As part of an on-going programme to re-balance the economy away from oil revenues and enhance the UAE’s business environment, a new 5% VAT regime came into effect on January 1, 2018.

The new standard rate is 5%, with some supplies exempt or zero-rated. There is an off-setting, or recovery mechanism, as is usual with VAT regimes, and the tax will in principle apply on the supply of all products and services except any specifically exempted, for example financial services.

Why is this relevant to franchising?

The supply of goods and services from abroad, including IP rights typically bundled together in franchise agreements which generate initial fees, individual store opening fees, regular royalty payments etc will, generally speaking, attract VAT at the standard rate of 5%.

Goods imported into the UAE from overseas suppliers will be subject to VAT on entry into the country. The importer, in many cases the local franchisee, will be liable to account for the VAT to the authorities.

Overseas franchisors and their supplies of services to UAE franchisees will however not be required to register for VAT in the UAE, because such supplies of services are in principle subject to the so-called “reverse charge mechanism”, which switches the liability to pay the VAT from the supplier to the recipient, and means that the franchisee, as the recipient of the services is liable to account for the VAT to the UAE authorities, and must register for VAT when its turnover exceeds the AED375,000 mandatory registration threshold (sales of approx. £76,000 or $102,000 at today’s exchange rate).

In addition, the supply of goods and services between a UAE-based supplier or franchisor to UAE franchisees will also (assuming the supplies are not exempt or zero rated) attract VAT at the standard rate of 5%. In this case of course, both parties to the domestic transaction will be potentially required to register for VAT in the UAE.

What’s the issue?

The general position under the VAT law is that prices are considered to be inclusive of VAT, meaning that unless the contract expressly states that VAT will be charged in addition, the supplier will not be able to seek that 5% from its customer.

Subject to the “savings notice” exemption mentioned below, in the case of the supply of goods and services between a UAE-based franchisor to UAE franchisees, the franchisor will have to account for the 5% from its own pocket where the contract is silent on VAT. If however the contract is silent on VAT and the customer is liable to pay the tax, the burden of the new VAT liability falling on it may provoke a discussion about the commercial terms between the parties.

What steps can be taken?

If a franchise agreement and/or supply contract does not expressly make clear that any sales tax or VAT is for the account of the buyer/franchisee and must not be deducted from the gross amount payable to the supplier/franchisor, both foreign and domestic franchisor can served a simple notice to the buyer/franchisee requiring that VAT be paid in addition, rather than the price being otherwise treated as VAT inclusive.

However, such notices should have been issued before January 1, 2018. After that date, if the contract is silent on the matter, the supplier/franchisor may not be able to require the price/fees to be treated as VAT exclusive, unless both parties mutually agree to vary the contract to require VAT payment on top of the purchase price/royalty etc. – which would of course impose an additional 5% cost on the buyer/franchisee and so is likely to be resisted.

In summary…..

Both foreign and domestic UAE franchisors whose contracts make clear that fees and prices are VAT exclusive and do not permit withholdings need do nothing, other than register for VAT, and start to charge and pay VAT where necessary in the case of UAE franchisors.

The position is not quite so straightforward for overseas franchisors with “VAT silent” contracts who ought to consider the position carefully with their advisers. It may be possible to vary existing contracts with the mutual cooperation of franchisees, or at the very least be ready to address this issue at the next renewal point.