Andersen

The rules generally provide for a Value Added Tax (VAT) to be imposed on a compensation or fine if the amount paid is a taxable supply.

According to the law, a taxable supply can be defined as a supply of goods or services in exchange for profits, made for the consideration by any person required to register inside the Kingdom of Saudi Arabia. This means that it does not include a tax-exempt supply. Thus, there must be a Supply of Goods or Services (GST) for the obligation to apply VAT to be imposed. Other payments that are not otherwise related to the supply of goods or services are not subject to VAT.

In this scope, to know if the payment is taxable or no, you must define first if it is related or no to a taxable supply. This requires the taxpayer to review the agreement stipulating the payment to determine if the receiver got any profits. The payments may vary from compensations to dispute settlement to violations or fines as you can read below.

Compensatory payments

According to the law, payments made to compensate for lost or damaged goods are not VATable, but some of the amounts may be in the scope of VAT. As for “Specific damages”, they represent an example of predetermined compensation. In fact, the due amount of the compensatory payments is set by the signatories when they sign the contract. As per this last agreement, the party suffering the “specific” loss or damage is entitled to a compensation, such as in the case of breaching pre-existing terms of a contract (early termination of the contract or late completion of a project).

These payments are not intended to provide profits for the supply of goods or services, but rather to compensate the claimant for losing the income. Therefore, these payments are outside the scope of VAT.

Dispute settlement:

Before determining whether a payment awarded in reference to dispute settlement is VATable or not, some issues need to be put in consideration, such as the precise reason behind the payment to be made. Is it related to a contractual term, damages or compensation, or granting a right?

– The payment may fall in the scope of VAT If its purpose is to apply contractual term. This applies when the dispute is related to the price of goods, and the payment may resolve the issue arising from a dispute over the price. In this case, the amount is subject to VAT because considered as a supply of goods.

– If the payment is in the nature of damages or loss compensation and made by one party to another, VAT may not apply (e.g. late payments, liquidated damages or earnings loss).

– If the paid amount is in return for granting a right, VAT may apply. For example, granting a right to use someone’s own real estate, in return for a certain amount.

Violation or fine

Government entities may impose fines or penalties on parties violating the terms of an agreement or performing an illegal act or violating legal obligations. Actual fines and penalties are not considered as a supply. Therefore, they fall outside the scope of VAT. For example: the contract may oblige one of the parties to pay an amount to the other party in case of breach to contractual times.

The amount awarded to cover the loss of nonbreaching party as a result of the breach of contract is intended as compensatory damage. In this case, the party imposing the fine is not making a supply for a service. Fines and penalties fall therefore outside the scope of VAT.