VAT is a tax on supplies of goods and services. In this manner, no VAT is expected if there is no supply. As a major aspect of business arrangements, organizations will frequently make payments to compensate one another for any loss, exclusions or other wrongdoings. A question emerges whether VAT is expected on such payments or not?
For the same issue, Federal Tax Authority (FTA) has issued a clarification (VATP001) stating that wherever the payment is not a consideration for supply; no VAT is due on the payment.
Let’s discuss in detail:
As per VAT law, VAT is applied on taxable supplies of goods and services. Taxable supply is defined in Article 1 of the VAT Law as a “supply of goods or services for a consideration by a person conducting business in the State, and does not include exempt supply”.
In order to charge VAT there should be taxable supply; if any payment is not for supply of goods and services then VAT will not be applied.
Whether the payment is for supply or not depends upon whether the taxpayer has provided anything in the return of the payment received.
Following are some case wise example to understand applicability of VAT in such scenarios; however this is not the answer to all type of payments / situation, applicability of VAT will vary from case to case:
- Payment for damaged goods: payment for damaged or lost goods to the owner of the goods will not be considered as supply; hence it is out of scope of VAT as it is for the compensation and breaching pre-existing terms of the contract.
- Payment of fine or penalty: The purpose of fine and penalty is to punish the wrongdoer for the wrongful act. The person imposing fine or penalty for not making any supplies will be out of scope of VAT. Payment for breach of contract or fine or penalty imposed by government authorities is good example for these types of payments.
- Payment for settlement of dispute: In case of dispute settlement (In or outside the court) and payment as a result of the settlement; VAT may or may not be applicable. It depends on the case.
For example a dispute with regards to the price of goods will be considered as supply and subject to VAT. In case of late payment of contractual consideration, it will be not subject to VAT as there is no supply associated.
- Payment for use of the rights: If a payment is made in consideration for using any rights to use any property including intellectual property such as patents, copyrights etc. will be subject to VAT as this payment for supply of the rights is for the use of the property.
- Contractual payments to compensate loss: Such type of payments is outside the scope of VAT as there is no supply involved. For example liquidated damages which are predetermined amount need to pay in result of breach of any contractual obligation such as early termination or late performance. However in case of cessation of any right, VAT will be applicable. For example a guest in hotel is allowed to cancel his booking by paying cancellation charges, such charges will be subject to VAT as the guest ceases his right regardless the hotel room remains available to the guest or not.
To summarize whether or not payment is to be considered for any supply, reasons of the payment need to be determined by reviewing contractual and legal arrangements. It may be necessary to consider whether:
- The payment is in return for any supply of goods or services previously agreed
- The payment is in return for any supply of goods or services newly agreed
- The purpose of payment is to adjust previously agreed consideration for any supply
- Any transfer of right or promising not to exercise a right between parties in return of payment,
Even the title (Compensation or penalty) of payment will not affect applicability of VAT. In order to determine the applicability of VAT nature of transaction or payment need to be determined
Flying Colour Tax Consultant’s competent team could assist you in:
- VAT Consultation
- VAT Registration, VAT Group Registrations, deregistration and amendments
- Registration under tourist VAT refund scheme
- Review of complete procedure and compliance related to VAT
- Assistance in selection of VAT compliant Accounting Software
- Timely and Correct Submission of VAT Tax Return (Form VAT201)
- Timely and Correct Submission of VAT Tax Refunds (Form VAT311)
- Assistance in preparation of FTA compliant Books of Accounts
- Assistance in FTA compliant Record Keeping, Documentation and Audit File and many more
This blog post is written by CA. Taher Bohra. Feel free to call our Tax Advisor today for a quality consultation related to your VAT related queries. Please send inquiry to email@example.com or call +971 4 4542366.