Out-Law Analysis | 14 May 2020 | 8:38 am | 14 min. read
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.
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.
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:
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:
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:
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:
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:
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:
Specifically, there should be:
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:
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:
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.
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