VAT TREATMENT OF COMPENSATION PAYMENT
Vide VATP001 the Federal Tax Authority has 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.
APPLICABILITY OF VAT ON
CONTRACTUAL PAYMENT TO COMPENSATE FOR LOSS
An example of this type of payment is liquidated damages which are the predetermined amounts that the parties to an agreement designate during the formation of the agreement for the injured party to collect upon specific breach. Thus these are outside the scope of VAT as the purpose of such payments is not to provide consideration for provision of any goods or service but to compensate the party for loss of earnings.
2. PAYMENT TO SETTLE A DISPUTE
A payment is awarded to a party on settlement of dispute.
IN CASE PAYMENT IS TO ENFORCE A CONTRACTUAL TERM
Under this, payment is the consideration for the contractual supply to which it relates. For example : Dispute regarding a price of goods is settled by requiring a contractual recipient of goods to make payment of these goods, thus in this case payment would be the consideration for the supply of goods and would be subject to VAT.
IN CASE PAYMENT IS IN THE NATURE OF DAMAGES OR COMPENSATION FOR ANY LOSS WHICH IS SUFFERED BY THE PARTY
Under this, payment would not be considered as a consideration for any supply and is thus outside the scope of VAT. For example : Payment for loss of earnings or payment of interest in respect for late payment of of contractual consideration would not be considered as a consideration for any supply.
IN CASE PAYMENT IS IN RETURN FOR GRANTING A RIGHT
If the payment is in consideration for supply of right, then it may be subjected to VAT. For example : A person may agree to allow another person to use its property including intellectual property in return for a payment, then the payment would be the consideration for the supply of the right to use the property.
3. FEES AND PENALTIES
Fines and penalties that are imposed for contravening the terms of an agreement, performing an unlawful act and thus are outside the scope of VAT.
For example : A contract that stipulates that a party must make payment if it breaches the terms of the contract. The payment under this which is made as a result of a breach of contract is outside the scope of VAT since it is in the nature of damages.
A fine or a penalty may also be imposed by a government authority for an unlawful act which is also outside the scope of VAT since the purpose of such fine would be to punish the wrongdoer for the act and the party that is imposing the penalty is not making any supply in respect of payment.
4. PAYMENT FOR DAMAGED GOODS
A person who has damaged or lost goods belonging to another person is required to make payment to compensate for the damage or loss. In case the payment is compensation for breaching the pre existing terms of a contract, then it would be outside the scope of VAT since it would not likely be any consideration for supply.
These public clarifications however mark a development for business as it indicates the FTA’s approach to clarify its interpretation of complex matters will be to issue short and helpful clarifications of this nature. In order to ensure that the businesses takes action to consider whether the FTA’s interpretation aligns with the current treatment adopted by the business they should continue to monitor the FTA website for Public Clarifications on additional topics.