Tax Update Regarding Compensation Payment

Tax Update Regarding Compensation Payment

The Federal Tax Authority (FTA) has clarified about VAT applicable on payments considering the type of compensation, which can structurally look like payments made to pay off for some loss, to clear up a dispute, to pay for a penalty or fine or similar transactions. The FTA has announced some guidelines around this and also advises the tax-payers to themselves evaluate the form of every transaction and decide if it would come under the purview of UAE VAT Law and Executive Regulations.

This clarification also lays out two important criteria to establish if these transactions would be counted in the scope of UAE VAT or not:

1. Evaluating the nature of the compensation
2. Deciding if a payment is a consideration for a supply or not
   
   

The Highlights for VAT

1. Payment made for damages or loss compensation

There is an exception here; liquidated damages are not counted under the scope of UAE VAT Laws because the aim of these payments is not to pay for any goods or services but rather to pay a compensation for some loss of earnings if a contract has been breached mid-way. However, the payments made for cessation of rights for supply of services or goods are not included in this and, thus it comes under the scope of UAE VAT Law. For example, a hotel charging cancellation fees, if someone cancels their booking after the stipulated period.

2. Payments to settle disputes

Where a payment is awarded to a party with reference settlement of dispute, it is necessary to analyze the reason behind the payment in order to arrive at a correct VAT treatment.

If the purpose of the payment is to enforce a contractual term, the same shall be subject to VAT. For example: the dispute regarding the goods is settled by making a payment for these goods, the payment will be a consideration for the supply and therefore subject to VAT.

If the purpose of the payment is for granting a right, the same shall be treated as a consideration for the supply of a right and subject to VAT. For example: granting of a right to use intellectual property for a fee.

3. Payment for fines and penalties

If one is paying for fines or penalties, then it is not considered as a supply and lies out of the scope of UAE VAT Law. The aim of fines or penalties is to penalize the party who has done something wrong and the other party who is imposing the fine is not providing any supplies lieu of the payment.

4. Payment for any damaged or broken goods

The compensation made for delivery of any damaged, broken or lost goods is not considered as a payment for a supply and therefore, it lies out of the scope of UAE VAT Law. However, if there is transfer of title of goods, then it would be counted in scope of VAT.

The FTA clarifies that the tax registrant needs to be check and be sure of the contract and legal details to be able to establish the taxability of the particular transaction. At certain times, the titles or language used for explaining the transaction could be deceptive; in that case, the transaction substance will decide the liability of VAT. It is important to consider the type of the compensation and its implications before deciding the taxability or non-taxability.