Dubai’s Real Estate sector is hugely data-driven and, like any other economic sector, it abides by its own taxation laws. But what happens when a buyer or an investor realizes a disconnect between his knowledge of the market and its applicable tax policies, particularly VAT.
Read through this article to better comprehend how Dubai VAT laws apply to the various real estate categories and transactional situations.
FROM THE VAT PERSPECTIVE
If we examine Dubai’s Real Estate market from the lens of Value Added Tax (VAT), we would find it to be comprised of -
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Any area of land over which rights, interests or services can be created.
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Any building, structure or engineering work.
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Any fixture or equipment which makes up a permanent part of the land or is permanently attached to the buildings, structure or engineering work.
In any of these cases, the supply of real estate may be standard-rated, zero-rated or exempted from VAT. The VAT liability in each case will differ depending on what is being supplied and whether the real estate is commercial or residential.
WHAT ARE GOODS & SERVICES?
For Goods - Any supply of real estate that includes sales and tenancy contracts is treated as a supply of goods for VAT purposes. This would mean that VAT rules which apply to goods will determine the appropriate VAT treatment of goods in Dubai.
Place of supply rules: The place of supply is where the real estate is located.
Time of supply rules: The time of supply will be the earlier of when payment was received or a tax invoice was issued for the supply.
For Services - With respect to services, they will only be considered to relate to real estate if they are directly related to the real estate in question. And, in this case, the specific VAT rules shall apply to those services.
The place of supply of services related to real estate is where the real estate is located.
Examples of services related to the Real estate include the following
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The grant, assignment or surrender of any interest in or right over real estate.
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The grant, assignment or surrender of a personal right to be granted any interest in or right over real estate.
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The grant, assignment or surrender of a license to occupy land or any other contractual right exercisable over or in relation to real estate, including the provision, lease, and rental of sleeping accommodation in a hotel or similar establishment.
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A supply of services by real estate experts or estate agents.
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A supply of services involving the preparation, coordination, and performance of construction, destruction, maintenance, conversion, and similar work.
TYPES OF BUILDINGS
There are two types of buildings in real estate - Residential & Commercial
Residential Buildings - Simply put, they are differentiated on the basis of intent of occupation or use. A Residential building is meant for residence and includes:
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Any building that the person occupies, or will occupy, as their principal place of residence;
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Residential accommodation for students, school pupils, police or the armed forces;
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Orphanages, nursing homes and rest homes; and
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A building that has a small proportion of it used as an office or workspace by the occupants.
It excludes any of the following:
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any place that is not a building fixed to the ground;
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any building that is used as a hotel, motel, bed and breakfast or hospital;
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a serviced apartment for which services in addition to the supply of accommodation are provided;
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any building constructed or converted without lawful authority.
According to Dubai’s Taxation laws, the supply of residential buildings is typically exempted from VAT treatment. However, there are certain exceptions to this rule -
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The first supply of a building which has been newly converted into a residential building and meets the conditions for zero-rating.
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The first supply of a residential building within 3 years of its completion, which will be zero-rated.
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The supply of residential accommodation for a term of less than 6 months will be standard rated (unless the tenant holds an Emirates ID card, in which case it will be exempt).
The first supply of a building (or part of a building) that is converted to a residential building will be zero-rated provided the following conditions are met:
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the supply of the building takes place within 3 years of the conversion work being completed; and
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the original building (or any part of it) was not used as a residential building or did not comprise part of a residential building within 5 years prior to the conversion.
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The presence of shared facilities, dividing walls or similar features should not cause a building to be considered as part of a pre-existing residential building.
Commercial Buildings?? - In contrast, a commercial building is any building or part thereof, that is not a residential building. Unlike residential buildings, commercial buildings are not exempt from VAT treatments and all their supplies are subject to a standard rate of 5% VAT. A few examples of such buildings are -
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Offices
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Warehouses
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Hotels
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Shops
Apart from residential and commercial buildings, the real estate market comprises of certain building types that are deemed as ‘special cases’ and their VAT exemption or treatment varies accordingly.
BUILDINGS DESIGNED TO BE USED BY CHARITY ORGANIZATIONS
Their VAT treatment is subject to the following conditions -
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The first sale or lease of a building (or part of a building) that is specifically designed to be used by a charity and only used for relevant charitable activities will be zero-rated.
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The building must be used by a Charity which is specifically listed in Cabinet Decision No. (55) of 2017 on Charities that may recover Input Tax or its amendments.
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A “relevant charitable activity” is any activity that does not intend to make a profit or provide benefit to any proprietor, member or shareholder of the charity, and is undertaken by the charity in the course of its charitable purpose.
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For example, a charitable purpose includes (but is not limited to) advancing health, education, public welfare, religion or culture.
MIXED-USE BUILDINGS
These are buildings that comprise of both residential and commercial parts and each part is treated separately from a VAT perspective.
VAT Liability
The supply of the residential part of the building shall be considered as exempted or zero-rated depending on when the property construction was completed and if it was a first supply.
The supply of the commercial part of the building will normally be subject to the standard rate of 5% VAT (however, remember there are special rules for supplies of real estate located within a Designated Zone).
Input Tax Recovery
Any input tax incurred on costs that wholly relate to the taxable (standard rated supply of the commercial building or zero-rated supply of the residential building) supply of the building can be recovered. However, any VAT incurred on costs that wholly relate to the exempt (e.g. residential) supply cannot be recovered.
Any remaining input tax that relates to both taxable and exempt supplies of the building (such as overheads) will need to be apportioned and recovered in part and this apportionment is determined using a set calculation that divides Value of input tax that relates to taxable supplies by Value of input tax that relates to taxable and non-taxable supplies resulting in Percentage Recoverable in Overheads.
VAT REFUND FOR NEW RESIDENCES
Although the construction of a residential building will incur VAT charges, there are circumstances where a refund can be sought (subject to certain conditions).
The given circumstances are where a person owns or acquires land in Dubai and builds (or commissions the construction of) his/her own residence on that land, he/she is entitled to apply for a refund of the VAT incurred on the construction expenses, provided the following conditions are met:
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The claim must be made by a natural person who is a national of the UAE
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The claim must relate to a newly constructed building to be used solely as a residence for the person and/or his/her family
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The claim must be made within 6 months of completion, where the date of completion is the earlier of: (1) the first time the residence is occupied; or (2) when it is certified as completed by a competent authority of the State or as may otherwise be stipulated by the Authority
It is to be noted that only VAT incurred on construction expenses can be reclaimed – such as the services of builders, engineers, architects and the purchase of building materials. This does not include VAT incurred on items like furniture or certain electrical appliances.
TRANSFER OF A GOING CONCERN (TOGC)
A Going Concern is defined as a business that functions without the threat of liquidation for the foreseeable future, preferably the next 12 months. The transfer of a going concern (or TOGC) is the transfer of the whole or an independent part of a business to a taxable person for the purposes of continuing the business.
A TOGC is outside the scope of Dubai VAT as it is considered as neither a supply of goods nor a supply of services.
An example of a TOGC could be the transfer of a property rental business, along with all the components that make it a business – including:
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Staff required to operate the business
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The real estate required to operate the business
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Continuing lease contracts with tenants
For a supply of real estate to be considered part of a TOGC (and outside the scope of Dubai VAT), it must be sold along with all the other components that would allow the purchaser of the business to continue to operate the business.
BARE LAND
Simply put, in order for land to be considered “bare land” for Dubai VAT purposes, none of the following must be present on top of the land -
The supply of bare land is exempt from VAT. This includes the supply by either lease or by sale. As a result, any VAT on costs associated with the supply of bare land e.g. legal fees or agents fees, shall not be recoverable by the supplier.
Leasing Bare land for Development
As the VAT exemption of Bare Land is subject to certain specified conditions, it is important that at the time of leasing to a tenant who intends to build on the land, the state of the plot of land is clearly identified by the landlord. The landlord needs to state if he has supplied bare land or covered land to the tenant as this will affect the VAT liability.
Where a landlord leases land to a tenant which meets the definition of “bare land” at the point it is first leased to the tenant, the supply shall be exempt from VAT. However, as soon as the piece of land becomes “covered” with a partially completed building, the land ceases to exist as "bare" and any subsequent supply of that land will be standard rated.
SUPPLIES BETWEEN TENANTS AND LANDLORD
These are the supply transactions taking place between the tenant and landlord.
Inducements: Where a landlord pays a prospective tenant to enter into a lease, the tenant is considered to be making a supply to the landlord of agreeing to enter into a contract. If the tenant is registered for VAT, then their services shall be subject to VAT at 5%, regardless of whether the property is a commercial or residential property.
However, where the prospective tenant is not VAT registered, any inducement paid by the landlord is outside the scope of VAT.
Rent-free periods: Where the landlord grants a rent-free period in return for no consideration, the rent-free period does not normally constitute a supply for VAT purposes. This is only the case where the tenant is not obliged or required to provide anything in return, and provided the tenant is not a related party.
However, if a tenant undertakes to provide anything to the landlord in return for the rent-free period, this would represent a barter transaction e.g. the tenant may be required to fit out the property in return for the rent-free period. This is a barter transaction and VAT must be accounted for on the value of the supply made by both parties.
Other similar transactions may take place between landlords and tenants. In all cases, it must be established whether the party receiving the money is providing anything in return for receiving the money – if so, it is likely that VAT shall be due on the consideration received.
CAPITAL ASSETS SCHEME
The Capital Assets Scheme (“CAS”) is a special mechanism for recovering input tax incurred on the purchase of a capital asset and monitoring how that asset is used over a period of time.
A capital asset is a single item of expenditure with a value of AED 5,000,000 (excluding VAT) or more on which VAT is payable (i.e. it was subject to VAT at the standard rate) and the asset has an estimated useful life at least:
Do note that a taxable person can hold more than one Capital Asset at any one time.
As well as one-off expenditure, if you make staged payments which collectively amount to AED 5,000,000 (excluding VAT) or more, the total cost shall be treated as a single item of expenditure – and the item will be regarded as a Capital Asset.
This relates to the purchase of any of the following:
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The purchase or construction of a building
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The extension, refurbishment, or other work undertaken for a building (except where there is a distinct break between works being undertaken)
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The purchase, construction, assembly or installation of any goods or immovable property where components are supplied separately for assembly
Capital Assets Scheme: Adjustments
The aim of the CAS is to monitor how each Capital Asset is used (and the recovery of input tax relating to each asset) for an adjustment period – i.e. 10 years for buildings.
Year 1: The tax year in which the asset is acquired shall be treated as Year 1.
Input tax incurred on the purchase of a Capital Asset is recovered at the time of purchase and in line with the normal rules on input tax recovery and input tax apportionment i.e. VAT is recoverable on the total purchase price at the time the cost is incurred, subject to the input tax apportionment recovery percentage.
Where the asset was already owned prior to registration, Year 1 is deemed to have commenced on the first date of use of the asset.
Year 2: This will be the subsequent tax year (i.e. if the Year 1 tax year ended on 31 January 2019, Year 2 will end on 31 January 2020).
A calculation (known as a “CAS adjustment”) must be carried out to compare: (i) the amount of input tax that was recovered in Year 1 per the Year 1 VAT recovery rate; (ii) the amount that should have been recovered in Year 2 per the Year 2 VAT recovery rate.
Year 3 onwards: An annual CAS adjustments must be calculated for each subsequent tax year for the duration of the asset’s useful life i.e. 10 years for buildings.
The CAS adjustment requires the person, at the end of each year, to perform 2 calculations:
Value of input tax incurred on the purchase of the asset / 10 for buildings x current year recovery rate = (A)
Value of input tax incurred on the purchase of the asset / 10 for buildings x Year 1 recovery rate = (B)
If the amount that should have been recovered in the current year (A) is greater than the amount recovered in Year 1 (B), then the difference can be recovered. This will be included on the tax return as an additional amount of input tax due to the person.
If the amount that should have been recovered in the current year (A) is less than the amount recovered in Year 1 (B), then the difference must be repaid. This will also be included on the tax return as a reduction in the amount of input tax the person can recover. The adjustment is made to the recoverable input tax amount on your VAT return for the first tax period after the end of each tax year.
Capital Assets Scheme: Other scenarios
If the asset is held for the full 10-year period, once you have carried out all CAS adjustments within that period, no further adjustments are required.
Other adjustments may be required if you do not retain the asset for the entire adjustment period.
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If the asset is disposed of (other than in the final CAS year), the VAT liability of the sale of the asset will dictate how the asset will be treated in all remaining CAS adjustment years. For example, if the sale of the asset was a taxable (or exempt) supply, the asset will be regarded as being used for making only taxable (or exempt) supplies in any remaining adjustment years.
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If a taxable person deregisters for VAT and is required to account for VAT on the asset as a deemed supply, the same rules for disposals also apply here.
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Where the asset is transferred as part of a transfer of that business or the taxable person joins or leaves a VAT group but remains VAT registered, then the CAS obligations pass to the new owner of the asset. The existing tax year of the previous owner ends on the day that the business is transferred or the entity is removed from the VAT group. On the following day, the tax year of the new owner will commence.
Any adjustments relating to the disposal of a capital asset should be included in the VAT return for the period in which the asset was disposed of.
So, whether you are a buyer/ investor or an agent, your capability to reduce risks and leverage resources to earn high returns depends on your conscious awareness about the market you are engaging with and the efforts to stay updated with credible information.