Everything You Should Know About VAT Treatment of Compensation Payments

Businesses often make compensation payments for any loss, omission or wrongdoings and this may often lead the businessmen to ponder over the UAE VAT treatment of such compensation payments. The VAT Public Clarification VAT P001 makes it clear that VAT in the UAE is a tax levied on supplies of goods and services and therefore no VAT is due if there is no supply. The Federal Tax Authority (FTA) views the VAT treatment of Compensation Payment from this vantage point (as detailed in the clarification) and the taxpayers can consult with VAT Consultancy firms in Dubai for further insights and assistance. For enthusiasts, here is a detailed guide that describes everything the businesses need to know about VAT on Compensation Payments in the UAE.

Key Principle to Determine VAT Treatment on Compensation Payments

The FTA through Public Clarification VATP001 has laid down the following principles that the businesses can use to determine if the VAT should be due on compensation payments:

1) A Contractual Payment to Compensate for Loss

Liquidated damages are the most common types of compensatory payments. Liquidated damages are the amounts that the two parties agree on during the signing of a contract in case any of the parties carry out a breach of contract. The rationale behind such payments is to compensate a party for the lost earnings caused by the specific breach and it is not in relations to supply any goods or services. Therefore such types of compensations are outside the scope of VAT. Examples include early termination of a contract or a late performance.

However, this doesn’t include cases like a contract that allows a hotel guest to cancel a booking in return for a cancellation charge. This is because such charges are deemed as a cessation of a right, which is a supply of a service and therefore is subject to UAE VAT. The best tax agents in Dubai will assist the businesses in clearing the air in such situations for VAT.

2) A Payment to Settle a Dispute

In cases where a dispute is settled (in or out of court) and payment is given to a party, VAT Consultancy firms in Dubai advise the businesses to consider the reason behind the payment to determine the VAT treatment. For example,

  1. In cases where a payment is made to enforce a contractual term, VAT is applicable as payment is a consideration for the contractual supply
  2. Where the payment is made as compensation for any loss, the FTA won’t consider the payment as a consideration for the supply and therefore it is outside the scope of VAT in the UAE.
  3. In cases where a payment is made in return for the grant of a right, the payment will be treated as consideration for the supply and therefore VAT is charged.

3) A Fine or Penalty

A fine or penalty may be imposed as a result of breaching terms of the agreement, carrying out activities that are against law etc. Payments made for compensating the breach of contract is in the nature of damages and is therefore outside the scope of VAT. Government Authorities often impose fine for speeding or unlawful parking. Such penalties are imposed to punish the violators for the act and the party imposing the penalty is not making any supply in respect of the payment. Therefore, no VAT is due on such fines and penalties

4) Payment for Damaged Goods

FTA says if the payment is compensation for the damage or loss of goods or breaching the pre-existing terms of a contract, it won’t be treated as consideration for a supply and therefore is outside the scope of UAE VAT. However, there is an exception to this in certain circumstances. For example, if a customer breaks a good and is required to take the tile of the broken good, then the payment made by the customer would be treated as a consideration for a supply of goods, and hence would be subject to VAT.

Advice from VAT Consultancy Firms in Dubai, UAE

In order to determine VAT is due to compensation payments, the businesses need to have clarity on whether the payment qualifies as a consideration for a supply. Prominent VAT Consultancy firms in Dubai advise the taxpayers to consider the various scenarios illustrated in this blog to determine the VAT applicability on compensations. The businesses should consider contractual arrangements and levy VAT accordingly. For assistance, the taxpayers can consult with the best VAT consultants in Dubai such as Jitendra Chartered Accountants (JCA).

JCA assist businesses in VAT registration, VAT deregistration, VAT Return Filing, Tax reconsideration etc. JCA ensures the seamless delivery of VAT services on the back of a team of highly qualified registered tax agents in Dubai.  With JCA’s expert assistance businesses can ensure VAT compliance and have a good image before FTA and the government.

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