Compensation payments are not subject to VAT, the Federal Tax Authority says

Federal Tax Authority issues public clarification statements to raise taxpayers awareness

“Regarding registration, this is a dynamic process because we have companies that are still reaching the compulsory threshold, when they reach that they need to register,” Mr Al Bustani said.Antonie Robertson/The National

Companies and consumers in the UAE will not be taxed on payments listed in their business and legal contracts, such as a speeding ticket or a late-delivery fine, unless these payments are related to the supply of goods and services, according to the Federal Tax Authority.

Payments that are specified in business contracts between companies to compensate for loss, negligence or other errors are not subject to VAT unless they are related to the supply of goods and services, the FTA said in a statement on Sunday, part of the authority's "public clarifications" service intended to raise awareness among tax payers about the technicalities of the tax system.

“This service helps spread tax awareness among businesses and consumers alike, providing useful information about tax laws, executive regulations and tax procedures, leading to a successful implementation of the tax system,” Khalid Ali Al Bustani, director-general of the FTA, said.

To determine if a payment is taxable or not, companies and consumers must consider the contractual and legal reason behind the payment.

For example, compensation payments such as liquidated damages, where the injured party can claim compensation for a specific breach such as early termination of a contract, have the purpose of compensating one party for a loss and not to provide goods and services. Therefore they are outside the scope of VAT, the FTA said.

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When  a contract allows a hotel guest to cancel a booking in return for a cancellation charge, these penalties are considered a cessation of a right, which are a supply of services, and therefore subject to VAT.

In the case of an out-of-court settlement, the reason behind the payment determines if its taxable. For example, if a dispute about the price of goods requires the buyer to pay for these goods, then that payment is related to the supply of products and is therefore taxable, the FTA said.

In the case of payments for damaged goods, such as damaging a leased car, the payment is considered compensation and related to breaching the contract not the supply of goods, therefore it is outside the scope of VAT.
Administrative penalties imposed usually by government bodies for breaching terms of an agreement, such as doing something unlawful or breaching statutory obligations, are not related to the supply of goods and services and therefore are not taxable.

"When a fine or penalty is imposed by a government authority for an unlawful act – for example, a speeding fine or incorrect parking fine – the purpose is to punish the person and the party imposing the penalty is not making any supply in respect of the payment," the FTA said. "Therefore, no VAT is due on such fines and penalties."