Real Estate VAT Guide I FEDERAL TAX AUTHORITY : Commercial Real Estate

 Definition

Commercial real estate is any land or buildings, which are not one of the following: 

1. a building designed as a residential building or number of residential buildings; 

2. a building intended for use by a charity for a relevant charitable activity; or 

3. bare land.

VAT liability of commercial real estate 

The supply of commercial real estate is subject to VAT at the standard rate of 5%. The supply of commercial real estate includes sale or lease. VAT is therefore due on the total consideration received for the supply of commercial real estate. Where the consideration for the supply is payable by instalment, VAT will be due on each instalment paid. 

As a result of making a taxable supply of commercial real estate, any VAT on costs incurred in relation to the supply shall be recoverable in full.

Cancelled developments

Where a supplier accepts full or partial payment in relation to a supply of real estate and the supply is subsequently cancelled, for example where the planned development is cancelled and does not take place, the supplier will normally be required to refund the money paid to the customer. 

Where this is the case, the supplier should issue a tax credit note to the customer in order to refund the consideration previously paid in respect of the supply. The tax credit note will have the effect of reversing the output tax which the supplier will have originally accounted for on the receipt of the payment. 

In the event the supplier is not required to refund the amount paid to the customer, it will be necessary for the supplier to establish the reason he is entitled to retain the money in order to determine the VAT treatment. Where the retained payment is treated as consideration for a supply of services by the supplier, it will remain subject to VAT at the standard rate and there will not be a requirement for the supplier to issue a tax credit note. 

Payment of VAT on sales of commercial real estate

A special payment process exists where sales of commercial real estate are made within the UAE. Detailed guidance on this process can be found in the VAT Payment for Commercial Property Buyers User Guide, however the process is also summarised in this guide below. 

The special payment process applies only in the case where commercial real estate is sold in the UAE by any supplier other than the developer of that property, and would be subject to VAT at 5%. Therefore, it does not apply to the following:

1. Sales or leases of residential property. 

2. Leases of commercial property 

3. Sales of commercial property by the developer of that property; and 

4. The sale of commercial property with the benefit of existing tenants to a buyer who is a taxable person which qualifies as the transfer of a business.

In such cases, the seller of the property will issue a tax invoice to the buyer in relation to the sale proceeds of the property as normal. However, before completing the ownership transfer process with the Land Department, the buyer of the commercial property will be required to pay the VAT due on the purchase directly to the FTA. Alternatively, subject to availability in the specific Emirate, the VAT may be paid via a bank nominated by the FTA for such purposes. 

Once the payment of the VAT has been made to the FTA, the buyer will receive a Payment Transaction Number or, in the case of a bank payment, the buyer will need to retain proof of payment containing the details of the VAT payment. 

The buyer will be required to produce the Payment Transaction Number or proof of payment (if applicable) to the Land Department in order to process the ownership transfer. Without this evidence that the VAT on the purchase has been paid, the purchase of the property cannot proceed and this will lead to delays. 

The supplier will declare the output tax due on the property within its VAT return in the normal way, and will then also include the value of the output tax in the adjustments column of the return. This will avoid paying the output tax to the FTA twice. 

In all other cases, the normal VAT rules regarding VAT accounting and payment are applicable.

Mixed use developments

What is a mixed-use development?

A mixed-use development is a building or plot of land which has clear and distinct areas which are put to different uses which would have a different VAT treatment when supplied. For example, a building which has retail units on the ground floor level, office or commercial space on the middle floors of the building and residential units on the top floor would be considered a mixed-use development. 

Where a distinct part of a mixed-use development is supplied, the VAT liability applicable to the supply shall depend on the use of the part of the building which is being supplied i.e. the supply of a commercial unit shall be taxable at the standard rate, whilst the supply of a residential unit (other than the first supply) shall be exempt from VAT.

Where a mixed use-development is sold in its entirety, it shall be necessary to apportion the consideration received between the different parts of the building. The value of consideration relating to the residential part of the building shall be treated as exempt from VAT (or zero-rated, where the supply is the first supply), and the value of consideration relating to the commercial part of the building shall be treated as standard rated.

VAT recovery on development costs

Input tax incurred on the development cost of new commercial real estate is recoverable in full, given that supplies of that building shall be taxable. This means that developers will be able to recover VAT over the duration of the development of the building. 

Where a taxable person incurs the costs of constructing a residential building, all of the VAT incurred on the costs of such development shall be recoverable in full on the basis that the costs relate to the zero-rated first supply. Any future supplies of the building by that taxable person (e.g. a subsequent lease, which would be exempt from VAT after the first supply) shall be ignored for the purposes of input tax recovery. 

As a result of the above, any VAT incurred on the construction of a mixed-use development should be recoverable in full.

VAT recovery on repair & maintenance costs

Input tax incurred on the repair and maintenance costs of a property which is used for wholly commercial purposes is recoverable in full. 
Input tax incurred on the repairs and maintenance of a property which is used for wholly residential purposes is not recoverable. 
Where input tax is incurred on a property which is used for both commercial and residential purposes, the taxpayer is required to directly attribute the VAT on costs  
incurred as far as reasonably possible. For example, where a building contains retail shops and residential apartments, any costs incurred which directly relate to the shops can be recovered in full. However, any costs which directly relate to the residential properties are not recoverable. This then leaves an amount of input tax, often called residual input tax, where the cost is used for both parts of the business e.g. roof repairs.

The input tax must be apportioned in accordance with the following method:

a) Input Tax that relates wholly to supplies where input tax is recoverable (e.g. taxable supplies), is recoverable in full. 

b) Input Tax that relates wholly to supplies where the input tax is non-recoverable (e.g. exempt and non-business supplies), is blocked in full. 

c) Input tax that cannot be allocated under (a) or (b) above (e.g. roof repairs) must be apportioned and is known as “residual input tax”.  

The residual input tax identified under point c) above should be apportioned using the following method:

1. Recoverable Tax % = supplies falling within paragraph (a) above / supplies falling within paragraph (a) + supplies falling within paragraph (b); 

2. The percentage calculated under paragraph (1) above is then rounded to the nearest whole number; 

3. The percentage calculated under paragraph (2) is to be multiplied by the amount of input tax referred to in paragraph (c) to establish the recoverable proportion of that input tax; and 

The total recoverable input tax is then the sum of supplies falling within paragraph (a) plus the answer under paragraph (3). 

The standard method of apportionment set out above may not be appropriate in every situation. Each business is different, and the standard method of apportionment may give rise to outcomes which might not be reflective of the actual use of goods or services by the business. As a consequence, the FTA introduced alternative methods of input tax apportionment which may be used where the standard method does not provide an outcome which is reflective of the actual use of the acquired goods or services. A special method may however only be used after written approval was received from the FTA. 

The floorspace method is available to businesses which deal with supplies (sales and rental) of commercial and residential properties, including real estate companies and other businesses which sell or rent out real estate on an ongoing basis, where expenses would be similar for floorspace regardless of whether used for making exempt or taxable supplies. Under the floorspace method, the apportionment percentage for residual input tax is calculated by identifying the portion of the floorspace used for taxable activity as a percentage of the total floorspace used by the business.

For more information on special apportionment methods, please refer to the Input Tax Apportionment: Special Methods Guide VATGIT1.