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VAT in the UAE – Questions answered

Dr. Michael Krämer

Author: Dr. Michael Krämer
Senior Lawyer.

Guiding Principle

On 1 January, 2018, value added taxes (“VAT”) have been introduced in the UAE. As could be expected, quite many people remain confused about what effect the introduction of VAT will actually have on them and how they are supposed to deal with it. While answers to many questions will only develop over time once a certain practice of the Federal Tax Authority (“FTA”) has been established, some essential questions can be answered already. Federal Decree Law No. 8 of 2017 (VAT-Law) and its Executive Regulations, Cabinet Decision No. 52 of 2017 (“ExReg”) form the main legal basis for VAT in the UAE. This article aims to answer some of the most essential VAT related questions based on the provisions of both, the VAT-Law and the ExReg.

A. What are “Value Added Taxes”?
In a nutshell, VAT is a tax that is paid by end-consumers. Any person further up the supply chain will have to pay VAT also, but will be able to deduct all VAT paid (usually called “Input Tax“) from the VAT it has to pay to the FTA (usually called “Output Tax“). Such person’s customer, in turn, pays the Output Tax. So for any person in the supply chain other than the end-consumer, VAT is nothing but a self-balancing item, which will be paid, but also be recovered.

B. Who does or does not need to register for VAT?
The VAT-Law distinguishes between three different scenarios:

  • those who are obliged to register;
  • those who can register voluntarily; and
  • those who are not allowed to register.

I. Mandatory Registration
Traders (which, in principle, can be both, individuals and commercial entities) who have “exceeded the Mandatory Registration Threshold over the previous 12-month period”[1] are obliged to register with the FTA. The “Mandatory Registration Threshold” is AED 375,000[2]. Unfortunately, however, the calculation of the “Mandatory Registration Threshold is not entirely clear, but we assume that the VAT-Law[3] refers to the total turnover that has been made in the 12-month period prior to registration.

II. Voluntary Registration
Traders whose turnover in the 12-month period prior to registration exceeded the “Voluntary Registration Threshold” (AED 187,500[4]), but not the “Mandatory Registration Threshold” can opt to register with the FTA[5], but are not obliged to do so.

III. No Registration
Traders whose turnover in the last 12 months did not exceed the “Voluntary Registration Threshold” of AED 187,500 are neither obliged, nor even allowed to register.

C. Are Companies in Free Zones obliged to register?
Generally, yes. The VAT-Law is a federal law and applies throughout the UAE. Only “Designated Zones” will “be treated as being outside the [UAE]”[6]. “Designated Zones” within the meaning of the VAT-Law have just recently been defined and include mostly free zones which have their own customs department, such as the Jebel Ali Free Zone, KIZAD, Dubai Airport Free Zone and Hamriyah Free Zone. It also includes free zones, the existence of which was not yet known, such as free zone areas in Al Quoz and Al Qusais in Dubai.

Even if a company is based in such “Designated Zone”, however, it does not necessarily mean that such company is not required to register with the FTA. This depends on whether or not the entity in question is conducting business with customers inside of the UAE. If such business is being conducted and the customer is not obliged to pay VAT, the company is obliged to register even if it is based in a “Designated Zone”[7].

Given that VAT will be applied on the vast majority of all imported goods[8] and that the person importing such goods will be responsible for paying the corresponding VAT[9], we believe that most companies based in a “Designated Zone” will, in fact, not be obliged to register for VAT, because they will be falling outside of the scope of Art. 13 2. VAT-Law.

For the time being, however, unless and until the Cabinet has decided which free zone will be deemed a “Designated Zone”, it will be safer to assume that registration is, in fact, required, even for companies based in free zones.

D. Will VAT be applied to all Goods and Services?
Generally, the answer is yes, but there is a range of exceptions.

I. Business conducted on a Private Level
Probably the most important exception in everyday life is that transactions between individuals are usually not subject to VAT. According to Art. 2 1. VAT-Law VAT is imposed only on supplies of goods and/or services done by “Taxable Persons”. A “Taxable Person” is only such that is either registered or obliged to register[10]. Hence, transactions done by persons (in theory even companies) that are either not eligible for VAT registration or which choose not to register (only possible if their turnover does not exceed AED 375,000) are not subject to VAT. However, this applies only if the “supplier” of the goods and/or services in question is not a “Taxable Person”. If the supplier is a “Taxable Person” and the recipient of the goods or services is not, VAT (obviously) still applies. Hence, if a private individual (and generally persons or companies that are not obliged to register for VAT) sells something to a VAT registered company, no VAT will apply, but if the same VAT registered company sells the same item to the private individual, VAT will, in fact, apply.

II. Government Services
Services provided by government entities, as long as such entities are acting in a sovereign capacity, will also be exempt from VAT[11]. The Cabinet will decide which services are to be considered performed in a sovereign capacity in due course, however[12].

Judging by experiences in other countries that do have a VAT system in place, we would expect that services provided by the courts, traffic fines, governmental permits, etc. will be exempt from VAT. Other services, which are provided by (semi-)government entities, but could in theory also be provided by private parties, such as the provision of electricity and water, are more likely to be subject to VAT, however.

III.  Zero Rated Supplies

Technically speaking, this is not an exemption, because VAT is still being applied albeit at “0%”. Art. 45 VAT-Law lists a range of goods and services, which will be “zero rated”. Most notably, the list includes the export of products[13], supply and import of precious metals[14] (which Art. 36 ExReg defines as gold, silver and platinum of not less than 99% purity), the “first supply of residential buildings within (3) years of its completion”[15], the “supply of educational services”[16] and the “supply of preventive and basic healthcare Services”[17].

IV. Exempt Supplies
According to Art. 46 VAT-Law certain “supplies” are exempt from VAT. This applies, primarily, to “financial services”, which Art. 42 2. ExReg defines as “services connected to dealings in money (or its equivalent) and the provision of credit […]”.

Exempt from VAT is also the lease of residential buildings[18], which presumably does not only apply to entire buildings as such, but also to apartments. The exemption applies only to leases of more than six months, however, and to situations where the tenant is a UAE resident or citizen.

Exempt from VAT are further transactions involving bare land and the provision of local passenger transport services, which presumably refers to taxi and metro services.

E. How is VAT calculated?
The basis for the calculation of VAT is the “value of the supply”[19], which is usually the agreed amount payable for the goods and/or services provided. Hence, if a person is selling a product for AED 100, such AED 100 are the basis for VAT calculation. With VAT currently set at 5%[20] the total price payable by the customer will be AED 100 plus AED 5 for VAT, so a total of AED 105.

F. How do I calculate the VAT amount payable to the FTA?
The response to this question is simple in theory, but often one of the trickiest questions in practice.

The basic principle is that the trader must pay all VAT invoiced to its customers during a certain “Tax Period” (which we will deal with in G. below) to the FTA, regardless of whether or not such VAT has actually been paid to the trader by the customer. Hence, payable is the invoiced, not the paid VAT. From this Output Tax the trader can deduct all “Recoverable” Input Tax, so in principle, the amount payable to the FTA is the total Output Tax invoiced during a “Tax Period” less all “Recoverable” Input Tax paid during such “Tax Period”[21].

The tricky part is determining what the “Recoverable” Input Tax is. Art. 54 VAT-Law states that “[t]he Input Tax that is recoverable by a Taxable Person for any Tax Period is the total Input Tax paid for Goods and Services which are used or intended to be used for […] Taxable Supplies[22]“. In simplified language, that means that all VAT a trader has spent in order to run his business can be deducted from such trader’s Output Tax prior to making any VAT payment to the FTA. The question remains, however, which amounts have been spent in order to run the trader’s business and which ones have to be seen as personal expenses? How about, for example, the new computer, which may be used for business purposes, but is also used for personal needs? How about expenses for mobile phone bills where most calls are business related, but the same phone is also used to make personal calls?

These are questions, which can only be answered once the FTA has developed a certain routine as to how such things are to be treated. Even then, however, these questions are likely to remain a source of constant dispute as experiences in other countries show.

The ExReg provide some further, non-exhaustive guidance on what qualifies as “recoverable” Input Tax. “Entertainment” expenses, for example, that have been incurred for business development purposes cannot be offset of a trader’s tax burden[23]. The same applies to expenses for vehicles (rented, leased or purchased), which can be used for both, business and personal needs[24] or items that a trader purchases for his employees, for his employees’ personal benefit[25].

These definitions, by necessity, leave quite a large grey area, which needs to be defined over time, but as we mentioned above, this will only happen over time once the FTA has developed a certain practice in dealing with such matters.

G. When does VAT need to be paid to the FTA? What is a “Tax Period”?
All amounts due to the FTA must be paid within 28 days following the end of a given “Tax Period”[26]. The regular “Tax Period” is three calendar months[27], ending “on a date that the Authority determines”. We assume that this will be calendar quarters; so payments would be due latest on 28 January (for the period of 1 October to 31 December of the previous calendar year), 28 April (for the period of 1 January to 31 March), 28 July (for the period of 1 April to 30 June) and 28 October (for the period of 1 July to 30 September) of each calendar year.

The FTA is authorized to assign different Tax Periods to different persons or groups of persons, however[28], and it has been mentioned that traders with a very high turnover are likely to have their “Tax Periods” reduced to individual calendar months.

H. How about Output Tax that has not been paid by Customers?
As explained in F. above, Output Tax are all VAT amounts invoiced to customers, not paid by customers, during a certain “Tax Period”. Hence, it is quite possible that a trader will pay VAT to the FTA, which it will not be able to recover later, simply because the customer did not pay the invoice (and thus, the applicable VAT).

According to Art. 64 VAT-Law, VAT already paid on such “bad debts” can be deducted from the trader’s tax burden during a later “Tax Period” if certain conditions are met. These conditions are that the trader must have properly invoiced the VAT amount due and paid such amount to the FTA. Also that the trader has written off such “bad debt” in his accounts, that more than six months have passed since the goods or services in question have been supplied, and, quite interestingly, that the trader has informed the customer whose invoice was not paid that he (the trader) has written off the customer’s debt.

The last condition in particular raises the question of how often this will actually happen in practice, because it essentially means informing the customer that the trader is no longer pursuing his claim. Hence, in our opinion, not many traders will be willing to overcome the hurdles set out in Art. 64 VAT-Law just in order to reclaim the 5% VAT already paid to the FTA and will aim to recover the full “bad debt” instead.

I. Penalties
Art. 76 VAT-Law deals with the penalties and lists various matters, which will be penalized. These matters include, for example, the following (in slightly simplified language):

  • not displaying the prices of a trader’s goods and/or services inclusive of the VAT due for such goods and/or services[29]; and
  • not issuing proper tax invoices to customers[30].

Art. 76 VAT-Law specifically refers to the penalty provisions of Federal Law No. 7 of 2017 on Tax Procedures (“TaxLaw”), however, which includes a more detailed list of sanctioned actions. We will not list all of the matters sanctioned by Art. 25 of the TaxLaw, but the following should be noted in particular:

Not maintaining proper accounting books is a sanctioned action[31], as is the failure to submit tax returns in Arabic[32]. Quite surprisingly, however, the accountability of company managers has been increased also. For example, in events where the manager fails to notify the FTA of his appointment within 20 business days of his appointment[33], the manager himself (as opposed to the company he represents) will be subject to fines[34]. Similarly, if the trader company’s tax return is not filed on time, the company’s manager will be fined personally[35].

Penalties range from not less than AED 500 to “three times the amount of Tax in respect of which the [fine] was levied”[36].

J. How do I object to Decisions made by the FTA?
All of the FTA’s decisions can be objected to within 20 business days following the day on which the relevant decision has been issued[37]. The FTA will decide upon all such objections within another 20 business days following receipt of the objection[38]. In addition, the FTA will form a “Tax Disputes Resolution Committee”[39], the task of which will be to act as “appeal instance” where the FTA as such did not resolve the objection satisfactorily.

The “Tax Disputes Resolution Committee” will not act unless the disputed tax amount or the penalty have already been paid, however[40], which forces traders to comply with the FTA’s decisions first and to hope for a favorable outcome later.

The Committee’s decision will be final in all events where the disputed amount in question does not exceed AED 100,000[41]. In events where the disputed amount is higher, the Committee’s decisions can be challenged in court within yet another 20 business days following the Committee’s decision[42].

K. Conclusion
While the reasons for the introduction of VAT to the UAE are evident, the precise processes and procedures remain, largely, unclear. This had to be expected, given that the introduction of VAT to any jurisdiction is a complex process, which will take several years to properly “settle in”. We hope that the FTA will consider this factor when issuing fines to individual traders. At present, there is a lot of uncertainty as to how exactly to comply with the new rules and regulations and we hope that traders will not be fined for non-compliance with rules that, by necessity, are not yet sufficiently clear.

[1] Art. 13 1. a. VAT-Law

[2] Art. 7 1. ExReg

[3] Art. 19 VAT-Law

[4] Art. 8. 1. ExReg

[5] Art. 17 VAT-Law

[6] Art. 50 VAT-Law

[7] Art. 13 2. VAT-Law

[8] Art. 2 2. VAT-Law

[9] Art. 4 2. VAT-Law

[10] Definition of “Taxable Person” in the VAT-Law

[11] Art. 10 1. VAT-Law

[12] Art. 10 2. VAT-Law

[13] Art. 45 1. VAT-Law. “Exports” from the UAE into one of the “Designated Zones” are not considered exports for VAT purposes though (see Art. 30 3. ExReg)

[14] Art. 45 8. VAT-Law

[15] Art. 45 9. VAT-Law

[16] Art. 45 13. VAT-Law

[17] Art. 45 14. VAT-Law

[18] Art. 46 2. VAT-Law

[19] Art. 3 VAT-Law

[20] Art. 3 VAT-Law

[21] Art. 53 VAT-Law

[22] Art. 54 1. a. VAT-Law

[23] Art. 53 1. a. ExReg

[24] Art. 53 1. b. ExReg

[25] Art. 53 1. c. ExReg

[26] Art. 64 3. / 1. ExReg

[27] Art. 62 1. ExReg

[28] Art. 62 2. ExReg

[29] Art. 76 1. VAT-Law

[30] Art. 76 4. VAT-Law

[31] Art. 25 1. a. TaxLaw

[32] Art. 25 1. b. TaxLaw

[33] Art. 7 TaxLaw

[34] Art. 25 1. f. TaxLaw

[35] Art. 25 1. g. TaxLaw

[36] Art. 25 3. TaxLaw

[37] Art. 27 1. TaxLaw

[38] Art. 27 2. TaxLaw

[39] Art. 28 TaxLaw

[40] Art. 30 2. b. TaxLaw

[41] Art. 31 4. TaxLaw

[42] Art. 32 TaxLaw

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