Federal Tax Authority Clears up VAT on Compensation Payment

If the payment is not related to the supply of goods and services then the payments will not be levied with the 5 per cent VAT, clarified the Federal Tax Authority (FTA) on compensation type payments.

As a part of business agreements, businesses that make payments to compensate each other for any negligence, loss or other errors must not be included in the VAT taxation as they are contradictory to the supply of services definition.

The FTA noted that under Article (2) of Federal Decree-Law No. (8) of 2017 on Value Added Tax, VAT is inflicted, among other things, on taxable supplies of goods and services, was stated in recent press. Taxable supply is defined in Article (1) of the same Law as a “supply of goods or services for a consideration by a person conducting business in the UAE and does not include exempt supply”.

Read Also: VAT in UAE: What Are Exempt Supplies under VAT

To govern the reason for the payment, it is important to appraise the contractual and legal arrangements fully and to decide whether a payment is considered a supply or not:

  • It is important to appraise whether the consideration of payment is agreed for past goods and services.
  • For creating new supply of goods and services, it is considered.
  • If for a supply, the past agreed-upon consideration calibrate the payment.
  • If rights are granted between two parties in return for a payment.
  • In return for a payment, a party is encouraging a not to exercise a right.
  • If anything is given in return for a payment by a party.

Under the liberty of UAE VAT Law, the damages do not fall for any provision of goods and services since such payments do not give considerations but for the loss of earnings, party can be remunerated. Liquidated damages is referred as the amounts which are commonly to remunerate the loss of earnings. They are outside the scope of VAT, as they are not consideration for supplies.

Any payment is not included in this, which are made towards termination of rights for the supply of services or goods, and accordingly fall under the aim of UAE VAT Law. Hotel charges cancellation fee is the example of this.

He added that, payments for compensation against any loss, negligence or other errors must not be treated as a consideration for a supply and must be outside the aim of UAE VAT Law.

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