FEDERAL TAX AUTHORITY CLARIFICATION ON TAX TREATMENT OF COMPENSATION TYPE PAYMENT
Vide VATP001 the Federal Tax Authority had published its first public clarifications on the Value Added Tax treatment of compensation type payments. This public clarification however states that no VAT would be due on the payment where a payment is not in consideration of a supply. The document further answers the question as to whether a compensation payment clarifies as a consideration of supply and the key factor to determine this is whether the recipient of the payment has provided anything in return for the payment or not. This clarification also describes various scenarios to illustrate the basis of making such a determination and also indicates as to where the FTA would draw a line as to what constitutes a genuine compensation.
Pertaining to this, the Federal Tax Authority issued another public clarification regarding tax treatment of compensation type payment in which it stated that,VAT is imposed on the supplies of goods and services and in case any payment does not relate to the supply of goods or services, then the payment would be subject to 5% VAT.
DETERMINING WHETHER A PAYMENT IS TO BE CONSIDERED AS SUPPLY OR NOT
In order to determine whether a payment is to be considered as supply or not we need to determine the reason for payment and for this purpose, the following contractual and legal arrangements are to be taken care of :
- Whether the payment is consideration for any previously agreed goods or services
- If it is the consideration for any supply of goods or services that has been created newly
- If the purpose of payment is to adjust a previously agreed upon consideration for supply
- If a party which is granting right to another party is in return for a payment
- If a party is promising not to exercise a right in return for a payment
- If a party has given something up in return for payment
In order to consider whether payment is consideration for a supply or is in the nature of compensation, the labels or titles given by parties to a payment are to be ignored.
SITUATIONS WHERE PAYMENT IS SUBJECT TO VAT
- Cancellation charges charged by the hotel for cancelling a booking is subject to VAT since these charges are considered as a cessation of a right which are supply of services.
- Payment made by a contractual recipient in case of a dispute regarding price of goods
- is subject to VAT since such payment is a consideration for supply of goods.
- Payment made for consideration of supply of the right to use the property( including intellectual property) is subject to VAT.
SITUATIONS WHERE PAYMENT IS NOT TO BE CONSIDERED AS SUPPLY OF GOODS AND SERVICES
The purpose of liquidated damages ( pre determined amounts designated by the parties during formation of an agreement that are to be collected by injured party as compensation upon a specific breach) is to compensate a party for loss of earnings and not to provide consideration for provision of any goods or services, thus they are outside the scope of VAT.
PAYMENT FOR LOSS OF EARNINGS OR PAYMENT OF INTEREST IN RESPECT FOR A LATE PAYMENT OF CONTRACTUAL CONSIDERATION
Payment for loss of earnings or payment of interest in respect for late payment of contractual consideration is not subject to VAT since it is not considered as a consideration for any supply.
PAYMENT FOR DAMAGED GOODS
Payment made for compensating a person for causing damage or loosing goods or for breaching pre existing terms of a contract are not consideration for supply and are outside the scope of VAT.
FINES AND PENALTIES
The Federal Tax Authority cautioned that an administrative penalty or fine may be imposed for contravening terms of an agreement, performing an unlawful act or otherwise be imposed, usually by government bodies, for breaches of statutory obligations. True fines and penalties are not consideration for any supply and therefore outside the scope of VAT since the purpose is to punish the wrongdoer for the act.
PAYMENT MADE AS A RESULT OF BREACH OF CONTRACT
Payment made for breaching the specific terms of a contract is not a consideration for supply of goods or services and is outside the scope of VAT.
The various instruments that are being used by the Federal Tax Authority in the form of clarifications is for the purpose of raising awareness among the tax payers about the technicalities tax system.