PUBLIC CLARIFICATION ON ZERO-RATING EXPORT OF SERVICES
The Public Clarification provides a high-level clarification of the FTA’s view of the zero-rating conditions in Article 31(1)(a) of the Executive Regulation relating to the residency and location of the recipient of services, taking into account the amendments made to Article 31(2) of the Executive Regulation in Cabinet Decision No. 46 of 2020.
Clarification 1: Factors considered to determine place of residence of recipient of services
A recipient of services may have a “place of residence” in the UAE if it has either of the following in the UAE:
- A “place of establishment”, being the place where the recipient is legally established pursuant to the decision of its establishment, in which significant management decisions are taken or central management functions are conducted; or
- A “fixed establishment”, being any fixed place of business in which the recipient conducts business regularly or permanently and where sufficient human and technology resources exist to enable the recipient to supply or acquire goods or services, including the recipient’s branches.
Where a recipient has a number of establishments in different countries, the place of residence of that recipient should be considered to be the country in which the recipient’s place of establishment or fixed establishment most closely related to the supply of services being made is located (Article 32 of the Decree Law).
In some cases, the supply of services made by the supplier may be received, to some degree, by both the place of establishment and the fixed establishment. In such a case, the supplier will need to identify which establishment is most closely related to receiving the supply by considering the facts of each case objectively. The following factors should be taken into consideration:
- Which establishment is the contractual recipient of the supply;
- Which establishment is benefiting from the supply;
- Which establishment will receive the invoice and make payment for the supply;
- Which establishment will provide instruction to the supplier; and
- Whether the services are related to business being carried on by the recipient through an establishment in a country
It should be noted that where a person does not have a place of establishment or a fixed establishment in any country (for example, a natural person), then the place of residence of the person is the state in which the usual place of residence of that person is located (Article 32(3) of the Decree-Law).
Example 1: a recipient of services may have a head office (i.e. a place of establishment) outside the UAE and a branch (i.e. a fixed establishment) in the UAE. If the services provided by the UAE supplier relate solely to the activities of the head office and do not involve the UAE branch, then the head office would be considered the establishment most closely related to the supply. As a consequence, the place of residence of the recipient of services would be the country where the head office is located.
Example 2: a UAE supplier makes a supply of services to the UAE branch of an overseas head office and the services will be used solely for the purposes of the branch, then the branch would be the establishment most closely related to the supply. As a result, the recipient would be treated as having the place of residence in the UAE, therefore preventing the supply from being zero-rated.
Clarification 2: Factors considered to determine location of recipient of services
The second condition for zero-rating is that the services are supplied to the recipient who is outside the UAE at the time the services are performed.
In other words, in order to determine whether this condition is satisfied, it is necessary to consider whether the recipient has any physical presence in the UAE at the time the services are performed. The requirement that the location of the recipient should be determined “at the time when the services are performed” requires consideration of the nature of the services supplied, and the period or duration during which the services are performed by the supplier and consumed by the recipient. Only the physical presence of the recipient during the period or periods in which the supplier performs services and the recipient consumes them needs to be taken into account; the location of the recipient before or after the services are performed and consumed should not be taken into account for the purposes of this condition.
For example, where services are such that they are continuously performed and consumed for duration of time, then any presence of the recipient during commencement, throughout, or during completion of the service in the UAE would result in the recipient being treated as being within the UAE “at the time the services are performed”. Similarly, if the services are of a nature that they are performed and consumed at the time that they are completed, then the location of the recipient at the time of completion of the services will determine whether the recipient is outside or inside the UAE at the time the services are performed.
It should be noted that where the recipient has multiple establishments, the supplier should only take into account the establishment of the recipient which is most closely related to the supply being made in determining whether the recipient is outside or inside the UAE at the time the services are performed. Therefore, where the recipient has establishments both inside and outside the UAE and the supply is most closely connected with the non-resident establishment of the recipient, then that non-resident establishment of the recipient will be treated as the location of the recipient for the purposes of Article 31(1)(a) of the Executive Regulation. In such circumstances, the condition that the recipient is outside the UAE would be met even if the recipient also has a UAE establishment.
It is important to note that a non-resident recipient of services (including a recipient which may already have a UAE establishment) may lose the ability to receive a zero-rated supply where they create a temporary presence in the UAE at the time the services are performed, which relates to the supply being made.
Extension to the term “outside the State”
Article 31(2) of the Executive Regulation provides an exception to the condition that the recipient of the services must be physically outside the UAE for zero-rating to apply. Specifically, a person can still be considered as being outside the UAE where they only have a short-term presence in the UAE of less than a month and the presence is not effectively connected with the supply.
The purpose of this condition is to ensure that the ability to zero-rate a supply is not unduly affected where the recipient has a UAE presence which is both short-term and is not effectively connected with the supply, and, as a consequence, this presence is unlikely to be known to the supplier of the zero-rated services.
For example, a recipient would still be considered to be outside the UAE in situations involving the following scenarios:
Case i) A UK-resident company employs a UAE law firm to represent it during an ongoing litigation before the UAE courts. During the course of the litigation, one of the company’s employees comes to the UAE for a conference not related to the ongoing litigation.
Case ii) A UAE investment fund provides fund management services to a US-based company. The company has a UAE branch which is not related to the supply being made by the investment fund. The US establishment sends a staff member to the UAE for 3 weeks to provide training to the employees of the UAE branch.
Case iii) A Canadian resident natural person engages a UAE company for assistance with due diligence on a company he is interested in investing in. During the process, the person comes to the UAE on a week-long holiday and does not visit the UAE company or meet with its employees.
Since zero-rating is an exception to the default VAT rate, a supply should only be zero-rated where the supplier can ascertain that all of the above conditions for the application of the 0% rate are satisfied. Therefore, in order to ensure that the zero-rated treatment is not applied incorrectly, the supplier should consider all available facts and seek, if necessary, additional information from the recipient in order to identify the recipient’s residency status and location at the time the services are performed. If the supplier is not able to establish the necessary facts to ascertain if the zero-rating conditions are met, the supplier must standard-rate the supply.
Maintaining adequate documentation, in terms of internal note on nature of service, identifying presence of recipient in the UAE along with necessary strong documents would become critical.
Consequences of ignoring these conditions, and merely going by the location of the Recipient as per the contract, may impose a significant penalty including but not limited to 5% VAT on the entire service value, up to 300% late payment penalty exposure and a remote possibility of recovering tax cost from the Recipient later.
Advisable to examine each export of service transaction to ensure it fulfils all the necessary conditions prescribed under the UAE VAT Law.