While supplies that are related to new building construction in the UAE are zero-rated for the purpose of VAT, supply of buildings (either by lease, rental, or sale) and bare land are considered VAT-exempt. Construction services that are provided outside the UAE as export services are zero-rated. In addition, there are a couple of conditions and exemptions associated with the different VAT treatments for the construction industry.
Developers, property owners, subcontractors, and contractors based in the United Arab Emirates all need to consider the VAT on Construction regulations carefully.
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The Applicability of VAT on Construction Businesses in the UAE
Construction services that are performed within the UAE are considered liable to VAT. As mentioned earlier, there are certain services that are exempt from VAT. The construction of commercial property in the UAE has a standard rate of five percent. For the construction of charity-related buildings and residential buildings, VAT treatment to be used is zero-rating.
This means VAT paid for building materials used in building charity-related and residential properties can be claimed without having to pay further on tax. The construction of commercial buildings requires the payment of VAT at the five percent standard rate. However, construction companies can claim input tax.
Note: it’s possible for subcontractors to be unregistered for the purpose of VAT. A subcontractor may be unregistered for VAT in the UAE, as turnover did not reach the threshold or limit for the UAE mandatory VAT registration. In such a case, it’s advisable for small contractors to voluntarily register when they reach the threshold or limit for the UAE voluntary VAT registration.
Levy of VAT for the UAE Construction-Related Transactions
According to relevant VAT regulations, VAT has to be charged for payments that are related to construction supplies, deposits if the deposits are charged for sales or intended to be utilized in offsetting future payments, retention sum, and other advance payments that aren’t for a refund but are going to be set off by the business against future payments. Also, it’s important to remember that VAT isn’t charged for damages, legal proceedings, and out-of-court settlements paid for delays of contract completion or breach of warranty. This is because they’re considered as compensatory in nature.
To avoid incurring fines and administrative penalties imposed by the UAE Federal Tax Authority (FTA), it’s important to understand terms such as deposit money, retention sum, and advance payment.
Most construction contracts in the UAE contain provisions for retention of the amount that is due to contractors. The amount, referred to as retention sum, is the amount that is withheld during each phase of the progress payment. The amount will be released to a contractor only when a customer or client is fully satisfied with the work that was performed. The total retention sum in the UAE is typically released when a project has been labeled as complete.
VAT has to be taken into account for retention sum during the following:
- Date of invoice issuance
- Date of receipt for payment
Generally, construction services involve the provision of a deposit for getting documents processed. This includes the plan specifications and schedules of quantities that are related to construction services. A deposit is liable for VAT, as there’s a supply of construction-related documents.
In the case of construction services, a tender is often invited for a project. There are some that require an advance deposit as security. This is to ensure a successful tenderer will carry out obligations that are detailed in a construction contract. VAT isn’t charged for this deposit, as it will be refunded.
Compensation for Work Suspension
In many cases, developers require the suspension of work from contractors for a period of time. In return, developers pay an amount to contractors as compensation.
If payment has to be made to the contractor for costs that are incurred due to work suspension or loss of income, the payment won’t be attracting VAT. If payment, however, is related to the work that was carried out by a contractor before the work suspension, the payment will be a consideration for a supply made by a client or customer to a contractor. VAT will be liable for this payment.
Similarly, when a payment is given for delays in project completion or breach of warranty, then it will not be subject to VAT as the payment is compensation to the client/customer from the contractor.
Read also: VAT Refund in UAE for Business Visitors
Common Errors of Construction Businesses Related to VAT
There are myriads of non-compliance activities that are intentionally or unintentionally made by construction companies. All of these attract fines and penalties by the FTA, including the following:
- Wrong treatment for VAT for retention sum
- The issued invoices are different from the prescribed format by the FTA (each mistake can lead to a fine of AED 5,000)
- Providing the FTA wrong figures from previously filed tax returns
- Wrong treatment for transportation of laborers or staff