Since the inception of VAT in the UAE in January 2018, the Federal Tax Authority (FTA) had put in place a strict penalty regime. It was much stricter than its neighbour Saudi Arabia, which implemented VAT at the same time. In terms of the types of penalties, it was not the harshest, since both Bahrain and Oman later imposed prison sentences for what are often considered administrative oversights.

The tax authorities were also very active from the start in 2018, mostly imposing automatic penalties, as our survey back then showed (https://aurifer.tax/news/vat-survey-shows-fta-is-very-active/?lid=482&p=14). However, the authorities also imposed their so-called 2-4-1 penalties for late payment, which were the most impactful. A business making a mistake and being audited would be subject to a fixed penalty of up to AED 5,000, but also a penalty of up to 356% of the unpaid tax. The predicted pushback in terms of litigation followed, as scores of tax payers challenged penalties, on whatever basis they could find. The litigation was potentially mainly in the interest of litigators.

The Federal Cabinet listened to the concerns of tax payers, and now decided to act and to reduce the penalties, but also propose a penalty amnesty for penalties applied under the old regime. Cabinet Decision No. 49 of 2021 amends provisions of the Cabinet Decision on Penalties (No. 40 of 2017) and enters into effect 60 days after the issuance, i.e. 28 June 2021.

In most circumstances, the new regime will be more beneficial. It should be noted as well, that there is still an FTA Decision to be expected to implement the changes.

Amnesty

First off the FTA would like to give all tax payers a clean slate. Tax payers having outstanding penalties under the old regime, i.e. imposed on 27 June 2021 or before, can benefit from a 70% waiver, provided they settle the penalties on or before 31 December 2021. This is surely to add substantial cash to the Federal budget.

What is currently not clear, and might be in the announced FTA Decision, is how to handle penalties against which tax payers have filed a reconsideration, have gone before the Tax Disputes Resolution Committee (“TDRC”), or have gone before the administrative courts. Insofar as we know, the FTA has not been open to negotiated settlements for these types of litigation, but perhaps this is an opportunity for tax payers and the FTA to agree on a settlement, even if they are already before court.

As a comparison, KSA until recently was offering a full waiver of all penalties for voluntary disclosures. The Cabinet has not opted for the same approach, though it offers a partial amnesty.

New penalty regime

What’s new in the new penalty regime then? A number of fixed penalties have been lowered (e.g. late registration, late deregistration, filing incorrect tax return, …). However, the paradigm shift came in the late payment penalties.

Where before, a tax payer was subject to the 2-4-1 penalties, i.e. 2% for paying one day late, 4% for paying a week late and 1% per day after one month, the monthly penalty is now only 4% (in addition to the 2% penalty which remains).

However, and this is probably the most fundamental change, in case of a voluntary disclosure or a tax assessment, the late payment penalty only starts to run as from 20 business days after the date of submission of the voluntary disclosure or receipt of the assessment. While this position was advocated before the UAE Federal Court of Cassation, the highest court had ruled that the FTA was correct in applying a penalty since the time of supply (UAE Court of Cassation 14 October 2020, Appeal No. 227 of 2020). The Federal Cabinet now decided that it is the right approach to start calculating late payment penalties after the submission of the voluntary disclosure, and not as of the initial supply.

In other words, under the new penalty regime, if the tax payer pays within 20 days, there is no late payment penalty due.

That does not mean he is completely off the hook as a proportional penalty is due ranging from 5 to 40% calculated on the difference between the tax calculated and the tax that should have been calculated. The range depends on the period elapsed between the error and the date on which the voluntary disclosure was submitted.

There is a substantial difference in the calculation of the penalty. Where the previously law had ambiguity around what constituted “payable tax”, the new regime is clear that any situation will be penalized where there is a difference between the tax calculated, and the tax that should have been calculated. Especially for tax payers in a constant refund position, this may constitute a higher penalty bill.

Comparison

In order to compare the effect of the amendments in the regime, let us have a look at a few examples.

Example 1 – Supply in January 2018

Company A in January 2018 made a supply which it had incorrectly zero rated. After reviewing its records, it came to the conclusion that it had not exported the goods from the UAE, but instead sold them on the local market. Company A comes to this conclusion on 15 June 2021. Company A has 20 days to file a Voluntary Disclosure.

It now faces the choice between making a voluntary disclosure under the old regime or under the new regime. The goods supplied had a value of AED 300,000 and the applicable VAT was AED 15,000. This is the first time Company A is subject to a penalty for submitting an incorrect tax return.

                                                Old regime           New regime

Fixed Penalties                     AED 3,000.00        AED 1,000.00

Proportional penalties         AED 750.00           AED 4,500.00

Late Payment Penalties       AED 45,600.00      AED 0.00

Total                                       AED 49,350.00     AED 5,500.00

It is clear that Company A has a real benefit in waiting for the new regime to be in force. However, as illustrated below, because of the dynamics triggered by the tax amnesty, depending on when the mistake is made, business may need to try and have the penalties imposed before or on 27 June 2021.

Example 2 – Supply in January 2021

Company B in April 2021 made a supply which it had incorrectly zero rated. After reviewing its records, it came to the conclusion that it had not exported the goods from the UAE, but instead sold them on the local market. Company B comes to this conclusion on 15 June 2021. Company B has 20 days to file a Voluntary Disclosure.

It now faces the choice between making a voluntary disclosure under the old regime or under the new regime. The goods supplied had a value of AED 300,000 and the applicable VAT was AED 15,000. This is the first time Company B is subject to a penalty for submitting an incorrect tax return.

                                              Old regime        New regime

Fixed Penalties                    AED 3,000.00     AED 1,000.00

Proportional penalties        AED 750.00        AED 750.00

Late Payment Penalties      AED 900.00        AED 0.00

Total                                      AED 4,650.00    AED 1,750.00

Waiver                                   AED 3,255.00      N/A

Net                                         AED 1,395.00     AED 1,750.00

Company B has an incentive to voluntary disclose the transaction before the new regime enters into force so that the penalties are imposed under the old regime.

Example 3 – Supply in January 2021

Company C in January 2021 made a supply which it had incorrectly zero rated. After reviewing its records, it came to the conclusion that it had not exported the goods from the UAE, but instead sold them on the local market. Company C comes to this conclusion on 15 June 2021. Company C has 20 days to file a Voluntary Disclosure.

It now faces the choice between making a voluntary disclosure under the old regime or under the new regime. The goods supplied had a value of AED 300,000 and the applicable VAT was AED 15,000. This is the first time Company C is subject to a penalty for submitting an incorrect tax return. Company C is in a constant refund position, and even after correcting the January 2021 supply, it remains in a refund position.

                                              Old regime        New regime

Fixed Penalties                    AED 3,000.00    AED 1,000.00

Proportional penalties        AED 750.00       AED 750.00

Late Payment Penalties      AED 0.00           AED 0.00

Total                                      AED 3,750.00     AED 1,750.00

Waiver                                   AED 2,625.00     N/A

Net                                         AED 1,125.00      AED 1,750.00

Company C has an incentive to voluntary disclose the transaction before the new regime enters into force. Note that we have observed here that the FTA had not applied penalties under the old regime for these kinds of mistakes. However, we would have expected it to treat an over claimed amount in the same way as an underpaid amount.

Example 4 – Failure to register

Company D in January 2021 made supplies worth AED 400,000 but failed to register for VAT purposes. On 15 June 2021 it discovers it had to register for VAT purposes already back in January 2021. 

                                   Old regime         New regime

Fixed Penalties         AED 20,000.00   AED 10,000.00

Waiver                        AED 14,000.00    N/A

Net                              AED 6,000.00     AED 10,000.00

Company D has an incentive to make use of the old regime to register for VAT purposes, before the new regime enters into force.

Audit and enforcement

When we conducted our survey back in 2018, we saw a very active FTA. With the additional resources it has gained over the years, it has conducted a great number of additional audits. Especially refund audits have been very prevalent. More regular audits have happened as well, although these often focused on entertainment expenses and non-compliant invoices. In 2023, transactions conducted in 2018 will be statute barred, so we may see additional activity by the FTA to ensure compliance before that date.

Tax payers have consciously being disclosing non compliant transactions and reporting under the old regime, and were hit with penalties, which then often spilled over into litigation.

Once the liabilities are final, or the court case ruled, the file would eventually end up in enforcement. The advantage the FTA had in litigation is the application of the “pay and claim” principle. If the tax payer lost the case, the litigious amount was already paid.

In situations where there was no Tax Disputes Resolution Committee litigation, the liabilities sometimes remained outstanding (with no additional penalty being added), or for businesses in a refund position, the refund was compensated bit by bit by the penalty amount.

Since 2018, the FTA did take a number of steps to encourage compliance and try and move tax payers towards settling their liabilities.

It had for example suspended the application of the automatic reverse charge mechanism for businesses with a customs number and a VAT number which were linked. The only impact of this decision was negative cash flow.

In addition, in early 2021, the UAE appointed judicial officers which have the powers to seize assets. This was seen as a step up in terms of the enforcement in the UAE.

Conclusion

Rather than stepping up enforcement under its tax procedures law (see our article on the FTP law (https://www.aurifer.tax/news/the-uae-publishes-more-detail/?lid=482&p=19) and on the FTP law lacking director’s liability (https://www.aurifer.tax/news/dawn-of-a-new-tax-era–corporate-perspectives/?lid=482&p=14), the UAE has chosen to make it easier to correct mistakes.

It has taken a substantial turn with the newly implemented policy, which will surely have a very beneficial impact on the tax compliance climate in the UAE. While the penalties are still there as a deterrent, there is now a real motivation in most cases to voluntary disclose and to build a more horizontal and transparent relation with the FTA. The move is without doubt a benefit to businesses, in terms of reduced penalties applied for errors made, and a benefit to the FTA, in terms of increased compliance and perhaps additional revenues from this increased compliance and the amnesty.