FTA clarifies VAT on compensation payments

Compensation payments will not be subject to five per cent tax if the payment does not relate to a supply of goods or services.

The Federal Tax Authority (FTA) on Sunday issued a clarification about the imposition of VAT on compensation type payments, saying those payments will not be subject to five per cent tax if the payment does not relate to a supply of goods or services.

The authority noted that as part of business agreements, businesses usually make payments to compensate each other for any loss, negligence or other errors. VAT should not be applied to such amounts if they do not relate to a supply.

In a recent press statement, the FTA noted that under Article (2) of Federal Decree-Law No. (8) of 2017 on Value Added Tax, VAT is imposed, among other things, on taxable supplies of goods and services. 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".

The authority explained that in order to determine whether or not a payment is considered a supply, it is necessary to consider the contractual and legal arrangements in full to determine the reason for the payment. Thus, it may be necessary to consider whether the payment is consideration for any previously agreed goods or services; if it is consideration for any newly created supply of goods or services; if the purpose of the payment is to adjust a previously agreed-upon consideration for a supply; if a party is granting a right to another party in return for a payment; if a party is promising not to exercise a right in return for a payment; or if a party is giving something up in return for a payment.

Anurag Chaturvedi, managing partner at Chartered House Tax Consultancy, said damages do not fall under the scope of UAE VAT Law since the purpose of such payments is not to provide consideration for a provision of any goods or services but to compensate a party for the loss of earnings. These amounts are generally to compensate for loss of earnings and are often referred to as liquidated damages. They are not consideration for supplies and are outside the scope of VAT.

However, this does not include any payments which are made towards cessation of rights for supply of services or goods, therefore would fall under the scope of UAE VAT Law. A typical example of this is where a hotel charges cancellation fee.

Payments for compensation against any loss, negligence or other errors shall not be treated as a consideration for a supply and shall be outside the scope of UAE VAT Law, he added.

- waheedabbas@khaleejtimes.com