We are Aurifer. We are a boutique
tax firm established in Dubai.
Aurifer assists in tax controversies with the tax administration. We guide you through initial stages of securing tax treatment through agreements with the tax authorities, through administrative controversies after an audit, and finally before the courts through our partnership with renowned law firms.
Who we serve
for governments and businesses to understand the implications to their organization.
Global top tier businesses
Law and services firms
The Holy Month of Ramadan is the ninth month of the Islamic calendar, observed by Muslims worldwide as a month of fasting, prayer, self-reflection and enhanced community spirit. The annual observance of Ramadan is one of the five pillars of Islam.
Ramadan is regarded as a time of piety, charity and blessings. Charities and foundations are noticeably more active during the Holy Month, providing assistance to those in need. Meals are provided at mosques, malls and other public places in a spirit of generosity.
Businesses see the Holy Month of Ramadan as an opportunity to organize sales and offer promotions, deals, discounts, gifts and benefits of all kinds. For example, companies may offer "buy one, get one free” or "two for the price of one” promotions or combined offers, where certain products are offered for free or at a reduced priced when bought together with another product (e.g. receiving one year of car insurance free of charge when buying a new car).
Traditionally, businesses also celebrate the Holy month by hosting Iftar parties, hand out Iftar snack boxes or give gifts in cash or in kind during Eid al Fitr, the religious feast which marks the end of Ramadan.
This article discuss how to deal with UAE VAT in the spirit of generosity.
There is no such thing as a free lunch?
VAT does not like free items. It taxes so-called deemed supplies, where businesses give things away for free for which it previously deducted input VAT. However, not all free supplies are deemed supplies. Even though both look similar, i.e. a third party seemingly receives something without paying for it, only deemed supplies carry VAT consequences.
As part of its sales strategy, a business may provide a customer with a free item. A supermarket could offer a ‘buy one get one’ formula, for example for shampoo bottles. Although it is providing the second bottle for free, the customer has actually paid a lower price for two bottles. Therefore, this situation is rather a so-called joint offer, and not a deemed supply.
The same reasoning holds for promotional discounts, where a business is slashing its prices with 50% during Ramadan. A business is not offering half of the product for free, but rather a discount on the price.
Perhaps a business considers giving a different item in addition to the item bought. Upon purchase of an electrical toothbrush, the seller offers 2 free tubes of toothpaste. Although the item is given for free, it is still not a deemed supply. The free item is given with the objective of increasing sales of the main item and is ancillary to it.
It is a very different situation when a grocery store decides to donate food supplies to a shelter or to allow all employees to pick an item from its stock for Ramadan. Those constitute deemed supplies and VAT needs to be charged on them. This means that VAT on these deemed supplies constitutes a cost for the business since it is giving the items for free.
If employers upon purchase however already know that they are purchasing items which are not intended for taxable supplies, they cannot recover the input VAT (and the subject of the deemed supplies is not even on the table).
The business making the deemed supplies needs to issue a tax invoice for the deemed supply and ideally deliver it to the recipient. The VAT on the tax invoice is not deductible in the hands of the recipient.
In the UAE, the taxable value of deemed supplies is its cost. This constitutes the taxable basis on which VAT should be accounted for.
However, even though a supply may constitute a deemed supply, two thresholds apply. If a business stays below the thresholds, it can continue to recover the input VAT and does not have to account for VAT on the deemed supply.
There are two thresholds:
- The output tax chargeable on all deemed supplies should not exceed AED 2,000 in a 12 month period (i.e. AED 40,000 of costs VAT exclusive), and;
- The value per person does not exceed AED 500 in a 12 month period (i.e. AED 10,000 of costs VAT exclusive) and it concerns samples or commercial gifts.
These thresholds allow businesses to occasionally provide small benefits or gifts to their employees and third parties without incurring VAT liabilities.
Given the fact that these thresholds are very low, a business will easily exceed the threshold. Taking into account the substantial administrative burden of having to monitor the thresholds and put a process in place, a business could chose to ignore the thresholds and always account for output VAT. That is also what most informed businesses seem to do.
Entertainment and personal expenses made during Ramadan
VAT is only recoverable when it is paid for goods and services bought for making taxable supplies. However, even though a business may exclusively make taxable supplies, there may still be expenses which are non-recoverable.
When an employer buys items and gives them to its employees for no charge and for their personal benefit, the employer cannot recover the input VAT. For example, if the employer decides to purchase chocolate dates for Ramadan to give to its employees, the input VAT paid is irrecoverable.
The same holds for so-called 'entertainment expenses’. Entertainment services are “hospitality of any kind”. This includes hotel stays, food and drinks, tickets for shows and events and trips for entertainment.
Therefore, if a business organizes an iftar for its employees and for third parties, the input VAT is not deductible. Even though the event is held with the objective of improving social cohesion and increase sales, and therefore it has a clear business purpose, it is considered an entertainment expense.
In a public clarification published by the Federal Tax Authority, it did confirm however that VAT on certain entertainment costs is recoverable when used for a genuine business purpose, or when incidental to a business purpose. For example, VAT on food and drinks provided during a business meeting, is recoverable, if:
- The hospitality is provided at the same venue as the meeting;
- When the meeting is interrupted, it is only by a short break for the provision of the hospitality and then resumes as normal e.g. a lunch break;
- The cost per head of providing the hospitality does not exceed any internal policy the business has established;
- The food and beverage provided is not accompanied by any form of entertainment e.g. a motivational speaker, a live band etc.
On the other hand, where the hospitality provided becomes an end in itself and is the purpose for attending an event, it will be considered as entertainment costs and VAT is not recoverable.
In other words, if the staff comes for the party or for the Ted talk, the business will not be able to recover the input VAT. If the gathering is serious business, the input VAT will be recoverable.
Despite the fact that charities will mostly carry out transactions which are out of scope of VAT, given they do not charge any consideration, they may still occasionally render taxable supplies and therefore incur certain VAT obligations, such as the obligation to register for VAT purposes.
Charities will mostly receive their income from subsidies or donations. Such income is outside of the scope of VAT. Occasionally, it may provide sponsoring opportunities to business, which are subject to VAT.
Under normal VAT recovery rules, input tax is only recoverable where it relates to taxable supplies. In most cases, charities will therefore be required to allocate and apportion VAT recovery between taxable activities (recoverable) and non-taxable activities or exempt activities (non-recoverable). The input VAT recovery may therefore prove to be quite complex.
A special refund scheme applies to so-called Designated Charities, which meet the criteria set by the Federal Tax Authority.
The Holy Month of Ramadan triggers VAT consequences for businesses. Businesses making sales promotions are required to examine the VAT consequences of these sales promotions. Business also may need to not recover input VAT on certain purchases or charge VAT on a deemed supply when providing employees with entertainment or gifts. Charities also do not have an easy task ahead in calculating their VAT liabilities.
Given the very strict penalty framework, it is important to be aware of the VAT consequences of these activities in order to avoid VAT claims or penalties.
With the impending publication of the drafting of an economic substance law in the UAE, it is important to anticipate the consequences of the introduction of such a law on the UAE and offshore structures in the UAE. The UAE currently has no such substance requirements but has been strongly encouraged by the European Union to implement them. The impact on offshore structures will be substantial.
Current lack of substance requirements
The UAE is a federation of seven emirates. There is currently no direct tax legislation on a federal level in the UAE. However, some Emirates (e.g. Abu Dhabi, Dubai, Sharjah,...) have introduced income tax regimes for oil and gas companies and foreign banks. These decrees only apply to companies which are established in one of the aforementioned Emirates. The Income Tax Decrees do not contain any substance criteria.
Partly as a result of the current lack of substance requirements in the UAE, it has become increasingly important for international companies established or operating in the UAE to prove that the entity or structure has not been set up solely for tax purposes.
Tax residency certificate
Corporations established in the UAE can apply for a ‘tax residency certificate’ ('TRC') with the Ministry of Finance of the UAE. A tax residence certificate (‘TRC’) is a certificate issued by the UAE government to eligible government entities, companies and individuals to benefit from Double Tax Treaties signed by the UAE.
The following documents are generally required in order to apply for the tax residency certificate:
- Valid Trade License.
- Certified Articles or Memorandum of association.
- Copy of identity card for the Company Owners or partners or directors.
- Copy of passport for the Company Owners or partners or directors.
- Copy of Residence Visa for the Company Owners, partners or directors.
- Certified Audited Report.
- Certified Bank Statement for at least 6 months during the required year.
- Certified Tenancy Contract or Title Deed.
Please note that although the requirements do not expressly mention that the certificate can only be granted to local companies, the Ministry of Finance does not issue tax residence certificates to offshore companies (not to be confused with free zone companies).
Although the TRC may be helpful to obtain benefits under double tax treaties, in itself it cannot be considered as proof of economic substance in the UAE.
Developments on substance requirements in the UAE
On 1 December 1997, the EU adopted a resolution on a code of conduct for business taxation with the objective to curb harmful tax competition. Shortly thereafter, the Code of Conduct Group on Business Taxation (COCG) was set up to assess tax measures and regimes that may fall within the scope of the code of conduct for business taxation.
On 5 December 2017, the COCG published the (first) EU list of non-cooperative jurisdictions for tax purposes, in cooperation with the Economic and Financial Affairs Council (ECOFIN).
The EU applies three listing criteria, which are aligned with international standards and reflect the good governance standards that Member States comply with themselves:
- Transparency: Jurisdictions should comply with the international standards on exchange of information, automatic (1.1) and on request (1.2). In addition, jurisdictions should sign the OECD's multilateral convention or signed bilateral agreements with all EU Member States to facilitate such exchange (1.3).
- Fair Tax Competition: Jurisdictions should not have harmful tax regimes (2.1) nor facilitate offshore structures which attract profits without real economic activity (2.2).
- BEPS Implementation: Jurisdictions should commit to implement the OECD's Base Erosion and Profit Shifting (BEPS) minimum standards, starting with Country-by-Country Reporting.
The UAE was initially placed on the EU Black list. However, following commitments to take appropriate measures against the above criteria, the EU transferred the UAE to the EU Grey list.
However, due to non-compliance with criterion 2.2, the UAE was subsequently put back on the Black list at the start of this year. Criterion 2.2 requires that a jurisdiction should not facilitate offshore structures or arrangements aimed at attracting profits which do not reflect real economic activity in the jurisdiction.
Therefore, in order to fulfill its commitments to the EU, it is reasonable to expect that the substance requirements are likely to be introduced in the UAE in the foreseeable future.
In accordance with the scoping paper on criterion 2.2 published by the COCG on 22 June 2018 and the associated work of the OECD's Forum on Harmful Tax Practices (FHTP), the below describes how businesses may be impacted and what substance requirements could potentially be introduced in the UAE in the future.
Expected substance Law requirements
The scoping paper suggest to implement the substantial activities requirement in three key steps:
(1) identify the relevant activities in their jurisdiction;
(2) impose substance requirements;
(3) ensure there are enforcement provisions in place.
According to the Scoping Paper, the economic substance test would be met if:
a) Taking into account the features of each specific industry or sector, the concerned jurisdiction introduces requirements concerning an adequate level of (qualified) employees, adequate level of annual expenditure to be incurred, physical offices and premises, investments or relevant types of activities to be undertaken.
b) The concerned jurisdiction ensures that the activities are actually directed and managed in the jurisdiction. Any UAE substance requirements are likely to further specify when this condition would be met e.g., depending on frequency of board of director meetings, directors physically present, minutes recording strategic decisions and the knowledge and expertise of the directors.
c) The core income generating activities are performed in the jurisdiction. These substance requirements should mirror the requirements used in the FHTP in the context of specified preferential regimes. As per the scoping paper, the core income generating activities for banking could be: raising funds; managing risk including credit, currency and interest risk; taking hedging positions; providing loans, credit or other financial services to customers; managing regulatory capital; and preparing regulatory reports and returns.
Comparison with the other low tax jurisdictions which introduced the substance requirements
Following the EU blacklist of non-cooperative jurisdictions, many other low and nil tax jurisdictions have introduced economic substance requirements. Jurisdictions where substance compliance is required from 2019 include Bermuda, the British Virgin Islands (BVI), the Cayman Islands, Guernsey, and Jersey.
The Economic substance Law of BVI and Cayman Island are inspired by the core requirements in the scoping paper of the COCG and the FHTP requirements. The UAE is expected to follow the same path.
Currently, there are no substance requirements in the UAE. Corporations established in the UAE may apply for a ‘tax residency certificate’ with the Ministry of Finance of the UAE, when they qualify. Obtaining such a 'TRC' does not necessarily entail that a company has economic substance in the UAE.
Considering the efforts made by the UAE with respect to compliance with the fair tax competition criteria of EU, we anticipate that the UAE will issue economic substance requirements in the very foreseeable future, similar to the ones published recently by other low tax jurisdictions.
The specific substance requirements in the UAE will likely depend on the type of activities conducted by the relevant business (e.g., banking, shipping and headquarter services would each require different substance requirements).
Businesses in the UAE should already assess their operations against the substance requirements in the light of the COCG and FHTP guidelines.
In March 2019, the NBR published its fourth VAT Guide, i.e. the VAT Real Estate Guide. This guide aims to provide an overview of the rules and procedures regarding real estate in Bahrain as well as the necessary background and guidance to help taxable persons determine how a supply is treated for VAT purposes. In this article we elaborate on the Bahraini VAT treatment of transactions linked to Real Estate and we included the excerpts from our article “GCC - VAT on Real Estate Transactions – A Comparative View of Saudi Arabia and the United Arab Emirates”and “VAT in United Arab Emirates, Saudi Arabia and Bahrain - Transitional Rules”.
Definition of real estate
Real estate includes any area of land over which rights, interests or services can be created, as well as any building, structure or engineering work permanently attached to the land and any fixture or equipment which makes up a permanent part of the land or is permanently attached to a building, a structure or engineering works. Real estate does not include any furniture, fittings, plant and apparatus which are not attached to land or a building and which can be removed without damaging the property.
VAT treatment of the sale of Real Estate
Under the Bahraini VAT Law, a supply relating to the grant of rights in rem deriving from ownership giving the right to use real estate is considered as a supply of goods. Therefore the place of supply of real estate is there where the real estate is located. This is in line with the GCC agreement and the UAE and KSA apply the same place of supply rule for real estate.
The sale, lease or license of real estate located in Bahrain is an exempt supply, regardless of whether the real estate is residential, commercial or land (bare or partly developed). Even though the GCC VAT agreement allows the implementation of an exemption for both residential and commercial real estate, it is very striking that Bahrain used this opportunity since the KSA and UAE have a stricter exemption.
Some supplies are not considered as real estate for VAT purposes and the VAT implications of these supplies will need to be determined on a case by case basis. The following supplies will not be considered as the sale or rental of real estate and will therefore, be taxable at the standard rate of 5%:
- Hotel accommodation
- Provision of paid car parking for periods of less than one month
- Provision of serviced office space where the customer does not have the right to use a designated space on an exclusive basis
- Rental of a function room, hall or similar facility
- Providing permission to affix equipment and signage to land or buildings.
- Provision of space for retail or promotional stands (e.g. at a shopping mall, retail or entertainment area) for a period of less than one month
- Serviced accommodation with a rental agreement for a period of less than a year
- Rental of storage or warehousing facilities to a customer without the right to access the space
- Provision of labour accommodation which is not the principal place of residence of labourers in Bahrain
In the UAE, the sale of bare land is exempt. The sale and lease of commercial building is subject to VAT at 5% whereas, the first sale of the residential building made within three years of the completion date and lease of the same building is zero rated for VAT purposes. The subsequent sale and lease of the residential building is exempt from VAT.
However, in the KSA sale of both commercial and residential land and buildings is subject to VAT at 5% whereas the lease of residential real estate is exempt for VAT purposes in the KSA.
The difference in the application of VAT on sale of commercial and residential buildings and land makes the VAT treatment of the real estate much more complicated in the UAE and the KSA than in Bahrain. On the other hand, by applying a wide exemption on the supply of real estate , it is more likely that VAT becomes a cost for the real estate sector in Bahrain than in the other countries.
VAT treatment of Real Estate related services
Real estate related services in Bahrain are those services which are directly connected with the real estate. These include, but are not limited to, the following:
- Services by real estate experts or agents
- Services which involve the preparation, coordination and performance of construction, destruction, maintenance, conversion and similar work
- Accommodation services provided at extra charge such as management services, utilities, telecommunications, internet and television etc.
- Services by auctioneers, architects, interior designers, surveyors, engineers and others involved in matters relating to real estate
For real estate related services the same place of supply rules apply as for the supply of real estate, which is that the supply takes place where the real estate is located. A resident taxable person making a supply of such services will account for VAT on the provision of these services.
If a non-resident person makes a supply of these services in relation to Bahraini real estate to a Bahraini taxable person, the Bahraini taxable person will need to self-account for VAT under the reverse charge mechanism. That means that the supplier is not liable for Bahraini VAT and should not charge Bahraini VAT on its supply. Where the recipient is not a taxable person, or is a taxable person but not registered, the non-resident will need to register for VAT in Bahrain and account for VAT on the provision of the service.
The real estate services will be taxed at the standard rate of 5%, unless the supply is specifically exempt from VAT or zero-rated.
Apart from the exemption for commercial real estate, the UAE and KSA apply similar rules for the supply of real estate related services.
VAT treatment of construction works
Construction generally means building something such as a house, office, factory, warehouse, road, bridge etc. Construction may also involve demolition, refurbishment/reconstruction of existing buildings or structures and site clearance activities. Construction involves providing a building service but may also involve providing goods as part of such a service.
Construction services and the goods supplied in Bahrain for construction are regarded as taxable supplies if they are carried out by a taxable person. This is irrespective of the type of building (e.g., residential, commercial, industrial building) being worked on or the type of other construction work (e.g., civil engineering works).
Construction services and the goods supplied in the course of providing construction services for a new building are zero-rated for VAT purposes in Bahrain. All other taxable supplies of construction services or supplies of goods used for construction will be subject to the 5% VAT rate.
All types of construction services performed in the KSA and in the UAE are supply of services which is subject to VAT at the 5% rate. This VAT treatment will apply regardless of the type of building which is being constructed.
Transfer of a going concern
The transfer of a going concern in all three concerned GCC states (KSA, UAE and Bahrain), with or without consideration, does not fall within the scope of VAT if certain conditions are met. If a transaction involves real estate (e.g., the sale of the freehold interest in a building with tenants in situ) and all of the conditions for the transaction to be a transfer of a going concern for VAT purposes are met, the transaction will be outside the scope of VAT. If the relevant conditions are not met, the VAT implications of the transaction will need to be considered as it may involve both taxable and exempt supplies.
Output VAT payment
For the sale of Real Estate, VAT becomes due on the date that property is transferred to the recipient. However, VAT can become due earlier if (i) a tax invoice is issued by the supplier before the transfer date or (ii) the recipient makes a payment to the supplier.
Typically, when there is a supply of services, some supplies will be considered as “one-off” services, which will follow the general tax due date rules set out above, whereas other services will be considered as continuous supplies (for example, rentals and lease agreements). In case of continuous supplies VAT becomes due across the period the goods and services are provided, in line with the invoicing and payment arrangements.
When twelve months have passed from the start of the contract or from the previous tax due date, a tax due date will be triggered at that twelve-month point.
A construction contract may contain provisions whereby the customer may withhold a retention amount pending rectification of matters identified as part of the snagging process. The VAT treatment of such retentions often leads to important discussions.
Input VAT deduction
Deduction of input VAT is based on the intended use at the time of purchase. A VAT registered person may deduct input VAT charged on goods and services it purchases or receives for its taxable activities purposes. A person making both taxable and exempted supplies can only deduct the input VAT related to taxable supplies.
For example, VAT incurred on expenses or purchases (i.e., professional legal fees, refurbishment, etc.) that is attributable to making exempt supplies of real estate will not be recoverable by the taxable person. When a taxable person will use the building for the purposes of fully taxable activities, it can recover the VAT on costs on the construction of the new building in full.
The overhead costs/expenses incurred by the taxable person for making both taxable and exempted supplies must be apportioned to most accurately reflect the use of those costs in the taxable portion of the taxpayer’s activities. A prescribed default method of proportional deduction is calculated on the values of supplies made in the year, using the following fraction: value of total taxable supplies made by the taxable person divided by total value of taxable supplies and exempt supplies made by the taxable person. This fraction is identical to the input tax apportionment method in the KSA. However, in the UAE the apportionment is by default made on the basis of relevant input tax incurred.
The Bahraini VAT Law provides special rules for contracts concluded prior to the VAT-implementation date. In case the contracts do not contain any tax clauses, the agreed consideration is considered to be inclusive of VAT. Furthermore a zero rate applies for contracts entered into before 1 January 2019 with the government where the supply takes place after the implementation date. This zero rate can only be applied until the date of the contract's renewal, or its expiration, or 31 December 2023, whichever is earlier.
The transitional provisions in Bahrain are a combination of the KSA grandfathering rule (temporary zero rate on contracts concluded prior to 30 May 2017) and the UAE’s transitional rules (by default inclusive of VAT).