in order to determine the VAT treatment on such payments. The following are different scenarios,
A fine or penalty may be imposed on people not for an exchange of goods or services, but for a breach of rules and regulations, and by that, such payments are outside the scope of VAT. For example,
Where two parties have entered into an agreement, in which the 1st party will lend a property owned by them to the 2nd party, and the 2nd party returns the property with a damage to the 1st party and it clearly mentioned in the contract the a specific amount is to be paid by the 2nd party if there is any damage in the property. In that case the amount that is to be paid by the 2nd party for damaging the good is not made in return for any good or service, and therefore shall not be subjected to VAT as it is outside the scope of VAT. For example, damaging a leased car.
However, it is always important to analyze the reason behind every payment made, and only by that, the payer will know if their payment is subjected to VAT or not.
Fame Legacy DMCC
Tax Assistant Manager – Tax Agent, TAAN: 20040382