Public Clarification on Compensation Payments

Feb, 2020

Compensation Payments are for any loss, breach of contracts, omission etc. This type of expense occurs in the normal course of business only. Recently, FTA has issues a clarification vide no.: VATP001, on VAT
treatment on compensation payments.

This Public Clarification issued by the FTA is meant to clarify certain aspects related to the implementation of the Federal Law No 7 of 2017 on Tax Procedures, Federal Decree-Law No 8 of 2017 on Value Added Tax and their Executive Regulations.

In order to charge VAT on compensation payments, it has to be satisfied as a supply under the UAE VAT Law. Hence, VAT should be applied if it is related to supply of any goods or services in the normal course of business. FTA has issued in the clarifications that
“in order to determine whether or not a payment is considered a supply, it is necessary to consider the contractual and legal arrangements in full to determine the reason for the payment. Thus, it may be necessary to consider whether the payment is consideration for any previously agreed goods or services; if it is consideration for any
newly created supply of goods or services; if the purpose of the payment is to adjust a previously agreed-upon consideration for a supply; if a party is granting a right to another party in return for a payment; if a party is promising not to exercise a right in return for a payment; or if a party is giving something up in return for a payment.”

Compensation payments are considered as outside the scope of VAT and not considered as supplies. However, this does not include any payments which are made towards cessation of rights for supply of services or goods therefore would fall under the scope of UAE VAT Law. A typical example of this is where a hotel charges cancellation

Payments for compensation against any loss, negligence or other errors shall not be treated as a consideration for a supply and shall be outside the scope of UAE VAT Law.

Below table explains some types of compensation payments and its taxability

SNo. Type of Compensation Payment Taxability under UAE VAT
1 Insurance claim on stock loss due to fire Not Taxable
2 Payment against damaged goods Not Taxable
3 Violation of agreement / breach of terms of a contract Not Taxable
4 Liquidated damages Not Taxable
5 Compensation for Late Performance(Exception Hotel cancellation fees) Taxable
6 Payment for granting a right Not Taxable
7 Payment for loss of earnings(Interest Charges) Not Taxable
8 Payment to settle a dispute Taxable
9 Payment to enforce a contractual term Taxable

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