If you don’t charge VAT on a sale, that doesn’t necessarily mean the sale is VAT exempt.
Under UAE VAT rules, there is an important difference between a zero-rated supply and an exempt supply.
In both cases, your customer may pay no VAT. But the impact on your business can be very different.
The biggest difference? Whether you can recover the VAT you pay on your own business costs.
What is a zero-rated supply?
A zero-rated supply is still a taxable supply, but VAT is charged at 0% rather than the standard 5% rate.
Subject to the relevant conditions, examples can include certain:
- exports of goods and services;
- international transportation;
- first supplies of qualifying residential buildings;
- qualifying healthcare services; and
- qualifying educational services.
Because these remain taxable supplies, a VAT-registered business making zero-rated supplies can generally recover VAT incurred on associated business costs, subject to the normal UAE input VAT recovery rules.
What is an exempt supply?
An exempt supply is different.
No VAT is charged to the customer, but the supply is exempt rather than taxable at 0%.
An exempt supply falls within the UAE VAT regime but is specifically exempt from VAT under the legislation.
Examples can include certain:
- financial services;
- supplies of residential property;
- supplies of bare land; and
- local passenger transport.
The key difference is that VAT incurred on costs directly relating to exempt supplies is generally not recoverable.
That can make VAT an actual cost to the business.
Zero-rated vs exempt: a simple example
Consider two UAE businesses that each make AED 1 million of sales.
Business A makes zero-rated supplies.
Business B makes exempt supplies.
Neither business charges VAT to its customers on those particular supplies.
Both businesses then incur AED 200,000 of expenses plus AED 10,000 VAT.
If Business A’s expenditure relates to its zero-rated taxable activities, the AED 10,000 VAT may generally be recoverable, subject to the normal input VAT recovery conditions.
If Business B’s expenditure relates entirely to its exempt activities, the AED 10,000 VAT would generally not be recoverable.
Business B therefore effectively bears an additional AED 10,000 cost.
This is why 0% VAT and VAT exempt are not the same thing.
The difference at a glance
| Standard-rated | Zero-rated | Exempt | |
|---|---|---|---|
| VAT charged | 5% | 0% | None |
| Taxable supply? | Yes | Yes | No |
| Counts towards taxable turnover for VAT registration? | Yes | Yes | No |
| Related input VAT generally recoverable? | Yes* | Yes* | No* |
Subject to the UAE input VAT recovery and apportionment rules.
Why does this matter for VAT registration?
Zero-rated supplies are still taxable supplies.
They therefore generally count towards taxable turnover when determining whether a UAE-resident business has exceeded the mandatory VAT registration threshold, currently AED 375,000, subject to the applicable rules.
A business making AED 1 million of zero-rated sales should therefore not simply assume:
“I don’t charge VAT, so I don’t need to register.”
There are circumstances in which a person making only zero-rated supplies can apply for an exception from VAT registration, subject to the relevant conditions.
Exempt supplies, on the other hand, are excluded when calculating taxable turnover for the VAT registration threshold.
This distinction can therefore determine whether a business needs to register for VAT in the first place.
Property is a good example
UAE property illustrates the difference particularly well.
Subject to the relevant conditions, the first supply of a qualifying residential building within three years of its completion can be zero-rated.
Subsequent supplies of residential property are generally exempt.
Commercial property, meanwhile, is generally subject to VAT at the standard 5% rate.
You can therefore have three different properties — or transactions involving property — with very different VAT consequences.
This distinction can be particularly important where significant VAT has been incurred on construction, professional fees and other expenditure.
What if my business makes both taxable and exempt supplies?
Some businesses make a mixture of:
- standard-rated supplies;
- zero-rated supplies; and
- exempt supplies.
In these circumstances, VAT on costs directly relating to taxable activities may generally be recoverable, while VAT relating directly to exempt activities generally cannot be recovered.
There may then be costs which support both activities, such as certain office, professional or general overhead expenses.
In these circumstances, the business may need to consider the UAE’s input tax apportionment rules to determine how much VAT can be recovered.
For businesses with significant expenditure, the amount of irrecoverable VAT can become substantial.
Which businesses particularly need to understand the difference?
The distinction can be especially important for businesses operating in:
Property – residential and commercial property can have very different VAT treatments.
Financial services – certain financial services can be exempt, while others may be taxable depending on the nature of the service and how consideration is charged.
Healthcare and education – qualifying supplies can be zero-rated rather than exempt, subject to specific conditions.
International trade and services – certain exports can qualify for zero-rating, provided the relevant conditions are satisfied.
Businesses operating across more than one type of activity should pay particular attention, as making exempt supplies alongside taxable supplies can restrict the amount of input VAT they are entitled to recover.
Zero-rated, exempt and outside the scope are not the same thing
There is one further distinction worth understanding.
A transaction can also be outside the scope of UAE VAT.
This is different from both a zero-rated and an exempt supply.
Therefore, when a business does not charge 5% VAT, the question shouldn’t simply be:
“Do I need to charge VAT?”
It should be:
“Is this supply standard-rated, zero-rated, exempt or outside the scope of UAE VAT?”
The answer can affect your VAT registration obligations, VAT return and ability to recover VAT on business expenditure.
Why getting it right matters
For many businesses, VAT is not intended to be an additional cost — the business collects VAT from customers and recovers qualifying VAT incurred on its expenditure.
But where a business makes exempt supplies, some VAT incurred on its costs can become irrecoverable.
For a business with significant expenditure, this can have a real impact on profitability.
This is why understanding whether your income is zero-rated or exempt matters even though your customer may pay no VAT in either case.
How SOA Accountants can help
At SOA Accountants & Business Advisors, we help UAE businesses determine the correct VAT treatment of their activities and understand the impact on VAT registration and input VAT recovery.
This is particularly important if your business operates in property, financial services, healthcare, education or international trade, or makes a mixture of taxable and exempt supplies.
If you’re unsure why you aren’t charging VAT on a particular source of income, it is worth checking.
Zero-rated and exempt may look similar on the sales invoice, but the financial impact on your business can be very different.
This article provides general information only and does not constitute specific tax advice. UAE VAT treatment depends on the particular facts and circumstances of each transaction and the applicable UAE VAT legislation.
