Understanding and effectively leveraging Value Added Tax (“VAT”) recovery and refund mechanisms is crucial for businesses to optimize their financial operations under the United Arab Emirates (UAE) tax laws. This article elucidates the intricacies of VAT recovery and refund procedures, providing valuable insights into how to navigate the tax terrain of the UAE. Drawing from both legal provisions and practical scenarios, we explore key processes, eligibility criteria, common challenges, and best practices to equip businesses with the knowledge to manage VAT obligations efficiently and potentially unlock significant savings.
As of 1 January 2018, the UAE has implemented the Value Added Tax (“VAT”) regime. VAT is an indirect tax applicable to the import and supply of goods and services, mostly borne by the end consumer but collected by the taxable supplier on behalf of the Federal Tax Authority (“FTA”). In light of that, businesses do not bear the cost of VAT, and merely act as collectors of such tax. To facilitate such concept, the UAE tax legislation explicitly permits businesses to recover, or request a refund of, the VAT incurred by such businesses if certain conditions as prescribed in the tax legislation are met.
This article dives into the mechanisms and procedures for VAT recovery and refunds, enabling taxable persons to obtain a cashflow advantage and preserve their funds.
Difference between VAT Recovery and Refund
On a current reading of the UAE tax legislation, there appears to be an implicit difference between VAT ‘recovery’ and VAT ‘refund’.
It is important to distinguish between VAT recovery and VAT refund, as these terms, though closely related, have different implications in the context of the UAE VAT law. VAT recovery refers to the process where businesses offset the VAT they have paid on their business expenses (input VAT) against the VAT they have collected from their customers (output VAT). This offsetting happens during the filing of the VAT return and aims to ensure that businesses only bear the cost of the VAT on their value addition, not on the entire value of the goods or services.
On the other hand, VAT refund comes into play when a business has incurred more VAT on its expenses (input VAT) than it has charged its customers (output VAT) during a tax period. In such situations, the business is in a refundable position and can request the FTA to refund the excess VAT paid. The refund mechanism enables businesses to reclaim this excess VAT, ensuring that they are not left out of pocket due to their VAT payments. The VAT refund is thus a mechanism to return the VAT to businesses, while VAT recovery is a process of offsetting the input VAT against the output VAT. In brief, the context within which the term “recover” is used, is almost always in relation to incurred tax that is deductible within a tax return without any actual cash being exchanged or transferred between the FTA and the taxable person. On the other hand, the context within which the term “refund” is used, is almost always in relation to amounts actually transferred to the taxable person’s bank account.
Recovery of VAT by Taxable Persons
As stipulated above, VAT is not generally a cost to be incurred by businesses. Therefore, VAT incurred by businesses when purchasing goods and services for the purposes of making taxable supplies are generally recoverable by businesses, unless such VAT was explicitly blocked from recovery as per the tax legislation. VAT incurred by businesses when purchasing goods and services is known as input VAT.
According to the Federal Decree-Law No. 8 of 2017 on Value Added Tax, and its amendments, taxable persons may recover any recoverable input VAT through their submitted tax returns, as part of the process of calculating the payable tax for a specific tax period. For example, if a taxable business charged customers AED 50,000 in output tax for a given tax period, and incurred AED 30,000 in input VAT within that same tax period, that business shall ‘recover’ the AED 30,000 from the AED 50,000 in the tax return, and only declare a payable tax of AED 20,000.
In addition to the substantive requirements, businesses must ensure that input VAT is recovered in the correct tax period, as collecting input VAT in an earlier period can result in the FTA imposing administrative penalties for invalid recovery.
The first step in determining whether input VAT may be collected in a given tax period is to verify and confirm that at least one of the below three events has occurred within that tax period:
– In the case of a supply without an import, receipt and retention of a valid tax invoice, or an equivalent document as prescribed in the law.
– In the case of an import of services, receipt and retention of the relevant invoices.
– In the case of an import of goods, receipt and retention of the relevant invoices and import documents.
The second step in determining whether input VAT may be collected in a given tax period is to verify that in addition to the occurrence of one of the above events, the taxable person pays the consideration for the received supply or intends to make such payment within six months from the agreed date for the payment. Failure to make the payment within the six-month period results in the taxable person being required to reduce the input VAT in the VAT Return of the tax period following the expiry of the six-month period, and wait until payment is made to re-recover the relevant input VAT.
The tax period within which the above steps are verified is the tax period within which the taxable person may recover the relevant input VAT. If the taxable person fails to recover the relevant input VAT within that tax period, it may still recover that input VAT in the subsequent tax period. However, if the taxable person fails to recover the input VAT in the above mentioned two tax periods, the FTA confirmed in its Public Clarification VATP017 on the “Time-frame for recovering Input Tax” that the taxable person may no longer recover the input VAT except by way of submitting a voluntary disclosure. The voluntary disclosure can relate to either of the two abovementioned tax periods. It is not clear whether the voluntary disclosure thresholds as envisaged below would apply in this case, and this remains at the sole discretion of the FTA, which may or may not accept processing the voluntary disclosure in accordance with the AED 10,000 threshold provisions.
Generally, unless one of the exceptions prescribed in the UAE tax law applies, it is also possible for a taxable person to recover input VAT incurred prior to registering for VAT purposes with the FTA. Such recovery is only possible if the input VAT was incurred when purchasing goods or services used post VAT registration to make a supply for which input tax is recoverable. For example, where a business purchases a furniture sofa and incurs input VAT, then sells the furniture sofa prior to the effective date of VAT registration, that business would not be eligible to recover the input VAT incurred on the purchase of the furniture sofa as it did not subsequently use it for a taxable supply.
In some instances, a taxable person may erroneously recover more or less input VAT than it was entitled to. In such instances, depending on nature and amount of error, the UAE tax legislation provides for the following remedies:
– If the payable tax was less than it should have been by a margin of more than AED 10,000, the taxable person must submit a voluntary disclosure to the FTA within 20 business days of becoming aware of the error.
– If the payable tax was less than it should have been by a margin of AED 10,000 or less, the taxable person must either correct the error in the tax return for the tax period in which the error has been discovered, or submit a voluntary disclosure to the FTA within 20 business days of becoming aware of the error if there was no tax return to be submitted (for example, in the cases of final stages of deregistration).
– If the payable tax was more than it should have been by a margin of more than AED 10,000, the taxable person may only submit a voluntary disclosure to the FTA within 20 business days of becoming aware of the error.
– If the payable tax was more than it should have been by a margin of AED 10,000 or less, the taxable person may either correct the error in the tax return for the tax period in which the error has been discovered, or submit a voluntary disclosure to the FTA within 20 business days of becoming aware of the error if there was no tax return to be submitted (for example, in the cases of final stages of deregistration).
Refund of VAT to Taxable Persons
The the UAE tax legislation explicitly allows a taxable person to apply to the FTA to request a refund of amounts held by the FTA, specifically in cases where the taxable person pays an amount in excess of the value of payable tax and administrative penalties, or has credit with the FTA. The FTA may accept such request, decline it, or accept it subject to offsetting certain non-disputed liabilities due from the taxpayer prior to processing the refund.
The FTA may only reject a refund request submitted to it by a taxable person in the three following instances:
– The existence of other disputed amounts in relation to the taxable person.
– The existence of an order from the competent court preventing the refund.
– An ongoing tax audit in relation to the taxable person, if conditions to be specified by the FTA’s Board of Directors are met. It is noted that to date, the FTA has not published any material in relation to such conditions.
Where the taxable person does not request a refund of excess amounts due to them, such amounts are treated as credit utilizable against future liabilities of the taxable person.
Once a refund application is submitted by the taxable person to the FTA, the FTA is generally required to decide on the refund application either by acceptance or rejection within 20 business days. However, the FTA may extend such a period indefinitely, provided that it has reasonable grounds for requiring a period longer than 20 business days.
If a refund application is approved by the FTA, the FTA is required to action one of the following options within five business days:
– Transfer the refunded amount to the taxable person.
– Notify the taxable person of postponing the refund until all due tax returns are submitted to the FTA.
– Notify the taxable person of offsetting the refundable amount, wholly or partially, against current tax-related liabilities.
In some instances, a taxable person may erroneously apply for a refund of an amount more or less than it was entitled to. In such instances, depending on nature of error, the UAE tax legislation provides for the following remedies:
– If the amount of refund was less than it should have been, the taxable person may submit a voluntary disclosure to the FTA within 20 business days of becoming aware of the error.
– If the amount of refund was more than it should have been, the taxable person must submit a voluntary disclosure to the FTA within 20 business days of becoming aware of the error.
Businesses may often face challenges in managing VAT recovery and refunds, due to complexities of the law, administrative burdens, and risk of penalties for non-compliance. It is crucial to maintain accurate and complete records, regularly review VAT recovery positions, and consider seeking professional advice.
In conclusion, effective management of VAT recovery and refunds can significantly impact businesses’ financial health in the UAE. As the tax landscape continues to evolve, staying informed about the latest developments in UAE tax law is critical. While the VAT recovery and refund procedures may seem daunting, understanding the mechanisms and adopting best practices can turn this challenge into an opportunity for businesses to optimize their operations and potentially unlock significant financial savings.
While understanding and complying with the tax laws may be complex, doing so is critical for maintaining the financial health and reputation of businesses, as well as the economic stability of the UAE. If you are unsure about your obligations, it is recommended to seek advice from a legal/tax professional.
This Article is prepared by, Marwan Alnooryani, Senior Tax Associate, at Habib Al Mulla Law Firm.
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September 28, 2023
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