Businesses in the United Arab Emirates (UAE), which has some of the world’s largest and most complex real estate projects, are now starting to feel the impact of the tax.
The UAE VAT regime has many real estate specific provisions requiring businesses to perform detailed analysis of their contracts and transactions in order to assess the correct VAT treatment; timing of accounting for VAT, if due; the person accountable to report any VAT due; recovery entitlement for VAT on costs; documentation and record retention requirements; and compliance obligation.
The UAE VAT regime is fairly new, effective since 1 January 2018, and some aspects of the law are still viewed as ambiguous or open to interpretation. Maturity of the regime and a consistent understanding of its application will come in time, as the Federal Tax Authority (FTA) issues further technical clarifications privately to taxpayers and issues further public guidance.
FTA’s interpretation and application of the VAT law
The FTA published guidance in 2018 setting out its interpretation of how the UAE VAT law and regulations should be applied in the context of real estate transactions. The guide was updated in April 2020 (38-page / 393KB PDF).
The FTA has also previously published public clarifications on labour accommodation (6-page / 882KB PDF) and farm houses and farmland (8-page / 1MB PDF). A new public clarification on a change in the permitted use of a building (8-page / 449KB PDF) was issued in April 2020.
Note that public clarifications are non-binding on the FTA, and intended solely to guide taxpayers on its interpretation and application of the UAE VAT legislation. All FTA guidance and public clarifications are effective from 1 January 2018, when VAT was introduced, regardless of when they are issued. Businesses operating in the real estate sector or that undertake real estate transactions should keep up to date with the FTA’s interpretation of the law, including any changes or additions in interpretations as they are made available, in order to promptly identify any VAT matters which create risk for the business.
VAT treatment of change in use of land or buildings
There are a number of different VAT treatments for real estate transactions under UAE VAT legislation. It is therefore important for the supplier to assess the circumstances, facts and intentions for the land or building at the time of supply in order to ensure that the correct VAT treatment is applied: 5%, 0% or exemption.
In the previous version of the Real Estate Guide, at section 5.6, the FTA set out its view on how a supplier should treat a real estate transaction for VAT purposes where there is a change in use of the real estate. The specific example provided was in relation to the lease of 'bare' land which subsequently becomes developed for VAT purposes. Previously, the position was that regardless of the timing of the “date of supply”, any lease of bare land which subsequently became developed land during the course of the lease would require the supplier to make a VAT adjustment to the appropriate portion of the consideration, from an exempt supply of bare land to a supply of developed land liable to VAT at 5%.
Following amendment to the Real Estate Guide and issue of the public clarification (8-page / 449KB PDF), the FTA has re-stated its view as follows:
- a supply of real estate (bare or developed, by sale or by lease, commercial or residential) is determined by the supplier at the date of supply depending on the nature of the land or building at that point in time;
- a subsequent change in nature of the land or building, or change in use by the customer or tenant, will not effect the VAT treatment of the previous supply;
- if another tax point occurs, the supplier should reassess the status of the land or building and the supply at that point in time, and apply the correct VAT treatment.
The FTA’s amendment to its position on this technical point is warmly welcomed, and aligns the FTA’s interpretation with that of many experienced VAT professionals in the region.
The FTA provides some examples including:
- lease of bare land by a landlord which the tenant converts to developed land during the course of the lease. In this case, if a tax point is triggered before the land is converted to developed land - for example, Q1 rent is paid up front before development - there will be no change to the initial treatment of the lease as an exempt lease of bare land. If a tax point is triggered after the land is converted to developed land - for example, Q2 rent is paid after development - this rent should be treated as liable to VAT at 5% as the lease of developed land;
- sale of a residential building as a principal private residence liable to VAT at 0% or exempt. If the customer then leases the building together with additional services as ‘serviced accommodation’ liable to VAT at 5%, this will not affect the previous VAT treatment applied;
- sale of a building to be used as serviced accommodation liable to VAT at 5%. If the customer then leases the building to a tenant as their principle private residence without services, subject to VAT exemption, this will not affect the previous VAT treatment.
The FTA has also clarified that, regardless of the payment milestones agreed under a Musataha agreement (a type of long-term lease), the ‘date of supply’ for VAT purposes of the full supply under the contract should be viewed as taking place up front, similar to an outright sale. Therefore, no subsequent change in status of the land or change in use by the tenant will affect the VAT treatment.
While the above deals with the VAT treatment of real estate transactions where there is a change in use, it will also have a direct effect on the deduction entitlement of a business on associated costs, especially where there are multiple tax points for the same supply and the VAT treatment changes during the course of the commercial contract. For example, if the transaction shifted from being taxable at 5% to being exempt, then the supplier would no longer be able to recover VAT on associated costs and vice versa. Deduction entitlement should also be considered in the context of the Capital Goods Regime, and any change in use assessed as part of the VAT period and year end review process.
As the above sets out a change in the FTA’s technical interpretation and application of the law, there is a real risk that businesses have already experienced a change in use of a building or land, and have adjusted the VAT treatment based on the FTA’s historical guidance. Unfortunately, this may create errors in a business’ VAT compliance to date and may require a voluntary disclosure to be submitted to correct the position, including the potential application of penalties.
This change in the FTA’s interpretation more than two years after the implementation of VAT in the UAE clearly demonstrates that the regime is still young, and needs time to settle and mature. It is of critical importance that businesses closely monitor the FTA’s publications on a continuous basis, as early identification of VAT issues will always lead to a more timely resolution and mitigation of any associated costs.
VAT treatment of accommodation in labour camps
Employers of manual labours in the UAE construction industry and some other industry sectors often provide accommodation for those employees. This accommodation is often referred to as 'labour camps' and can take many forms, including movable accommodation and apartment blocks. It may at times be accompanied by additional services such as laundry or cleaning services.
Determining the correct overall VAT consequences associated with labour camps requires looking at each scenario on a case by case basis; identifying the exact facts surrounding the provision of the accommodation; and applying the various rules set out within UAE VAT legislation.
Sections 3.5 and 3.6 of the 2018 edition of the FTA Real Estate Guide, and the later public clarification on labour accommodation, set out the relevant UAE VAT rules together with the FTA's views on the correct application of these rules. The recent change to the Real Estate Guide in the context of labour accommodation has not technically amended the FTA's interpretation of the rules.
The first test is to determine whether the provision of the labour camp accommodation to employees is:
- a supply for VAT purposes by the employer to the employee; or
- a normal overhead cost of the business.
For the supply to be recognised for VAT purposes and therefore fall within the scope of UAE VAT it must be made in return for a consideration – for example, a direct charge to the employees, a deduction from the employees' salaries or a deduction of housing allowance due to the employee.
Where consideration is provided by the employee in return for the accommodation, the second test is to determine whether the accommodation would qualify as 'residential' or 'commercial'. This is important because:
- supply of 'residential' property is liable to VAT at 0% for the first supply, whether sale or lease, within three years of its completion, and is exempt from VAT for all other transactions;
- supply of 'commercial' property is liable to VAT at 5%.
Residential property is very strictly defined within UAE legislation, including examples of what will or will not qualify for VAT purposes. Anything which does not qualify will automatically be treated as commercial, and will therefore be liable to VAT at 5%.
The most relevant conditions for whether labour accommodation qualifies as residential are:
- it must be the employees' principal place of residence;
- it must be fixed to the ground and cannot be movable; and
- it must not be 'serviced' accommodation, for which non-incidental services in addition to the supply of accommodation are provided - this includes hotels, motels and similar accommodation.
The public clarification on labour accommodation issued by the FTA sets out some guidance on when the FTA views services provided with accommodation as 'incidental', and therefore not affecting the qualification of the property as residential.
Employers should assess the above conditions for the qualification of the property as residential including the level of additional goods and services supplied to employees, whether there are any separate charges for these and whether or not the services are 'incidental' in order to determine the correct VAT treatment of the provision of accommodation to staff.
Where no consideration is provided by employees in return for labour camp accommodation, then all costs associated with the provision of these benefits to staff should be assessed in the normal manner in order to determine if they are deductible by the employer in its periodic VAT returns. In this regard:
- the employer should have obtained and retain a valid VAT invoice for the costs on which VAT has been incurred in connection with the labour camp;
- the employer should have paid the relevant vendor invoices, or have a genuine intention to pay, within six months of the end of the credit period agreed with each vendor;
- the types of costs should not be specifically 'blocked VAT' items under UAE VAT legislation.
Specifically, there should be:
- a legal obligation for the employer to provide the accommodation and any additional goods or services to the employee under an applicable labour law;
- a contractual obligation or published internal policy to provide the accommodation and the additional goods or services to the employee, it can be proven to be normal business practice to do so and it is required in order for the employee to perform their role; or
- the provision of the accommodation and additional goods or services require the employer to account for sales VAT under the 'deeming' provisions set out within the UAE VAT regime.
Employers should assess employee accommodation in labour camps and any associated goods or services provided to employees under the above tests very carefully in order to determine their entitlement to recover VAT on these costs. Otherwise, this VAT will become a real cost to the business and affect its bottom line.
As a practical example, generally companies in Dubai that have more than 50 employees are legally obliged to provide accommodation to employees who are receiving a basic salary of AED 2,000 (approx. £442) or less. Therefore, if an employer obtains accommodation for these employees from an external vendor which has identified the provision of this accommodation as 'commercial' due to the supply of additional services, any VAT associated with this accommodation should be fully recoverable for the employer.
The FTA, in its recent update to the Real Estate Guide, has re-emphasised that VAT shall not be recoverable in scenarios where accommodation is not necessary for the employee to perform their role and is not legally required under applicable labour laws - for example, the provision of accommodation to staff in hotel apartments. The fact that the FTA felt the need to reiterate this point demonstrates that it is applying the relevant tests and considerations strictly, and that it may have come across businesses applying the rules incorrectly through recent audits. Businesses should therefore ensure that they are comfortable with the approach that they have taken to date, or should submit a voluntary disclosure in order to correct their VAT records.
VAT treatment of bare land
The supply by means of a sale or lease of bare land is exempt for UAE VAT purposes, meaning no VAT is required to be charged on the sale and there is no entitlement for the supplier to recover VAT incurred on associated costs.
Depending on the transaction in question and the parties to the transaction, there may be a natural preference for land to be treated as exempt bare land – for example, where there are no significant associated costs and the customer does not have full input VAT deductibility; or for it to be treated as taxable developed land – for example, where there are associated costs on which VAT has been incurred. However, it is not at the discretion of the parties to make this decision. Instead, they must assess the true status of the land at the time that it is supplied.
The UAE VAT legislation provides almost no guidance on how to determine whether the land is 'bare' or 'developed' for VAT purposes. It simply states that in order for then land to be bare land, it must not be covered by completed buildings, partially completed buildings or civil engineering works.
Sections 5.3, 5.4 and 5.5 of the 2018 of the FTA Real Estate Guide provided a lot more clarity as to how the FTA believes a taxpayer should determine whether the land is 'covered' in fully or partially completed buildings or civil engineering works. The recent update has not technically amended its interpretation or application of the UAE VAT legislation.
The FTA's guidance includes:
- the term 'covered' is viewed by the FTA as meaning that the building or works should be on top of the land. Therefore, if civil engineering works have been performed or construction of a building has started but neither the works nor the building are on top of the land, then the land would continue to be bare for VAT purposes. This would include, for example, foundations of a building below the level of the land or water pipes running under the land which never break the surface of the land;
- civil engineering works are not defined within the UAE VAT legislation or by the FTA. However, it is the FTA's view that they would need to be of sufficient substance to represent a fixed and immovable part of the land. For example, if a plot of land has been fenced to allow construction to begin, this would not be viewed as civil engineering works or a partially completed building on top of the land.
In the recent update, the FTA has extended its practical example of "temporary fencing around the plot of land" as something which would not convert the land from bare to developed for VAT purposes by adding additional wording that any other "temporary movable structures" placed on the land would also not render the land developed. This is another re-emphasis of a FTA interpretation that is already somewhat stated within the guide, and so the fact that the FTA felt the need to add this additional wording suggests that it may have come across businesses applying the rules incorrectly through recent audits.
Again, businesses should perform a self-assessment on their determination of land as bare or developed to date, and submit a voluntary disclosure in order to correct their VAT records if required.
The FTA's other updates to its Real Estate Guide were relatively minor, as follows:
- the section on apportionment methodology, para 7.3, was updated to be aligned with the December 2019 Input VAT Apportionment Special Methods Guide;
- the section on new residence refund requests, para 13.4, was updated to be aligned with the January 2020 New Residences VAT Refund User Guide;
- the section on owners associations, section 8, was updated in terminology to refer to 'management entities' in addition to owners associations. This may be viewed as an important update by management entities which took the view that they could not apply the rules for owners associations to date.
VAT on real estate and Covid-19
As the economic environment in the UAE continues to be turbulent and cash remains at the centre of business decision-making, it is important for in-house tax and finance leads to consider steps to mitigate the risk of additional tax costs and avail of tax optimisation opportunities.
Businesses should identify any risks created as a result of the above changes, or the broader application of the full VAT rules on real estate transactions in the region, and neutralise any liabilities or penalties before they increase to higher values. They should also seek to use tax in order to increase short term cash flow and even, where possible, reduce costs.
See our Out-Law guides: GCC tax planning and mitigation during Covid-19, and GCC tax reliefs for coronavirus.