VAT and real estate: a legal perspective

Until such time as the VAT laws are finalised and publicised, there will remain an element of doubt as to their final form. Nonetheless, some patterns are emerging which may allow those in the real estate industry to take steps now to protect or clarify their position regarding VAT in their legal documentation.

What we know or think we know

VAT will be charged at five per cent on the taxable supply of goods and services. VAT is a tax on the value added at each stage of the supply chain.

Any entity or person required to register must charge VAT on their taxable supplies. The difference between the VAT charged on supplies made (outputs) by a registered entity and the VAT that entity pays to suppliers (inputs) is the tax payable to the VAT authority. If the inputs exceed the outputs a credit may be due.

Only businesses making supplies over a certain threshold (anticipated to be Dh375,000) shall be required to register for VAT on a mandatory basis. However, to take advantage of being able to set off inputs and outputs, many businesses under this threshold may opt to register to recover VAT provided that their supplies exceed a lower threshold of Dh187,500.

It is also anticipated that certain supplies will be either “exempt” or “zero rated”. In simple terms, a “zero rated” supply will enable the supplier of the relevant goods or services to charge VAT at zero per cent, while being able to recover any VAT paid on its inputs. An “exempt supply” is where the provider of goods or services cannot charge VAT on the supply, but must pay VAT on its inputs.

Residential property

As the sale and purchase of newly constructed real estate is likely to be “zero rated” and secondary market real estate transactions are likely to be “exempt”, investors in residential property will not be required to pay VAT to the developer or a subsequent seller.

Similarly, residential landlords are not expected to charge VAT to tenants. However, investors are likely to have to pay VAT to providers of leasing or management services relating to the property and will not be entitled to recover this VAT.

Residential developers

As the first sale of a property is likely to be zero rated, it is expected that developers will not be able to charge VAT on such a sale, but will be able to claim back any input VAT paid to their suppliers in the course of developing the project. For this reason, it is not necessary to specify that the purchase price in contracts with investors is “exclusive of VAT” or “plus VAT”; doing so could confuse investors and result in them seeking to reduce the purchase price to offset the risk. However, developers’ management documentation (strata or otherwise) should clarify that VAT will be payable by investors on any management service fees.

Commercial investors

It appears relatively settled that investors in commercial real estate will be required to pay VAT on the purchase price, whether from the developer or secondary market. It is anticipated that if the taxable activity of the investor is the leasing of real estate, the investor shall be entitled to claim a credit for the VAT paid on the acquisition of the real estate. As such, the payment of the VAT on acquisition should be more of a cash flow issue.

Commercial tenants

Commercial tenants will be required to pay VAT. For most commercial tenants, this will not be a material issue as they will be able to set off this input VAT against output VAT that they are collecting on their supplies.

Accordingly, it should not be an issue in most cases for landlords to insert clauses stating clearly that all sums charged to tenants under the lease will be “exclusive of VAT” and that VAT will be payable in addition to such sums. Landlords will also pay VAT on any management services they receive. In the case of net leases, where service charges are payable by the tenants, VAT may also be payable on such service charges.

With regard to leases entered before the VAT laws come into force, a key issue will be whether the tenant is required to pay VAT on the rent if the relevant lease does not clearly state that rent is exclusive of VAT. In this respect we would expect the transitional provisions of the VAT laws to state that VAT would be payable in addition to the rent where the tenant is registered for VAT and is entitled to a deduction for the input VAT. If the tenant is not registered for VAT the position is more controversial as there is no ability for the tenant to claim the rent as an input credit. In this situation it is plausible that the rent will be deemed to be inclusive of VAT. However, the position that the VAT laws adopt on this key issue remains to be seen.

Commercial developers

As noted above, developers will be entitled to charge output VAT on the sale of commercial real estate and to set off such amounts against the input VAT they pay to their suppliers. Accordingly, developers should provide in their sale and purchase documentation that the purchase price will be “exclusive of VAT”.

Other issues

Precisely how commercial and residential real estate is defined also remains uncertain at this stage. Whilst we would anticipate that real estate assets such as workers’ accommodation, hotels and serviced apartments would be considered commercial real estate, the status of optional rental pool properties or holiday homes is less obvious. Mixed-use developments incorporating residential and commercial components may also create some challenges in terms of how the apportionments of VAT inputs are calculated. Another key issue may be what exactly constitutes “bare land” in determining whether or not an “exempt” supply has been made.

In the absence of the final form of the VAT law or additional guidance from the authorities, it is difficult to be prescriptive as to what amendments developers or investors may want to make in relation to their legal documentation. Moreover, this article is not intended to be a full summary of all issues likely to emerge from the VAT law. We trust, however, that this article alerts stakeholders in the real estate industry to some of the relevant issues and gives guidance as to what areas may need to be explored.