Bahrain Real Estate and VAT

Bahrain Real Estate and VAT

In March 2019, the NBR published its fourth VAT Guide, i.e. the VAT Real Estate Guide. This guide aims to provide an overview of the rules and procedures regarding real estate in Bahrain as well as the necessary background and guidance to help taxable persons determine how a supply is treated for VAT purposes. In this article we elaborate on the Bahraini VAT treatment of transactions linked to Real Estate and we included the excerpts from our article “GCC – VAT on Real Estate Transactions – A Comparative View of Saudi Arabia and the United Arab Emirates”and “VAT in United Arab Emirates, Saudi Arabia and Bahrain – Transitional Rules”.

Definition of real estate

Real estate includes any area of land over which rights, interests or services can be created, as well as any building, structure or engineering work permanently attached to the land and any fixture or equipment which makes up a permanent part of the land or is permanently attached to a building, a structure or engineering works. Real estate does not include any furniture, fittings, plant and apparatus which are not attached to land or a building and which can be removed without damaging the property.

VAT treatment of the sale of Real Estate

Under the Bahraini VAT Law, a supply relating to the grant of rights in rem deriving from ownership giving the right to use real estate is considered as a supply of goods. Therefore the place of supply of real estate is there where the real estate is located. This is in line with the GCC agreement and the UAE and KSA apply the same place of supply rule for real estate.

The sale, lease or license of real estate located in Bahrain is an exempt supply, regardless of whether the real estate is residential, commercial or land (bare or partly developed). Even though the GCC VAT agreement allows the implementation of an exemption for both residential and commercial real estate, it is very striking that Bahrain used this opportunity since the KSA and UAE have a stricter exemption.

Some supplies are not considered as real estate for VAT purposes and the VAT implications of these supplies will need to be determined on a case by case basis. The following supplies will not be considered as the sale or rental of real estate and will therefore, be taxable at the standard rate of 5%: 

  • Hotel accommodation
  • Provision of paid car parking for periods of less than one month 
  • Provision of serviced office space where the customer does not have the right to use a designated space on an exclusive basis 
  • Rental of a function room, hall or similar facility 
  • Providing permission to affix equipment and signage to land or buildings. 
  • Provision of space for retail or promotional stands (e.g. at a shopping mall, retail or entertainment area) for a period of less than one month
  • Serviced accommodation with a rental agreement for a period of less than a year 
  • Rental of storage or warehousing facilities to a customer without the right to access the space
  • Provision of labour accommodation which is not the principal place of residence of labourers in Bahrain

In the UAE, the sale of bare land is exempt. The sale and lease of commercial building is subject to VAT at 5% whereas, the first sale of the residential building made within three years of the completion date and lease of the same building is zero rated for VAT purposes. The subsequent sale and lease of the residential building is exempt from VAT. 

However, in the KSA sale of both commercial and residential land and buildings is subject to VAT at 5% whereas the lease of residential real estate is exempt for VAT purposes in the KSA. 

The difference in the application of VAT on sale of commercial and residential buildings and land makes the VAT treatment of the real estate much more complicated in the UAE and the KSA than in Bahrain. On the other hand, by applying a wide exemption on the supply of real estate , it is more likely that VAT becomes a cost for the real estate sector in Bahrain than in the other countries.

VAT treatment of Real Estate related services

Real estate related services in Bahrain are those services which are directly connected with the real estate. These include, but are not limited to, the following:

  • Services by real estate experts or agents 
  • Services which involve the preparation, coordination and performance of construction, destruction, maintenance, conversion and similar work 
  • Accommodation services provided at extra charge such as management services, utilities, telecommunications, internet and television etc.
  • Services by auctioneers, architects, interior designers, surveyors, engineers and others involved in matters relating to real estate 

For real estate related services the same place of supply rules apply as for the supply of real estate, which is that the supply takes place where the real estate is located. A resident taxable person making a supply of such services will account for VAT on the provision of these services. 

If a non-resident person makes a supply of these services in relation to Bahraini real estate to a Bahraini taxable person, the Bahraini taxable person will need to self-account for VAT under the reverse charge mechanism. That means that the supplier is not liable for Bahraini VAT and should not charge Bahraini VAT on its supply. Where the recipient is not a taxable person, or is a taxable person but not registered, the non-resident will need to register for VAT in Bahrain and account for VAT on the provision of the service.

The real estate services will be taxed at the standard rate of 5%, unless the supply is specifically exempt from VAT or zero-rated. 

Apart from the exemption for commercial real estate, the UAE and KSA apply similar rules for the supply of real estate related services.

VAT treatment of construction works

Construction generally means building something such as a house, office, factory, warehouse, road, bridge etc. Construction may also involve demolition, refurbishment/reconstruction of existing buildings or structures and site clearance activities. Construction involves providing a building service but may also involve providing goods as part of such a service.

Construction services and the goods supplied in Bahrain for construction are regarded as taxable supplies if they are carried out by a taxable person. This is irrespective of the type of building (e.g., residential, commercial, industrial building) being worked on or the type of other construction work (e.g., civil engineering works). 

Construction services and the goods supplied in the course of providing construction services for a new building are zero-rated for VAT purposes in Bahrain. All other taxable supplies of construction services or supplies of goods used for construction will be subject to the 5% VAT rate. 

All types of construction services performed in the KSA and in the UAE are supply of services which is subject to VAT at the 5% rate. This VAT treatment will apply regardless of the type of building which is being constructed.

Transfer of a going concern 

The transfer of a going concern in all three concerned GCC states (KSA, UAE and Bahrain), with or without consideration, does not fall within the scope of VAT if certain conditions are met. If a transaction involves real estate (e.g., the sale of the freehold interest in a building with tenants in situ) and all of the conditions for the transaction to be a transfer of a going concern for VAT purposes are met, the transaction will be outside the scope of VAT. If the relevant conditions are not met, the VAT implications of the transaction will need to be considered as it may involve both taxable and exempt supplies. 

Output VAT payment

For the sale of Real Estate, VAT becomes due on the date that property is transferred to the recipient. However, VAT can become due earlier if (i) a tax invoice is issued by the supplier before the transfer date or (ii) the recipient makes a payment to the supplier.

Typically, when there is a supply of services, some supplies will be considered as “one-off” services, which will follow the general tax due date rules set out above, whereas other services will be considered as continuous supplies (for example, rentals and lease agreements). In case of continuous supplies VAT becomes due across the period the goods and services are provided, in line with the invoicing and payment arrangements. 

When twelve months have passed from the start of the contract or from the previous tax due date, a tax due date will be triggered at that twelve-month point.

A construction contract may contain provisions whereby the customer may withhold a retention amount pending rectification of matters identified as part of the snagging process. The VAT treatment of such retentions often leads to important discussions.

Input VAT deduction

Deduction of input VAT is based on the intended use at the time of purchase. A VAT registered person may deduct input VAT charged on goods and services it purchases or receives for its taxable activities purposes. A person making both taxable and exempted supplies can only deduct the input VAT related to taxable supplies. 

For example, VAT incurred on expenses or purchases (i.e., professional legal fees, refurbishment, etc.) that is attributable to making exempt supplies of real estate will not be recoverable by the taxable person. When a taxable person will use the building for the purposes of fully taxable activities, it can recover the VAT on costs on the construction of the new building in full. 

The overhead costs/expenses incurred by the taxable person for making both taxable and exempted supplies must be apportioned to most accurately reflect the use of those costs in the taxable portion of the taxpayer’s activities. A prescribed default method of proportional deduction is calculated on the values of supplies made in the year, using the following fraction: value of total taxable supplies made by the taxable person divided by total value of taxable supplies and exempt supplies made by the taxable person. This fraction is identical to the input tax apportionment method in the KSA. However, in the UAE the apportionment is by default made on the basis of relevant input tax incurred.

Transitional provisions

The Bahraini VAT Law provides special rules for contracts concluded prior to the VAT-implementation date. In case the contracts do not contain any tax clauses, the agreed consideration is considered to be inclusive of VAT. Furthermore a zero rate applies for contracts entered into before 1 January 2019 with the government where the supply takes place after the implementation date. This zero rate can only be applied until the date of the contract’s renewal, or its expiration, or 31 December 2023, whichever is earlier.

The transitional provisions in Bahrain are a combination of the KSA grandfathering rule (temporary zero rate on contracts concluded prior to 30 May 2017) and the UAE’s transitional rules (by default inclusive of VAT).


Bahrain third GCC country kicking of VAT

Bahrain third GCC country kicking of VAT

Following the publication of the VAT legislation in Bahrain and the start of a new year, VAT has now become a reality in Bahrain. Bahrain is the third GCC country introducing VAT and the National Bureau of Taxation (“NBT”) will be policing it. In this article we will touch upon the most interesting and striking parts of the VAT legislation.

Real estate

Unlike the UAE and KSA, the Bahraini VAT legislation provides for an exemption for the supply or lease of both residential and commercial buildings. Bahrain is the first GCC country that implements a VAT exemption for the supply and lease of commercial buildings. The exemption may have far reaching consequences for the real estate market.

Furthermore, a zero rate is applicable on construction services related to new buildings (residential and industrial). Goods supplied by a business that supplies construction services and which are supplied in the course of providing construction services for a new building, are also zero rated. This includes for instance building materials and materials necessary to construct specialised raised flooring for computer server rooms. 

However, goods like furniture that is not affixed to the building, swimming pools and decorative lighting, paintings, carpets and murals and other artwork are not zero rated.

The zero rate is also not applicable on restoration works, demolition of existing buildings and architects and interior design fees. VAT incurred on these purchases will therefore constitute a cost for businesses who want to sell or lease their new constructed building.

Food items

Bahrain implemented the optional provision in the GCC VAT Agreement and applies a zero rate on the supply and import of certain basic food items. Bahrain is again the first GCC country doing this. The Bahraini Tax Authority published the list with zero rated items, indicating that 94 types of food will fall under this special rule. The list includes ten categories:

  1. Meat and fish 
  2. Fruits and vegetables 
  3. Coffee, tea and cardamom
  4. Wheat and rices
  5. Sugar
  6. Children’s food
  7. Water
  8. Salt
  9. Egg products
  10. Bread

Note that the supply of food by restaurants, coffee shops or caterers will still be subject to the standard rate. There is a great deal of conflict expected around the interpretation of mixed supplies which include a zero rated part, or between take in and take out products.

Financial services 

Bahrain has taken an unoriginal position in line with KSA and UAE. Financial services are exempt from VAT, except where the consideration for the service is expressly determined as a fee, commission or commercial discount. Financial services are defined as services related to cash transactions in the VAT Executive Regulations. 

Additionally the regulations also include a list with examples of financial services that are exempt (e.g. depositing money in current accounts, savings accounts or deposits, granting and transferring loans, borrowings and credit, issue or cancellation of cheques, debit cards and credit cards). 

Some services like the issue, allotment, or transfer of ownership of an equity security or debt security and life insurance and reinsurance contracts, will be exempt, irrespective of how the consideration for them is payable.

Furthermore the supply of financial services to non-residents will be zero rated.

In case the financial institution supplies services which do not fall under the VAT exemption nor the zero rate, the standard rate will have to be charged. Consequently the financial institutions will have to issue compliant invoices. In this regard the regulations clarify that a bank statement shall be treated as a tax invoice provided it contains certain information like the name, address and registration number of the bank in the Kingdom and the name and address of the customer.

Transport services

Similar to the UAE and KSA, in Bahrain a zero rate is applicable on the international transport services of goods which begin in, end or pass through its territory, including services and the supply of related means of transport. The zero rate is also applicable on the supply of services and goods directly or indirectly associated with the international transport of passengers and goods, including goods and services supplied for use or consumption on board a means of transport.

A zero rate is also applicable on the local transport services of goods and passengers by land, water or air. Exceptions apply, i.e. the standard VAT rate is applicable in the following five cases:

  1. Transport services provided by a person who does not meet any regulatory or licensing requirements from the authorised body to provide such services,
  2. Services of vehicle rental without a driver, 
  3. Transport services for sightseeing or leisure purposes,
  4. Food delivery services provided by a person supplying food,
  5. A transport service which is ancillary to the principal supply of goods or services which is taxable at the standard rate, and is not priced separately to the supply of a good.



By default, VAT on imported goods will be payable to Bahrain’s customs authority prior to the release of the goods. The tax authority may allow the deferral of payment of VAT on import if the importer is registered for Tax purposes and if the Taxable Person is bound by Customs Affairs records at the Ministry of Interior.

Further details are expected soon. The import VAT deferral mechanism should be implemented by the end of Q1 2019.


Non-resident suppliers supplying services which are taxable in Bahrain to Bahraini customers, will have to account for the VAT themselves unless the customers are registered taxable persons. In that case the Bahraini recipient will have to account for the VAT himself under the reverse charge mechanism.



The export of goods and services are zero rated, provided that certain conditions are met (e.g.). Exporters who are primarily engaged in making exports can apply for a domestic reverse charge on certain purchases that are subject to the standard rate and received from taxable persons in Bahrain, allowing them to benefit from cashflow advantages. This burdensome procedure is also used in France but the French authorities have to spend important resources in policing it.

In order to get the approval from the NBT to apply the reverse charge mechanism, the taxable person should be able to fully recover any input VAT, export more than 50% of its turnover, show that he will be in a refund position on a recurring basis and that the refund will have a material impact on his financial position.


So-called “exports of services” (a term absent in the GCC treaty) supplied by a taxable person in Bahrain are subject to the zero rate if certain conditions are met. For instance the services should be supplied to a person who does not have a place of residence in Bahrain and who was outside Bahrain when the services were provided. The services should be performed and enjoyed outside the country and should also relate to tangible goods or real estate located outside the country. It remains to be seen whether the NBT will take an equally very restrictive view like its KSA counterpart.

Telecommunication and electronic services

Telecommunications and electronic services supplied to a non-registered customer shall be taxable at the place of use and enjoyment of the services on the date of supply. Supplies made to taxable customers will be taxed at the place of residence of the customer. 

The regulations provide some further information on the determination of the place of use and enjoyment as well as how to determine the place of residence of a customer who is a taxable person.


Bahrain releases further information on VAT

Bahrain releases further information on VAT

Important VAT update from Bahrain
With less than one month to go before the VAT will be implemented in Bahrain, the MoF of Bahrain and the National Bureau for Gulf Taxation organised an informative session yesterday. 
During the session more information on the Bahraini VAT rules was provided. See below an overview of the main points:
I. Registration deadlines
Three deadlines are applicable:
  1. 20 December 2018: businesses with turnover > BD 5 million, effective date is 1 January 2019.
  2. 20 June 2019: businesses with turnover > BD 500,000, effective date is 1 July 2019.
  3. 20 December 2019: businesses with turnover > BD 37,500, effective date is 1 January 2020.
No threshold is applicable for non-resident companies. Businesses which are not already contacted by the tax authorities have to register through a portal that will be available soon. 
II. Filing VAT returns
Four options are applicable:
  1. Quarterly in 2019: businesses with turnover > BD 5 million.
  2. Semi-annual in 2019: businesses with turnover < BD 5 million.
  3. Monthly in 2020: businesses with turnover > BD 3 million.
  4. Quarterly in 2020: businesses with turnover < BD 3 million.
III. Invoice requirements
  1. No requirement for invoices to be in Arabic.
  2. Simplified invoices can be issued for supplies to non-registered customers and for supplies with an amount < BD 500.
  3. Bank statements will be valid as tax invoices for banks.
  4. The required mentions on the invoices will be similar to KSA’s rules and the potential number of the required mentions will be around 14.
IV. Real estate
  1. Zero rate: construction of all buildings (residential and commercial).
  2. Exempt: sale and lease of all buildings (residential and commercial) and bare land.
V. Financial services
  1. Dividends are out of scope of VAT.
  2. Life insurances are exempt from VAT, all other insurances are subject to VAT.
Further information is expected soon, so keep checking our daily updates for news. Please treat this update with the necessary caution as currently the Executive Regulations have not been published yet.

More often than not JAFZA offshore companies need to register for VAT

More often than not JAFZA offshore companies need to register for VAT

Offshore companies in the Jebel Ali Free Zone Authority (JAFZA) are a special breed in the UAE. An offshore company incorporated under the recently amended 2018 JAFZA Offshore Companies Regulations (“Regulations”) is not subject to the federal commercial laws in the UAE and is not able to conduct any commercial business activities in the country. They are considered as non-resident for commercial purposes but are in fact treated as resident for VAT purposes.

The benefit of incorporating a JAFZA offshore company, amongst others, is to allow foreign investors to hold shares in other companies within the UAE as well as to own property in freehold areas in Dubai.

Assessing the VAT Impact

Like many other companies in the UAE, JAFZA offshores have been impacted by the introduction of VAT on 1 January 2018. Although for all intents and purposes JAFZA considers such companies as “offshore”, for VAT purposes they are not.

JAFZA offshore companies still need to determine whether they need to register for VAT with the UAE’s Federal Tax Authority (FTA). Any business making taxable supplies with a total value exceeding the mandatory threshold of AED 375,000 (+/- USD 100,000) must get registered. Whether or not the JAFZA offshore companies need to get registered will depend on their activity. Although they are not allowed to conduct business in the UAE as per the Regulations, from a VAT perspective they may still receive a business income.

JAFZA Offshore and Rental Income through Property Ownership 

In accordance with the Regulations, JAFZA offshore companies are allowed to own property in Dubai, and therefore many offshore companies choose to exercise this right. The purpose of such property ownership would most likely be to obtain some form of rental income. 

Any rental income obtained from a residential property is exempt from VAT (in most cases) and does not trigger an obligation to register for VAT. 

The situation differs however for offshore companies leasing commercial units and obtaining their rental income as such, since the leasing of commercial properties is considered a taxable supply for VAT purposes, and is subsequently subject to 5% VAT. When the value of such supplies exceeds the VAT mandatory threshold, VAT registration is required. Therefore, any JAFZA offshore company which owns property in Dubai needs to carefully assess the criteria they fall under in order to determine their VAT liability. 

Receiving Dividends and Selling of Shares 

Since such JAFZA offshore companies act as holding companies, they will often be receiving dividends or income from selling participations. 

The receiving of dividends from UAE companies and the sale of shares to UAE companies are transactions which are VAT exempt. They impact negatively the right to recover input VAT of the holding company.

The fact that the receiving of dividends is exempt in the UAE is unusual from a VAT perspective. Generally, the payment of dividends is out of scope of VAT, like for example in the Kingdom of Saudi Arabia or like in all EU countries.

As such, if the JAFZA offshore company only receives dividends from UAE companies or only sells shares to UAE companies, it will not have to get registered for VAT purposes.

However, when these same transactions are done with non-resident recipients, they are no longer VAT exempt, but they are zero rated. Accordingly, dividends paid to a JAFZA offshore company by a foreign company and shares sold to foreign investors are, for VAT purposes, treated as taxable supplies. Therefore, if the total amount of these transactions exceeds AED 375,000, the JAFZA offshore company needs to register for VAT. Since one of the purposes of setting up a JAFZA offshore company is holding participations, this will often occur. 

The rationale behind this rule copied from the EU is not to disadvantage the financial sector when it has to compete with businesses in countries which do not have VAT. However, the unusual position taken by the UAE on dividends has the strange consequence that these JAFZA offshore companies may be required to register for VAT purposes.

Applicable Exceptions

Due to the nature of its revenue, more often than not, a JAFZA offshore company will indeed have to register for VAT.

The FTA does provide certain exceptions from registration in the event a taxable person’s supplies are exclusively zero rated. Therefore, if the offshore company solely exports financial services – by virtue of receiving dividends from participations abroad or selling shares to non-residents – an alternative is to apply for this exception from registration for VAT with the FTA, in order to mitigate the impact of the offshore company’s VAT obligations.

The exception from registration cannot be granted when the offshore company is leasing commercial property and it cannot be granted retroactively.

Penalties and Consequences

All JAFZA offshore companies need to assess whether they need to register for VAT with the FTA. In practice, most JAFZA offshore companies have been under the impression that they do not need to register.

The FTA imposes very strict fines for companies which have not yet registered for VAT. The penalty for late registration is AED 20,000. In addition, a penalty of up to AED 2,000 per return will apply for not filing the VAT return.

Furthermore, in case VAT is due (e.g. leasing of commercial property) and is not paid to the FTA, a daily penalty of 1% may be charged on any amount that is still unpaid one calendar month following the deadline for payment (with a maximum of 300%). In addition to that, a penalty of 50% on the amount unpaid to the FTA will be imposed as well.


Bahrain publishes VAT law

Bahrain publishes VAT law

The Kingdom of Bahrain will be the third GCC member state to implement VAT after all members had agreed to adopt VAT when they signed the GCC VAT Framework Agreement in 2016. The UAE and KSA have been the first States to introduce VAT on 1 January 2018. The other States will follow most likely in the following order: Oman, Qatar and Kuwait.

On 10 October 2018, Bahrain published its VAT Decree law (No. 48) in its Official Gazette. The Bahraini VAT law was written mainly by the Ministry of Finance and borrows largely from the GCC VAT Framework and the KSA VAT legislation. In addition to the VAT Decree law, Decree No. 47 approves the GCC VAT Treaty and Decree No. 45 establishes the Bahraini Tax Authorities. As a next step, Executive Regulations will be adopted in Bahrain to provide further detail on all provisions.

As is expected the VAT rate is 5% and businesses making taxable supplies in excess of BD 37,500 are required to register for VAT purposes. Bahrain has adopted a similar stance to financial services as the UAE and KSA. With respect to Real Estate, Education, Health Care and Local transport it has borrowed more from the UAE. Contrary to both the UAE and KSA, it has zero rated a number of foodstuffs. Regretfully it has taken over the too strict conditions to apply the zero rate on “exports of services” (in fact services’ which place of supply takes place abroad) like the UAE and KSA have. These conditions are not in line with modern international EU VAT practice or the guidelines of the OECD in this matter.

Unfortunately it has also implemented the obligation to appoint a fiscal representative in some cases, whereas experience has taught that in KSA this structure is practically difficult to implement and leads to less compliance. No automatic reverse charge on imports of goods has been foreseen, contrary to the UAE. Remarkably, the sale of pearls in Bahrain has been zero rated, relatively similar to the wholesale of diamonds in the UAE where a reverse charge applied.

In line with KSA and UAE, steep penalties have been adopted to deter any non-compliance. A specific prison sentence has been determined as well for tax evasion. Extremely long transitional provisions have been foreseen for supplies to governments.

Businesses in Bahrain have to prepare for the introduction of VAT now and UAE and KSA businesses with subsidiaries in Bahrain have to compare their current implementation with the Bahraini framework. In addition, businesses in the other GCC States will have to analyse the impact of the implementation on their dealings with Bahrain, such as the exchange of VAT numbers but also the different Customs framework which will apply.


Gulf Businesses Rethink Structures Under New VAT Regime

Gulf Businesses Rethink Structures Under New VAT Regime

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  • Survey reveals one-quarter of businesses fined for wrong or late returns
  • Executives grapple with increased costs, impact on supply chain and cashflow

Businesses in Saudi Arabia and the United Arab Emirates are having to look again at their operation designs, as they continue to struggle under a edgling value-added tax regime.

The VAT regime began in the Gulf countries nine months ago. Since then, the UAE’s Federal Tax Authority has published six clarications to plug the gaps in the bare-bones legislation and regulations, a sign of the continued uncertainty that has surrounded the regime.

Companies are now having to revamp invoicing, allocate staff to VAT compliance, and respond to increased cost and cashow issues, practitioners told Bloomberg Tax. Both countries introduced the regime on Jan. 1, 2018.

“When it comes to the business model, it’s a hassle to have to deal with VAT because it cascades through the whole supply chain and it requires you to ask questions,” Jeremy Cape, Tax and publicpolicy partner at London-based law rm Squire Patton Boggs.

A September survey from Aurifer Tax in Dubai found respondents “have had to reassess their existing arrangements” within the supply chain and with product pricing, because of the regime. About 33 percent of its 55 company respondents feel VAT has had “a signicant impact on their business model” and 38.5 flagged increasing revenue eects. The respondents are based in the UAE and Saudi Arabia.

Thomas Vanhee, founding partner at Aurifer, said finding a business model that is suitable for VAT will be crucial for companies to plan their budgets and operations.

“At this point, many businesses are still subject to penalties and many businesses are experiencing teething problems. Tackling these as soon as possible will prevent important corrections a few years down the line,” he said in an email.

‘Fundamental Change’

The tax regime required “a fundamental change in some of our processes, in particular our Purchase-to-Pay process,” said Paul Lidke, regional CFO for the Middle East and Africa for the German-based pharmaceutical and health care company Merck Serono Middle East FZ-LLC.

That’s because the regime ensnared contractual agreements with vendors, invoicing, and accounting. VAT also affects the company’s cashow “and for certain services increases our cost,” he said.

The Saudi and UAE VAT regulations also require different approaches based on where the supplier is located, where the service takes place, and what the service is, he said.

“It therefore took us some time to fully understand the requirements and we are still learning,” he said.

Grappling With Rules

To comply, companies face a range of challenges, including the implementation of new IT accounting systems, training staff, remodeling the supply chain to incorporate VAT invoicing and its effect on cashflow, and managing the impact on clients.

About a quarter of the survey respondents had been penalized by the tax authorities, mainly for late payment and incorrect filing of returns, and about 8 percent have already been audited by the FTA, the survey said.

About 26 percent of the respondents said preparing and ling VAT returns took more than 10 hours to complete, requiring more time and money to deal with the demand.

“The survey showed that IT configurations, supply chain management and interpreting the legal framework were considered as the most challenging VAT aspects. These may compound the challenges to businesses as they are required to reassess their processes and business models,” Vanhee said.


Financial sector hard hit by VAT

Financial sector hard hit by VAT

The UAE and KSA will both introduce VAT on 1 January 2018. The other GCC countries are expected to follow over the course of 2018. In KSA the laws are in place whereas in the UAE the publication of the implementing regulations is imminent.  

On the basis of the VAT laws in both countries, VAT applies on supplies of goods and services at a rate of 5%. The introduction of VAT has a profound impact on the business community in the GCC, triggering a higher cost of the products and services they offer, and a higher administrative burden to administer VAT.  

The financial and insurance sector occupy a special place in VAT legislation benefiting from deviating rules and therefore introducing even greater complexity. Applying VAT on complex products is not an easy task. The legislation often ends up zero rating or exempting financial and insurance transactions, instead of just subjecting them to VAT. The VAT exemption is not on any social or economic reason but on account of the conceptual and administrative difficulties associated with measuring the value of financial services.

The distinction between both is important, as on the face they both do not carry VAT, but the consequences in terms of the possibility to deduct input VAT are very different. Zero rating still allows input VAT deduction whereas the application of an exemption does not. This blockage of input taxes gives rise to cascading of tax and competitive distortions.

Additionally, certain income in the financial and insurance sector is out of scope of VAT, such as dividends or certain capital gains, which in turn again may impact the VAT recovery of such a business.   

KSA will tax fee based products (e.g. obtaining a credit card) and exempt margin-based products (e.g. a credit card loan). This principle will be applied throughout the financial sector. In terms of the insurance sector, life insurance will be exempt whereas other insurances subject to VAT. The UAE will only exempt certain financial services. The Director General of the FTA has recently declared that the sale and purchase of shares will be out of scope of VAT and profit margins will not be taxed. But the VAT treatment of financial services is much more extensive and complicated. The other GCC countries will likely apply a similar treatment.  

The fact that the financial and insurance sector is often largely exempt from VAT entails that they have a ‘mixed status’ for VAT purposes. It means that businesses need to get registered for VAT purposes but cannot deduct all of their input VAT, like regular businesses can. Instead, they need to apply a method to apportion the deductible input VAT. This method needs to be revised regularly.  

Contrary to regular businesses, VAT does not just flow through the financial and insurance sector. Instead it constitutes a cost. This has a number of negative consequences for purchases, outsourcing and intercompany charges, which may come at a higher cost.  

Even if the financial institution is fully VAT exempt, it will still have to pay VAT to its vendors and required to register for VAT purposes if they purchase services from outside the UAE. And even if the financial and insurance sector is largely exempt, the compliance burden is high. It has to keep the same records as a general business, i.e. a sales and purchase journal, and will have to file a VAT return like any other business.  

For example, it has to pay VAT itself on all services which businesses it receives from abroad. It requires that it keeps a purchase journal and makes a clear distinction between its foreign service supplier and its domestic suppliers.  

Opportunities lie in grouping related companies in the same country for VAT purposes, or by analysing which kinds of transactions could potentially benefit from a zero rate for VAT purposes.  

Islamic finance products further challenge the qualification of financial and insurance products for VAT purposes. Because of the riba prohibition, or prohibition to earn interest on loans, the underlying assets are often sold or given as security. This triggers a number of unsought consequences from a VAT perspective.  

The commercial opportunity for banks lies in a higher need for businesses of working capital and higher lending pending the introduction of VAT. The myriad of providers in the financial sector each have their specific position and VAT impact. Funds are impacted in a very different way than insurers or payment providers.   

Likewise credit card services, asset management services, insurance, investment in marketable securities all will be treated differently for VAT purposes. The common aspect for all financial services businesses is that all of them will be confronted with VAT and most of them simply have to get registered for VAT purposes.
Taking into account the date set for the implementation the UAE, (1 January 2018), it is about time that the FTA determines their comprehensive regulations for the implementation of VAT in financial sector. The uncertainty may deter investors in the UAE and lead it to shift to other jurisdictions where VAT is not implemented yet or is implemented in a more favorable way. Businesses in the financial sector need to make an impact assessment and determine their strategy for the implementation.   





Future of VAT in the EU

Future of VAT in the EU

The most recent VAT gap study showed that the Member States of the EU in 2015 missed out on around 150 billion EUR. According to estimates, around 50 billion EUR of that is due to cross-border VAT fraud.

The proposal of the European Commission to tackle this cross-border VAT fraud is to tax any cross border supplies in the EU. Currently, for goods these are broken down into a (potentially) exempt intra-community supply in the country of departure and a taxed intra-community acquisition in the country of arrival. For services, in a B2B environment these are simply taxed in the country of establishment of the recipient.

In the Common VAT Agreement of the States of the Gulf Cooperation Council, which is the Treaty signed by the GCC States to introduce VAT, cross-border supplies of services are treated in the same way as currently in the EU. For goods however, these supplies are in a B2B sale taxed in the country of recipient and the customer is liable for the payment of VAT on this supply.

In both the EU and the GCC the issue of cross-border VAT fraud was examined. The circumstances are obviously different. The EU has a VAT system in place since decades, whereas the GCC is only just about to start, with the United Arab Emirates and the Kingdom of Saudi Arabia introducing VAT on 1 January 2018.

The EU is choosing a different way forward than how it currently operates. Going forward, as from 2022, it intends to tax cross border supplies and hold the seller accountable for VAT. In other words no reverse charge applies. An exception would be made for buyers who are trustworthy, so-called certified taxable persons. These buyers would be allowed to reverse charge on the purchase. In order to mitigate the additional administrative burden, a one stop shop will be foreseen to report cross border transactions.

The GCC had the intention to implement an electronic services system (“ESS”). The system was designed to match sales and purchases of goods and services within the GCC. It is comparable to the EU’s European Sales Listing but it would work in a safer and quicker way matching transactions and giving both seller and buyer reassurance. The GCC is kicking off though with not all States implementing VAT simultaneously and with the ESS not in place. Once in place it will provide a good test case to determine whether it is an effective measure to reduce cross border fraud.

Although the EU has a much longer tradition in the application of VAT, it chooses an option which is not necessarily more effective in tackling cross border VAT fraud. An electronic system matching sales and purchases in a fast and effective way, constituting a type of block chain solution, may be much more effective than taxing all cross border supplies. Time will tell whether either the EU’s option or the GCC option will be the more effective in tackling cross border VAT fraud.


VAT impacts important defense market in GCC

VAT impacts important defense market in GCC

With defense spending in KSA and UAE reportedly currently around 100 billion USD a year combined, the introduction of VAT on 1 January 2018 in those countries will have an important impact on businesses active in that segment.

Governments are generally outside of the scope of VAT. That is especially true in the defense sector, where governments take up one of their most important roles, that is guaranteeing the safety of their citizens.

This entails that when suppliers sell to governments, the VAT which they will charge will not be deductible for the governments. In other words, VAT constitutes a cost for the government.

Both in the UAE and KSA, there will be a list of governmental organisations that can request the refund of VAT charged to them by businesses. When put on this list, these governmental organisations can then ask from respectively the UAE’s Federal Tax Authority and KSA’s General Authority for Zakat and Tax the refund of this VAT.

Even if the Ministry of Defense would be put on such a list, it would have to pay its suppliers first and later recover this VAT. This entails that VAT could potentially weigh heavily on the budget of these Ministries. They will be looking to mitigate these effects and potentially push them to their suppliers.

Long term contracts with governments generally do not cater for the introduction of VAT. In other jurisdictions, international organisations often benefit from a zero rate (sometimes also known as an exemption allowing the recovery of input tax) of any supplies made to them. Supplies made to NATO or SHAPE for example are zero rated. Supplies made to the local military usually do not.

As always with VAT though, the contracts and the supply chain need to be analysed. A US supplier of weapons for the KSA MoD agreeing to deliver 50 millions USD worth of weapons but with the KSA MoD acting as the importer of record would not have to charge and collect any VAT. If however, it has a physical presence in KSA to render installation engineering and training services, it will have to charge KSA VAT at a rate of 5%.

The supply chain usually stretches longer and will involve multiple parties and potentially even foreign governments. It is paramount to analyse the capacity in which all of these parties intervene, as well as their delivery terms, in order to draw any conclusions around the impact of the introduction of VAT. It is most likely currently being relatively overlooked by governments and suppliers, but will no doubt heavily impact them.


KSA releases VAT law

KSA releases VAT law

The Implementing Regulations provide much more detail on how VAT will actually apply in the KSA. The draft VAT law was unique in its design as it referred back to the VAT Agreement concluded between the six Member States of the Gulf Cooperation Council. It did not provide the basis for domestic taxation, deviating in its design from international standards around the design of tax laws and potentially even deviating from its own Constitution, the Saudi Basic Law. 

The detail in the Implementing Regulations is important for businesses preparing for the implementation of VAT. They now at least have a sense of the direction the KSA is choosing in implementing VAT. For example, more details are given with respect to how tax payers can register, what kind of documentation is required for GCC supplies, but also how tax payers who have exempt supplies can deduct input VAT and to what extent expenses with respect to vehicles can be deducted. The Implementing Regulations are still subject to final amendments after the public consultation process. 

The publication of the Implementing Regulations is another step in the process towards the implementation of VAT in the KSA on 1 January 2018. Insofar as Saudi businesses have not started preparing for the introduction of VAT, it has now become high time to do so, as preparations are time consuming.