VAT and Employee Benefits

25 Dec, 2023
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Elleonor Grace E. Apostol

General Accountant, Elnaggar & Partners

Overview

  • VAT is a transaction tax for businesses. Businesses pay VAT on purchases and charge it on sales, with a net balance payable or refundable.
  • Challenges include integrating VAT into operations, complying with filing requirements, and managing cash flow implications, leading to administrative and working capital costs in regions with a VAT system.
  • Despite the overall neutrality of the VAT system for businesses, there are instances where there is VAT incurred on a business's purchases. The business is obligated to account for its supplies which becomes a tangible cost, impacting the business' income statement as a tax expense.
  • In general, three key scenarios lead to VAT becoming a real cost:
  • On costs directly or indirectly related to exempt activities.
  • On costs that are universally ineligible for deduction, irrespective of business activities.
  • On supplies where no consideration is involved, falling under the "deeming" provisions of VAT law.
  • This Practice Note specifically addresses scenarios two and three, focusing on the realm of employee benefits under the VAT regimes in the UAE.

Definitions

  • Consideration: Everything collected or to be collected by a taxable supplier from the customer or a third party for the supply of goods or supply of services inclusive of VAT.
  • Customer: A person who received goods or services.
  • Economic activity: An activity that is conducted in an ongoing and regular manner including commercial, industrial, agricultural, or professional activities or services or any use of material or immaterial property and any other similar activity.
  • Exempted supplies: Supplies on which no tax is charged, and for which associated input tax is not deducted pursuant to the provisions of local laws.
  • GCC: Gulf Cooperation Council.
  • GCC Vat Agreement: Common VAT Agreement of the States of the Gulf Cooperation Council (GCC) (the GCC VAT Agreement).
  • Deemed supplies: Anything that is considered a supply in accordance with the cases provided for in article 8 of the GCC Vat Agreement.
  • Local laws: Federal Decree-Law No. 8/2017 On Value Added Tax and any relevant legislation issued by each member state.
  • Member state: Any country with full membership of the GCC in accordance with the council's statute.
  • Supply: According to articles 5-9 of the GCC VAT Agreement, supply is defined as "any form of supply of goods or services for consideration in accordance with the cases provided in chapter two of the agreement". Chapter two of the GCC VAT Agreement sets out how transactions should be classified between a "supply of goods" and a "supply of services".
  • Supply of services: Any supply that does not constitute a supply of goods under this agreement will be considered a supply of services.
  • Tax: Value added tax (VAT) imposed on the import and supply of goods and services at each stage of production and distribution, including deemed supplies.
  • Tax invoice: There is no definition set out within the GCC VAT Agreement. However, articles 55-58 of the GCC VAT Agreement sets out rules regarding issuance, content and adjustment of tax invoices, with the granular details to be set out within local laws.
  • Taxable person: A person undertaking an economic activity independently for the purpose of generating income, who is registered or obliged to be registered for VAT in accordance with the provisions of the GCC VAT Agreement". There is no definition of "taxable supplier" or "taxable customer" and so they should be viewed as a supplier/customer who is a taxable person.
  • Taxable supplies: Supplies on which tax is charged in accordance with the provision of the GCC VAT Agreement, whether at the standard rate or zero-rate, and for which associated input tax is deducted in accordance with the provisions of the GCC VAT Agreement.
  • VAT: Value Added Tax.
  • UAE: United Arab Emirates.

 

Practical Guidance

Employee benefits

Businesses increasingly establish reward programs to recognise employee performance, but this trend also brings about the potential for hidden or unforeseen VAT expenses, making employee awards more expensive than anticipated. Recognising high-performing staff with vouchers is a commonly adopted method, and a recent case has examined the VAT implications of this practice. While businesses might anticipate reclaiming VAT on assets purchased for staff, doing so raises the question of whether the business is also obligated to account for output tax.

Cash benefits

For a transaction to fall under the purview of VAT, it necessitates the presence of a "supply" involving "consideration" within the framework of engaging in an "economic activity."

The actions carried out by an employee on behalf of an employer constitutes a provision of services. The remuneration, in the form of salary or wages, given by the employer to the employee in exchange for these services qualifies as consideration. Consequently, the crucial inquiry revolves around whether these activities, conducted within the context of an employment contract, qualify as an "economic activity."

The services provided by an employee are categorised as personal services, encompassing an individual's effort or labor as per contractual agreements. However, for VAT purposes, these services are not construed as constituting an economic activity. Consequently, any monetary compensation disbursed to employees under an employment contract falls outside the scope of the VAT regime. A non-exhaustive list of what cash benefits may include is as follows:

  • salary, wages, or basic pay;
  • accommodation allowance in cash;
  • travel allowance in cash;
  • language allowance in cash;
  • relocation allowance in cash;
  • bonus;
  • time-in-lieu pay; or
  • end of service benefit.

It is important to mention that agreements and payments involving "contracted labour" need careful examination. Depending on the specifics, even without a formal employment contract, it could be treated like an "employee/employer relationship" for VAT purposes.

Non-cash benefits

Besides the salary paid for services under an employment contract, employees commonly receive extra benefits from their employer. It is crucial to assess these additional benefits individually to ascertain if there are any VAT implications for the employer and any actual VAT costs linked to the benefits.

Mobile phones, airtime, and data packages

In UAE businesses, companies regularly spend VAT on things like employee mobile phones and data plans. With the rise of remote work due to COVID-19, these expenses have become even more crucial.

A business is eligible to reclaim input tax for phones, airtime, and packages if these expenses are related to making it taxable supplies and certain conditions are fulfilled:

  • The business must be registered for VAT and must have obtained phones, airtime, and packages in its own name. This entails providing business details on tax invoices and contracts with the telecommunications service provider.
  • The business needs to adhere to a documented policy explicitly stating that phones, airtime, and packages are exclusively for business purposes. Consequences for any personal use should also be outlined.
  • Regular monitoring of the usage of airtime and packages by the business, along with maintaining justifications for any discrepancies.
  • Taking disciplinary action against employees who use phones, airtime, and packages for personal purposes, following the established documented policy.
  • Retaining valid tax invoices concerning phones, airtime, and packages acquired.

It should be noted that only documented policies that were already in effect when phones, airtime, and packages were provided to employees will be considered.

If all the requirements are not met, the recovery of input tax incurred for phones, airtime, and packages will be restricted in accordance with article 53(1)(c) of Cabinet Decision No. 52/2017 On the Implementing Regulation of Federal Decree-Law No. 8/2017 on the Value Added Tax.

Employee health insurance

Employee health insurance in the UAE allows employers to reclaim VAT spent on the coverage, given it is a mandatory requirement. In certain instances, the employer might offer health insurance coverage for the employee's family members. In these situations, the reclaiming of input tax is contingent upon the legal obligation of the employer to furnish health insurance for the employee's family, i.e., only if the employer is legally required to do so. Varying emirate-level laws on insurance requirements may affect the VAT treatment of family members' health insurance.

Input VAT deduction rules

To recover VAT incurred on purchases of goods and services, a taxable person in the UAE must satisfy specific conditions. In summary, these criteria can be outlined as follows:

  • The input VAT should have been accrued on goods or services obtained for the purpose of conducting an economic activity.
  • The input VAT should be associated with goods or services used or intended for use in making taxable supplies, supplies outside the member state (considered taxable if made within the member state), or specific categories of supplies outside the member state (considered exempt if made within the member state).
  • A taxable person must possess a valid tax invoice, relevant customs import documentation, or other accepted commercial documentation as per local laws.
  • Payment of the invoice must have been made or there should be an intention to pay within a specified period, such as within six months of the end of the commercially agreed credit period in the UAE.
  • The input VAT should not be incurred on "blocked" supplies.

It is crucial to highlight that, except for specified "special categories," VAT incurred on costs related to exempt supplies is not entirely recoverable from the relevant tax authority. This poses a challenge for businesses in sectors like financial services, real estate, and domestic transportation, subject to exemptions outlined in local laws under article 29 of the GCC VAT Agreement.

Blocked supplies refer to specific goods or services listed in local laws, for which no input VAT deduction is available, regardless of the nature of supplies a taxable person engages in. The expenses on which input VAT recovery is blocked can be categorised as follows:

  • Entertainment expenses.
  • Motor vehicles used for personal purposes.
  • Employee related expenses.

Exceptions within local laws exist for employee non-cash benefits required by law or the employment contract for the employee to perform their role effectively. Determining whether an expense is deemed "personal”, or "entertainment" is subjective and requires careful consideration.

In the context of the above input VAT deduction rules, a taxable person should consider non-cash employee benefits such as:

  • travel costs;
  • canteen facilities;
  • gym membership;
  • life insurance;
  • medical insurance;
  • motor vehicles;
  • expense reimbursement;
  • second-hand IT assets;
  • seasonal gifts;
  • events/tickets;
  • mobile phone; and
  • accommodation.

It is essential to evaluate each benefit individually to determine the accurate VAT treatment and related obligations for the employer. In instances of uncertainty, the employer should consider seeking professional advice to mitigate the risk of misclassification and potential fixed or tax-related penalties resulting from any errors.

Deemed supplies

In cases where input VAT is recoverable for expenses related to non-cash benefits for employees, there might still be an obligation for a taxable person to report VAT on the "deemed supply" of goods or services to the employee. This implies treating the goods or services as if it were commercially sold to the employee for consideration, resulting in an actual VAT cost to the business. The authorisation for deeming provisions is stipulated in local laws and under article 8 of the GCC VAT Agreement.

These provisions aim to ensure the application of VAT on the ultimate consumption of goods or services, preventing the avoidance of VAT payment on end consumption when a business provides goods or services free of charge to its employees (or, in other cases, vendors, customers, etc.). In the context of employee non-cash benefits, deeming provisions typically come into play when VAT has been deducted by the business, and one of the following situations occurs:

  • Services are provided to an employee without charge.
  • Goods are transferred to an employee without charge.

Examples of such scenarios include a catering company buying food and drink for its taxable business, deducting VAT, and then providing a portion of the food free of charge to employees. Similarly, a legal firm buying laptops in bulk for all employees, deducting VAT, and then giving a laptop to an employee as a reward. Another example is a tax advisory firm offering free personal tax advisory sessions to employees and their families.

Although local laws outline certain thresholds and exceptions from deeming provisions, most of these are not applicable to non-cash benefits for employees and are more suitable for samples or commercial gifts provided to vendors or customers.

Next steps

Businesses should:

  • Recognise all employee benefits, both monetary and non-monetary, along with their terms and conditions.
  • Identify any employee benefits that result in non-deductible VAT costs for the business.
  • Identify any employee benefits leading to deemed supplies and the associated VAT costs for the business.
  • Assess, based on the business's strategy for employee remuneration and the associated VAT costs, the business's inclination toward optimising the structure of employee benefits.
  • Integrate the new structure and optimisation into the business through HR, internal policies, and employment contracts.
  • Revise internal procedures and checklists.
  • Stay vigilant and keep track of changes in VAT laws, regulations, and interpretations by tax authorities regarding employee benefits in the region.

Gray area

Considering the GCC VAT Agreement, various challenges may emerge, including:

  • Determining the classification of expenses as "business-related costs".
  • Identifying what constitutes "normal incidental office expenses" and "entertainment services".
  • Understanding which costs qualify for exceptions from "blocked" VAT.
  • Establishing the proper procedure if the acquisition of goods or services, initially not intended for employee benefit, is later redirected to employees.

 

Related Content
Legislation

GCC

  • Common VAT Agreement of the States of the Gulf Cooperation Council (GCC) (the GCC VAT Agreement)

UAE

  • Federal Decree-Law No. 8/2017 On Value Added Tax
  • Cabinet Decision No. 52/2017 On the Implementing Regulation of Federal Decree-Law No. 8/2017 on the Value Added Tax
  • VATP028 – VAT Public Clarification - Mobile Phones, Airtime, and Data Packages Made Available to Employees for Business Use

 

Daisy Cureg

Financial Controller and Tax Advisor

Elnaggar & Partners

 

             

Elleonor Grace E. Apostol

General Accountant

Elnaggar & Partners

 

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