VAT is implemented in UAE on 01st January 2018. Federal Tax Authority has been issuing updates to educate the tax payers for better compliance and also for ease in implementation of VAT in their business.

A recent update is the Public Clarification on Compensation type payment issued by FTA.

Summary of the clarification

What is Compensation type payments?

As a part of business arrangements, businesses will often make payments to compensate each other for any loss, omissions, non-performance or other wrong doings.

Underlying principles to determine VAT applicability on such payments:

For determining, whether a payment is for supply of goods/services or not, it is necessary to consider the contractual and legal arrangements in full. Following can assist:

– the payment is consideration for any previously agreed goods or services;

– the payment is consideration for any newly created supply of goods or services;

– the purpose of the payment is to adjust a previously agreed consideration for a supply;

– a party is granting a right to another party in return for a payment;

– a party is promising not to exercise a right in return for a payment;

– a party is giving something up in return for a payment.

Following are examples for better understanding:

1. Liquidated damages – the payment is for compensation of loss and not for provision of goods/services, hence there is no supply.

2. Payment to settle dispute –

To compensate for any loss to suffering party – the payment is for compensation of loss and not for provision of goods/services, hence there is no supply.

Eg: Late payment interest, Payment for loss of earnings

3. Fine or Penalty – The purpose of such fines is to punish the wrongdoer for the act and the party imposing the penalty is not making any supply in respect of the payment.

Eg. Breach of statutory obligations, fine imposed by govt. bodies for unlawful act.

4. Damages for breach of term of contract – the payment is to compensate for breach of terms of contract and not making any supply to the party making the payment.

Eg. Deduction of 10% fine for deficiency in standard of quality.

5. Payment for Damaged goods – compensation for breach of pre-existing terms of contract.

Eg.: Payment of damage for a leased car to car rental company, Insurance claim received for damaged goods.

6. Cancellation charges – considered as cessation of right, which are supply of services. This is irrespective that the room is available or not to customer after cancellation.

7. Payment to settle to dispute –

To enforce contractual term – It is consideration for supply and hence taxable.

Eg. Payment of price of goods.

To grant right – It is consideration for supply of granting right and hence taxable.

Eg. Use of Intellectual property.

8. Payment for damaged goods –  the payment for damage of goods and the customer is obliged to take title of the goods, then the payment made by customer is for supply of title of goods and hence taxable.

Download Public clarification on Compensation type payments under UAE VAT Law

Disclaimer: All contents above are as per information published by FTA. The comments are just a opinion. We are not responsible for any use of above information and the consequences arising thereafter.

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June 2021