Value Added Tax (VAT) in the UAE is the new kid on the block. It was introduced at the start of 2018 as a tax on the consumption of goods and services supplied by a taxable person – someone who carries out an economic activity that requires VAT registration.
Stay with me, people! It’s not rocket science. (It’s not even science. I imagine an urban dictionary definition for “tax accounting” would read something like this: “Precision guesswork based on unreliable data provided by those of questionable knowledge. See also Wizard, Magician.” (I saw that on a mug.))
VAT is an indirect tax, as opposed to a direct tax because the supplier collects and accounts for VAT on behalf of the tax authority. The government allows taxable persons to recover VAT incurred on supplies or services received where those supplies or services are used to make further taxable supplies or services. Have a headache already? Pop paracetamol and let me explain.
A design feature of the tax is that VAT is charged on each transaction within the supply chain (also known as Input VAT), but is reclaimed along the chain, until the ultimate consumer or user of services, who bears the cost of the tax (Output VAT). Simply put, a VAT-registered business should not incur any real cost when it comes to VAT because it should be fully recoverable, while the end user pays 5% tax in addition to the sales price.
The VAT rules in the UAE are:
- VAT charged at 5% standard rate.
- Mandatory VAT registration for businesses with taxable supplies and imports above AED375,000. Voluntary registration above AED187,500.
- 0% VAT, or zero-rated services or goods, is a taxable supply, which means that VAT is still recoverable on the zero-rated offering. These include certain education and healthcare supplies; goods and services exported outside the GCC; international transport; certain investment-grade precious metals; newly-built residential properties sold within three years of construction.
- VAT exemption means it is non-taxable services or goods, and include: residential properties; public transport; undeveloped land; life insurance; certain financial services.
- Fee-based financial services and non-life insurance are standard rated.
- Where goods or services are made up of partially taxable and non-taxable components, a partial exemption method of apportioning VAT will apply. Usually, the VAT apportionment would be based on the proportion relating to taxable supplies
- Generally, the place of supply is the location of the goods at the time of supply or, in the case of services, where the service provider is established.
- Specific rules apply for the supply of certain goods, like water and energy, and the cross-border supply of goods and services.
- VAT grouping allows UAE businesses operating under central control to account for VAT as a single person, and VAT can be ignored in transactions between these group companies.
- VAT registered entities must file VAT returns quarterly while retaining records for at least five years.
VAT and outsourced Payroll
What does VAT have to do with Payroll? Generally nothing. But where a VAT-registered services company outsources payroll, VAT is charged on the outsourced payroll services. If that’s the case, is the VAT reclaimable on payroll because your services are VAT-able?
Theoretically, if you offer services to clients that include VAT, the VAT on your outsourced payroll function should be recoverable as an input VAT. The wages of your workforce, the people who provide the ultimate VAT-able services to your clients, are an input cost in the generation of your business’s revenue, and should therefore be treated as such from a tax point of view.
It is imperative to check individual contracts of outsourced services so that it would accurately reflect the relationship of the outsourced function to the services your business provides. It can become even more complex if you outsource back-office functions to a business in a different country. Is the outsourced function now located in a GCC or non-GCC country, and what are the VAT rules there? Whether there are tax agreements between the UAE and another country is an important consideration because it will influence whether you can recover VAT in full or proportionately.
When the Ministry of Finance asks to inspect your business records to determine whether you treat VAT correctly, these contracts will form part of the bigger picture, as well as the meticulously kept financial records as stipulated under the VAT laws of the UAE.
The thought I want to leave you with is that VAT is not punitive. It is not a penalty, a curse, or meant to make life difficult for businesses. It’s part of the UAE government’s efforts to diversify its income to be less reliant on energy and gas as a means of income and to continue to offer high-quality public services to its citizens and residents.