Underlying Supply - Determines VAT on Recharges
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Underlying Supply – Determines VAT on Recharges

Businesses recover costs and charges from different stakeholders including employees and entities across borders. The World of Tax categorizes these recoveries as recharges and disbursements. The tax treatment of these recharges and disbursements are sometimes perplexed. A simple answer often is – taxability is determined based on the underlying supply. It is therefore really important to understand what the “Underlying Supply” in each context is.

The predominant context for the underlying supply is usually the contract between the parties or a formal Policy establishing the rules of engagement between parties. An in-depth analysis of the terms therein is paramount for the application of correct tax treatment.

The major categories of recoveries can be bucketed into recharge or disbursement. The authority has laid down the guiding principles for the correct classification in this regard in VATP013- The Public Clarification relating to Disbursements and Reimbursements (aka Recharges).

The attempt here is to analyze how different types of contract terms or rules of engagement between the parties can have varied tax implications for commercial transactions in the nature of recharges (reimbursements) between parties.

1. Disclosed Agent Relationship between the parties

Illustration 1

A, B and X are VAT registered businesses in the UAE. A buys standard-rated goods from X and sells them to B.

  1. X charges VAT @5% in his Tax Invoice to A.
  2. When A sells the goods to B, he charges VAT @5% in his Tax Invoice to B.

When A is selling goods that have been bought from X, the tax treatment on the onward sale is derived from the taxability of the “Underlying Supply”. In this case, the standard rated goods.

Illustration 2

A is a General Trading Business, B is A’s employee residing in the UAE and X is a telecom Service Provider. A & X are VAT registered businesses having POE in the UAE.

X raises Monthly invoices for telecom services to A. A recovers the personal-use part of the Invoice from B. B, as part of his job, travels outside the UAE at times and uses the roaming services as well. A has a formal policy in place which says its employees are eligible to make personal use of the telecom services. A will recover the charges of such personal usage from the employees based on the Invoice from the Telecom service provider.

Based on the above,

  1. X charges VAT @5% and 0% VAT in his Tax Invoice to A based on local and overseas services components.
  2. A recovers the personal consumption charges from B. A charges VAT @5% and 0% in his Tax Invoice to B based on the Place of Supply (POS) bifurcation in the Tax Invoice from X.

The question: Whether A can apply 0% VAT to B on the recovery of personally used roaming charges component. If A is the Disclosed Agent of X for the purpose of this transaction, can the underlying supply from A to B can be considered a supply of “Telecommunication Services” here and taxed based on the applicable POS accordingly? There can also be additional considerations like, whether A can “sell” telecommunication services under its commercial entitlement.

2. Service Provider for Support/ Facilitation Services

In Illustration 2 above, the tax lens will view the transaction differently if A is a service provider to B for the transaction in question. A is arranging the telecom connection allowing personal usage to B. A is therefore providing a support/ facilitation service to B. In this case, when A recovers/ recharges the cost of personal usage from B, it provides a service to B that is independent of the first leg of the transaction between X and A. VAT @ 5% will be applicable on the value of supply/ (deduction) from A to B in this case, irrespective of the fact that the underlying charges are for local or roaming usage. The telecom service loses its relevance to the Business Support Service from A to B in this case.

3. Recovery/ Recharge forming part of the Supply

Let us take yet another simple example to analyze the principle of “underlying supply” in cases where recharge is actually forming part of the supply itself.

Illustration 3

X LLC is a car leasing company. An LLC has leased cars from X LLC. An LLC has provided these cars to its employees to use for official purposes related to the business.

  1. The Transport authority charged toll charges and fines to X LLC because the cars were under the registration of X LLC.
  2. X LLC recovers these from A LLC based on the contractual terms.
  3. X LLC has to raise Tax Invoice to A for the monthly lease rental including toll charges and fines.

Question: Whether X LLC should charge VAT on the recharge of Tolls & Traffic Fines to A LLC?

In VATGAM1 – The Automotive Sector Guide issued in June 2021, reference has been made to a similar example, where it has been clarified that toll charges deducted from the lessor’s account are essentially a cost incurred by X LLC to provide car leasing services to A LLC. The recharge of such a cost is subject to VAT and should be included in the taxable value of the supply.

Should the fine charged by the transport authority to the account of X LLC be treated in the same way? Should X LLC recharge the fine to A LLC with VAT and include it in the value of taxable supply as well?

One school of thought says: Fines can be considered “costs” incurred by X LLC’s vehicle leasing business just like tolls assuming the liability to pay fines to the transport authority rests with X LLC and not with the person/ entity driving the car. Going by the explanation on toll charges, recharge of fines by X LLC to A LLC could also be included in the value of taxable supply and subject to VAT at the applicable rate. This is under the pretext that the “underlying main supply” is car leasing and all recharges are incidental to the main supply. Therefore, all recharges should take the tax treatment of the main component.

In case A LLC is considered a disclosed agent of X LLC in the above scenario, an alternative view can be formed based on VATP001- VAT treatment of compensation-type payments. As per VATP001: A fine or penalty charge may be imposed for contravening terms of an agreement, performing an unlawful act, or otherwise be imposed, usually by government bodies, for breaches of statutory obligations. True fines and penalties are not a consideration for any supply and therefore outside the scope of VAT.

VATP001 clarifies, where a payment is not a consideration for a supply, no VAT is due on the payment. VATP001 states “…..In considering whether a payment is a consideration for a supply or is in the nature of compensation, it is important to ignore the labels or titles the parties give to a payment. For example, a description of an administrative payment as a “penalty” or“compensation” will not prevent the nature of the payment from being considered for a supply.”

Let’s assume for a moment that the contract between the parties lays down that A LLC will be liable to fines and penalties from X LLC, in case the cars are driven in non-compliance of any traffic rules and regulations in force, which may/ may not lead to penalties/ fines levied by the authorities on X LLC. Under such circumstances, amounts charged by X LLC to A LLC could be considered in the nature of compensatory payments for breach of contract and not subject to VAT.

However, if that is not the case, the fines may also be considered a cost incurred by X LLC and forming part of the value of its supply to A LLC. The underlying supply, in this case, can be argued to be “Car Leasing” and not “fine”. The tax treatment may follow accordingly.

VATGDS1- Vat Guide on Director’s Services adds yet another dimension to these types of transactions. It says: “An individual may act as a director of a number of companies. For convenience, one company may pay all the director’s fees and then allocate the costs to recover appropriate proportions from the others. The individual’s services, such as attending meetings or approving expenditure, are supplied by the individual to the companies of which they are a director. The services are supplied directly to the relevant businesses by the individual and not from one company to another. In this case, there is no supply between the companies and accordingly, no VAT is due on the share of money recovered from each company.”

It is interesting to note that VATGDS1 states there is no supply of services in the case of one company recovering money from the other companies for Directors Services. This can hold good in a disbursement arrangement where the Director is raising Tax Invoices on the respective service recipient companies and the “payment” is done centrally by one company. The payee company then recovering the “payment” from the other companies is not a supply for VAT purposes and therefore no VAT is due on the share of money recovered by the payee company from each company.


It is in the interest of businesses that all commercial arrangements, payments, and recoveries are formalized, defined, and explained in contracts between the parties and/or the P&Ps. Formal contracts and P&Ps can be considered the definitive reference for the nature of amounts paid and recovered thereunder. An in-depth analysis and understanding of contract terms are paramount before arriving at decisions concerning “underlying supply” and the logical tax treatment, even for the simplest of contracts like the ones in our illustrations above.

News Courtesy : GCCFinTax

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