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Special Tax Payers in the GCC: Exempt taxable persons

Special Tax Payers in the GCC: Exempt taxable persons

The four GCC countries which have introduced VAT so far, UAE, KSA and Bahrain, have based themselves on the GCC VAT Treaty to draft their laws.

There is a special group of VAT payers, which have a special capacity as stakeholders in the VAT system. They sit on the fringes of the VAT system, not being a full on taxable person, and neither simply a payer, like private persons would be.

In the EU, this special group is sometimes called the “group of four”, or the “persons benefiting from an exception regime”. Together with the capital assets scheme, it is one of the more technical matters in VAT, and its status under GCC VAT is at a minimum lacking in clarification.

In a previous article, we explored the status of the non taxable legal persons (https://www.aurifer.tax/news/non-taxable-legal-persons-in-the-gcc-may-need-to-register/?lid=482). In this article, we cover the exempt table persons. In the upcoming articles, we will be covering also the other special categories of taxable persons. Going forward we will refer to them as “special tax payers”.

GCC VAT and its origins

While not stated, the origin of the GCC VAT Framework (or “Common VAT Agreement of the States of the Gulf Cooperation Council” in full) lies in the EU VAT directive 2006/112/EC. More specifically it corresponds to the version applicable after 2011 and before 2013. The reasons for drawing inspiration from the EU VAT directive are obvious. The GCC had ambitions to copy the EU model.

For example, the Economic Agreements between the GCC States of 1981 and 2001 read like the Treaty of Rome, which established the European Union.

The GCC had ambitions to form a similar trade bloc like the EU. While it indeed negotiates free trade agreements together, internally it works in a different way. It tried to establish a currency union as well, but was unsuccessful, although given that the countries have pegged their currency (relatively closely to) the US dollar, in practice they may have implemented certain elements of the monetary union. One of the more eye catching provisions of the Economic Agreements is that GCC citizens are allowed free circulation within the GCC. Such free circulation is again exactly the same principle which applies to EU citizens.

In addition to wanting to follow in the footsteps of the EU politically, there is another good reason to incorporate EU VAT provisions. The EU has the oldest VAT systems, and has the oldest VAT systems integrated in a customs union (see https://aurifer.tax/news/the-challenges-of-drafting-tax-legislation-and-implementing-a-vat-in-the-gcc/?lid=482&p=15 for a discussion on the genesis of the laws).

The copy is never better than the original

Like VHS tapes, the copy is never better than the original. This holds even more true when the copy is made from an old original. The GCC VAT Treaty does not incorporate the important changes to the EU VAT directive entered into force in 2013, 2015 and now in 2021.

At the same time, that does not necessarily need to mean that adverse consequences are triggered for the GCC States. The UAE has for example integrated the 2015 changes in its guidance and de facto applies them (https://www.aurifer.tax/news/e-commerce-vat-rules-in-the-gcc-a-missed-opportunity-at-perfect-harmonization-with-the-eu/?lid=482). Bahrain has done the same in its guidance for the place of supply rules applicable to telecoms services.

A special group of tax payers

Like EU VAT, GCC VAT has two important main groups of stakeholders. They are the taxable persons on the hand and the private individuals on the other. The taxable persons are the businesses complying with VAT. That means they charge it, collect it and pay it to the tax authority. The private individuals are the consumers who carry the economic burden of the VAT and pay it to the businesses. They are the ones hit with the rise in cost.

Let’s say that the taxable persons are “all in” and the private individuals “all out”. The private individuals have no obligation whatsoever. Although it may surprise, they have no legal obligations, except for their contractual obligations towards their contracting parties (and for imports made by private individuals).

There’s another special group though. They often go by a special name even. In France for example they call them the persons benefiting from an exceptional regime (“personnes beneficiant d’un regime derogatoire”). Elsewhere they may call them the “group of four”. In this article, we refer to them as the “special tax payers”.

Contrary to the taxable persons and the private individuals, the special tax payers are neither all in, nor all out. Whether they have VAT obligations or not, depends on their activity.

The special tax payers in the EU are:

  • Exempt tax payers
  • Non taxable legal persons
  • Small businesses
  • Farmers

Out of these four categories, the first three do not have any VAT obligations. The farmers are subject to special rules, but can generally opt out and follow the general rules.

An important feature of this group is that when it receives a service from abroad, it is obliged to apply the reverse charge mechanism. Indeed, for VAT purposes, it is considered as a taxable person. Equally so, when it receives goods from inside the EU, and the value exceeds a certain limit, they are liable for VAT on the intra-community acquisition (the EU internal equivalent of the import). Below, and in our next articles, we will analyze who the special tax payers are in GCC VAT. First however, we need to revisit the concept of taxable person.

The taxable person concept in the GCC

The concept of taxable person in the GCC is where the GCC deviates from more mature VAT systems. In the EU, a taxable person is “any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity.” (article 9, 1 EU VAT directive 2006/112/EC). Economic activity is then “Any activity of producers, traders or persons supplying services, including mining and agricultural activities and activities of the professions…”.(ibidem).

Although at first sight only subtly different, a taxable person in the GCC is “A Person conducting an Economic Activity independently for the purpose of generating income, who is registered or obligated to registered”. The last bit of the phrase is crucial.

In the EU, the registration is a consequence of the fact that an economic activity is conducted, it is not a defining element of it. Note also that it is a global concept in the EU, i.e. anyone in the world can be a taxable person. This last element is in stark contrast with KSA, which, strangely enough, does not acknowledge the fact that a foreign company could be a taxable person (but does require non residents in certain cases to register).

As a comparison, the GCC inspired itself on the UK definition of a taxable person, which is “A person is a taxable person for the purposes of this Act while he is, or is required to be, registered under this Act.”

Does the detail matter? In the majority of the cases it does not, but as we will demonstrate in the next section, it does sometimes. First however, we need to remind ourselves of when a business is required to register for VAT purposes.

VAT registration requirements

A Person is required to register for VAT purposes when resident in a Member State and making annual supplies in that State above the Mandatory registration threshold of SAR 375,000 (USD 100,000 or its equivalent in local currency). Non resident businesses making taxable supplies in a Member State need to be registered as from the first cents made.

A person can voluntarily register when resident in a Member State and making annual supplies in that State above the Voluntary registration threshold of SAR 187,500 (USD 50,000 or its equivalent in local currency).

The GCC Member States have not deviated from this principle yet, although the UAE has set the forward looking threshold for the next 30 days instead of the next year (mimicking the UK).

Calculating the thresholds

According to the GCC VAT Treaty, in order to calculate the threshold, the following elements need to be included:

  • The value of taxable supplies, except for capital assets
  • Value of goods and services supplied to the Taxable Person who is obliged to pay Tax
  • The value of intra-GCC supplies which have a place of supply in another State but would have been taxable had they taken place in the State of residence

The third element is not applicable right now, as none of the GCC Member States recognize each other as Implementing States.

The first element is straightforward, the second is much less so. The second one suggests that imported goods and services received from abroad need to be counted towards the registration threshold. It mentions a Taxable Person. It may be Circular, since a business may not be a Taxable Person, but as a result of purchasing from abroad may become a Taxable Person and therefore may be required to register.

The Second group of Special Tax Payers – The Exempt tax payers

In our previous article, we discussed the non taxable legal persons. In this article, we will discuss the exempt tax payers. All GCC countries so far have established a number of supplies which are exempt.

As a legislator, one exempts supplies, not tax payers. Tax payers become exempt though because they make exempt supplies. That is why we do not have exempt sectors, only exempt supplies.

From a tax policy point of view, when applying an exemption, you remove VAT from the supplies made, however you increase the costs for businesses making exempt supplies. Those businesses cannot recover input VAT. Until recently, the GCC countries which have implemented VAT have been very conservative in applying exemptions (see https://www.aurifer.tax/news/uae-publishes-its-vat-law/?lid=482&p=16,. Oman seems to be gearing much more towards a European model, applying wide exemptions for education and healthcare (https://www.aurifer.tax/news/oman-publishes-vat-law/ ).

Below we are listing the applicable exemptions (excluding the import exemptions) in the GCC countries so far.

UAE Residential rent; Bare land; Margin based financial services; Local passenger transport

Bahrain Residential rent; Sale or lease of Bare land and buildings; Margin based financial services

KSA Residential rent; Sale building; Margin based financial services

Oman Residential rent; Sale bare land and resale residential property; Financial services; Local passenger transport; Health care; Education

The descriptions in the above table are limited, and they are much more complex in practice, especially when it comes to applying the VAT exemption for financial services. This holds even more true when it comes to the application of VAT on Shariah compliant financial products.

Due to the fact that Oman has more exemptions, the status of the exempt businesses will become more important.

In the EU we refer to them as “exempt taxable persons”, suggesting that they are taxable persons, because they conduct an economic activity, but they are part of the VAT system.

In the GCC, a business making exclusively exempt supplies is not required to register for VAT purposes, and therefore it is not a taxable person. As shown above, the exempt supplies also do not count towards the VAT registration threshold.

What is its status then? Is it similar to the EU in the sense that it may have certain obligations? When examining their status, they in principle have no registration obligation, no obligation to charge VAT on their supplies, no bookkeeping or record keeping obligations, but also importantly, no right to recover input VAT.

However, similar to the non taxable legal persons, when the exempt tax payers start “importing” services or goods, and the exceed the registration threshold, they are required to register for VAT purposes.

Application of the exemptions

As stated above, the descriptions in the above table are limited, and they are much more complex in practice, especially when it comes to applying the VAT exemption for financial services.

In the EU, exemptions need to be interpreted in a strict way, as an exception to the broad base of VAT needs to be interpreted in a limited way (cf. EU case law citation).

In the GCC, we do not have such an established principle. The FTA has stated though that it considers that the VAT legislation in the UAE prescribes a “narrow approach to the VAT exemption”.

Complex mixed status for exempt and taxable tax payers

For many exempt tax payers, the complexities arise when these tax payers are also making taxable supplies, i.e. supplies subject to 5% (15% in KSA) or 0% VAT in the GCC. This triggers a mixed situation, where they are partly entitled to input VAT recovery and partly not.

Organising that input VAT recovery for what is referred to in the EU as “mixed taxable persons”, or in the UK as a tax payer subject to the “partial exemption method” is where complexities arise.

The default method in the EU is the application of the so-called “pro rata” on the basis of the turnover. The second most prescribed method is the “direct allocation”. There are a number of other methods possible as well (e.g. floorspace, transaction count, …).

When comparing the methods in the GCC States so far, different methods have been proposed. Especially the UAE stands out with its default direct attribution method followed by a very specific type of method, an input tax based apportionment method for residual tax. For residual tax, alternative methods can be used as well, but these do not replace the initial direct attribution method, unfortunately.

KSA prescribes a direct attribution method, followed by an apportionment method based on turnover. Although Bahrain initially seemed to have followed the EU in prescribing a default turnover method leading to the calculation of a pro rata in its VAT Law (article 45), in its Executive Regulations (article 59), it reverts back to the KSA approach: a direct attribution method, followed by an apportionment method based on turnover. The same goes for Oman (article 58 of its Executive Regulations).

The available alternative methods are:

  • For UAE: turnover, floorspace, transaction count, sectoral
  • For KSA: input tax based apportionment, floorspace, transaction count, sectoral, number of employees
  • For Bahrain: turnover, headcount, number of transactions
  • For Oman: none – it is left up to the tax payer to determine an acceptable apportionment based on actual use of the goods and services and which includes an annual adjustment.

Compliance obligations and conclusion

Barring the situation where an exempt tax payer makes imports, it does not have to be registered for VAT purposes. Where the tax payer is mixed, because he makes taxable supplies, he obviously needs to register for VAT purposes when meeting the registration threshold, or can choose to do so when meeting the voluntary registration threshold. Upon registration, periodic VAT returns need to be filed, and VAT invoices issued for taxable supplies. Obviously the associated record keeping obligations need to be met as well.

The main challenge with these types of tax payers is with the calculation of their input VAT deduction, less with the registration. The applicable regime is different in the different GCC States, with especially the UAE imposing quite extensive administrative obligations.