VAT Treatment of Demurrage and Despatch: UAE and Beyond

Summary

Based on the detailed analysis below, we conclude as follows:

DEMURRAGE

There is no specific provision/ rule directly providing for the VAT treatment of demurrage charges under the UAE VAT Law/ Executive Regulations. The analysis has therefore been guided by the general provisions and framework of Law, which resulted in the following alternative and potential approaches to VAT treatment of demurrage charges. All the approaches result in demurrage being either outside the scope of VAT or attracting VAT at 0%.

Transportation services approach

Normally, under the charter parties, freight covers carriage plus a fixed laytime. When laytime is exceeded, demurrage charges could be characterized as the agreed incremental price for the vessel’s continued availability. Further, UAE Maritime Law expressly treats such amounts as supplements to freight, confirming their nature as part of freight consideration.

Accordingly, demurrage is best characterised as part of the consideration for the transportation service, operating as an adjustment to freight.

The place of supply of transportation service is place where the transportation commences. Since in the instant case it is outside the UAE, the place of supply is outside the UAE. Consequently, the supply is outside the scope of UAE VAT.

Transport-related services approach

Transport-related services defined under VAT Law includes inter alia, loading and unloading services, closely related services and services necessary to conduct transportation services. Demurrage charges could be characterized as consideration for all these three categories of services alternatively.

Loading and unloading services: Demurrage arises only when the vessel and other facilities (where applicable) remain available beyond the laytime for loading and unloading the cargo. It is therefore payment for use of resources for loading and unloading the cargo and could be characterized as payment for loading and unloading services.

• Closely related services: Demurrage arises only when the vessel and its equipment must remain available beyond the agreed laytime to complete loading or unloading, operations that are indispensable to commencing and concluding the transportation of goods. It is defined and payable solely under the charter parties/ transportation contracts, confirming its exclusive link to the transportation of goods. Therefore, it can be characterized as consideration for a service closely related to transportation service as well.
• Necessary to conduct transportation service: Loading and unloading are integral to the transport service. Demurrage arises when these operations exceed laytime, ensuring the vessel and equipment remain available until completion. Therefore, demurrage may be characterised as consideration for services necessary to conduct the transportation service.
• The place of supply of transport-related service is also the place where the transportation commences. Since in the instant case it is outside the UAE, the place of supply is outside the UAE. Consequently, the supply of transport-related services, however it is characterized, is outside the scope of UAE VAT.

Compensatory payment/ Liquidated damages approach

Demurrage may alternatively be characterised as liquidated damages for failure to complete loading or unloading within the agreed laytime. Since UAE VAT applies only where there is a supply for consideration, and payments made solely as compensation do not constitute consideration, demurrage so characterised would fall outside the scope of VAT.

Taxable service approach

Even if demurrage is treated as consideration for a taxable service, it would still attract VAT only at 0% in terms of Article 31(1)(b) of VAT Executive Regulations, as the entire service was performed outside of the implementing states in the instant case. This conclusion holds regardless of the location of the recipient.

Where the recipient of services does not have a place of residence in the Implementing state and is outside the State at the time the services are performed, Supply could attract zero-rating under Article 31(1)(a) of the UAE VAT Executive Regulations, provided the other conditions listed under Article 31 are satisfied.

The below table summarizes the above-discussed alternative approaches to VAT Treatment of demurrage:

DESPATCH

There is no specific provision in the UAE VAT Law or Executive Regulations addressing the VAT treatment of despatch payments as well. The analysis has therefore been guided by the general provisions of the VAT framework, leading to the following different alternative approaches. All approaches result in despatch being either outside the scope of VAT or zero-rated at 0%.

Transport-related services approach

The definition of transport-related services inter alia include loading, unloading and other closely connected services.

• Loading and unloading: Despatch arises when loading and unloading are completed earlier than the contractual laytime, allowing the shipowner to regain use of the vessel sooner. On this basis, despatch may be characterised as consideration tied to loading and unloading services.
• Closely related services: When loading and unloading are completed earlier than laytime, the shipowner can despatch the vessel and complete the transportation sooner, improving efficiency and timing. The despatch payment is the contractual recognition of this benefit and therefore could be characterized as payment for service closely related to transportation.

The place of supply of transport-related service is the place where the transportation commences. Since in the instant case it is outside the UAE, the place of supply is outside the UAE. Consequently, the supply of transport-related services, however it is characterized, is outside the scope of UAE VAT.

Rebate/ Discount of Freight approach

Despatch could in substance be characterized as rebate or downward adjustment of the freight, reflecting that vessel resources were occupied for less time than priced. On this view, it does not represent consideration for a separate supply and is outside the scope of VAT.

Taxable service approach

Even if despatch were regarded as consideration for a taxable service, it would qualify for 0% VAT under Article 31(1)(b) of UAE VAT Executive Regulations, since the underlying service (early completion of cargo operations) occurs entirely outside the Implementing States.

Where the recipient is non-resident and outside the UAE at the time of performance, despatch may also qualify for zero-rating under Article 31(1)(a) of UAE VAT Executive Regulations, subject to the conditions of that Article.

The below table summarizes the above-discussed alternative approaches to VAT Treatment of despatch

Uncertainty

However, there is uncertainty with respect to the above treatments, in the absence of the UAE VAT Law, Regulations and FTA Guidance expressly addressing VAT treatment of Demurrage and Despatch.

There is also specific uncertainty with respect to interpretation of Article 31(1)(b) of UAE VAT Executive Regulations as it could be read as applying only in cases that satisfy the definition of “export of services”, even if underlying services are performed entirely abroad.

Therefore, there is a possibility that FTA could take positions contrary to the above, as elaborated in the Analysis section below.

Analysis

Demurrage

Under the Laytime Definitions for Charter Parties 2013, it is provided that demurrage shall mean ‘an agreed amount payable to the owner in respect of delay to the Vessel once the Laytime has expired, for which the owner is not responsible’. Laytime means ‘the period of time agreed between the parties during which the owner will make and keep the Vessel available for loading or discharging without payment additional to the freight’.

Potential Characterizations and VAT Treatment of Demurrage

Transportation service approach

The phrase “transportation service” is not expressly defined under the VAT Law. Applying its plain and ordinary meaning, it can be said as referring to the transporting of goods or passengers from one location to another.

The carrier provides the transportation service in return for freight charges. As part of that service itself, the carrier is obligated to make the vessel and its equipment available for the purpose of loading and unloading the cargo during the contractually stipulated laytime. This availability forms part of the overall bargain for which the freight charges constitute consideration.

Where loading or unloading of cargo is not completed within the laytime included in the freight bargain, demurrage charges are imposed. These charges represent the incremental price for the continued availability of the vessel, facilities and equipment beyond the laytime already covered by the freight charges. In commercial substance, therefore, Demurrage is best seen as an adjustment to the freight charge and part of the consideration for the transportation service itself, payable only where the contractual allowance of laytime is exceeded.

The above finds express support in Article 144 read with Article 133 of the Federal Decree Law No. 43 of 28 September 2023 Concerning the Maritime Law (‘UAE Maritime Law’), which state that amounts payable to the shipowner for additional time extensions for completion of loading or unloading operations shall be deemed as supplements of the Freight. They provisions remove any doubt as to the legal character of demurrage. It is an incremental component of the overall consideration paid for the transportation service itself.

This characterization also finds support in FTA’s Public Clarification VATP001, which explains that a payment will constitute consideration for a supply where “the purpose of the payment is to adjust a previously agreed consideration for a Supply”. Demurrage functions precisely as such an adjustment: it is an addition to the Freight Charge, triggered where the laytime allowance for loading and unloading is exceeded. Therefore, it is consideration for supply of transportation service.

Comparative practices from other jurisdictions support the above characterization as well:

• Australia: The Australian Taxation office (‘ATO’) has clarified through a public ruling under the Taxation Administration Act 1953 that “Demurrage and dispatch amounts are considered to be additions or refunds of the charter rate under contract. Therefore, these additions and refunds are adjustment events under the GST legislation.” Further, the ATO in their official website has through an Example clarified that demurrage charges are treated as part of the freight cost, and that the taxable value of the freight service must include the demurrage component.
• Singapore: The IRAS GST Guide for the Logistics Service Industry, treats Demurrage Charges as part of consideration for International Transportation Services (Para. 5.3, Example 1 and 2 and Annex B).
• Russia: The Russian Ministry of Finance in its letters No. 03-07-11/164 dated 10 June 2011 and No. 03-07-11/101 03.04.2009 has opined that demurrage should be treated as amount received in close connection with transportation services.

Further, custom valuation rules of other jurisdictions also support this characterization:

• European Union: Demurrage charges incurred before import are found as payable in respect of use of means of transport and therefore as part of costs of transport, includible in the customs value of goods.
• United Kingdom: Guidance dated 3 Nov 2022 published by HM Revenue & Customs, UK, states that demurrage charges for delay before the arrival of goods at the place of introduction are delivery costs which are to be included in the customs value.

The above references reinforce that demurrage charges are economically inseparable from transport costs. Accordingly, they should be characterised as consideration for transportation services.  

Article 30(8) of the VAT Law provides that, for transportation services, the place of supply is where the transportation commences. Since, in the case under discussion in this Article, the transportation service is carried out between two locations outside the UAE, the place of supply will be outside the UAE.

Consequently, demurrage charges fall outside the scope of UAE VAT Law.

Transport-related services

Under Article 1 of the VAT Law, ‘Transport-related services’ is defined as “Shipment, packaging and securing cargo, preparation of Customs documents, container management, loading, unloading, storing and moving of Goods, or any other closely related Services or that are necessary to conduct the transportation Services”.

Even if demurrage charges are not treated as an adjustment to Freight and consideration for the transportation service itself, they can nonetheless be characterized as consideration for services falling within the scope of ‘transport-related services’. This conclusion is supported by the following three complementary arguments:

• Consideration for loading/ unloading service.

The definition of “transport-related services” includes loading and unloading as highlighted above. Demurrage is triggered only when the Charterer exceeds the contractual laytime for loading or unloading under the charter party. The charge arises because the vessel, its berth, and its equipment must remain at the Charterer’s disposal to complete those loading/ unloading operations beyond the period already priced into freight.

Accordingly, demurrage is payment for the extended use of the carrier’s resources for loading/unloading and, as such, falls squarely within loading and unloading services in the definition of transport-related services under Article 1 of the VAT Law.

• Consideration for other closely related services.

The definition of “transport-related services” expressly includes both specifically listed activities as well as two residual categories: “any other closely related services” and services “that are necessary to conduct the transportation services”.

These two residual limbs are framed disjunctively, meaning that a service does not need to be “necessary” in order to qualify as “closely related.”

Demurrage charges would fall under the residual category of “closely related services” for the following reasons:

• • Direct Link to transportation of Goods. Loading and unloading of goods are necessary for the transportation of goods to commence and conclude. Demurrage arises solely because the vessel and equipment of the carrier must remain available for the loading and unloading of cargo beyond the contractual laytime. Therefore, there is a clear and direct nexus between demurrage and transportation of goods.
  • Arises from the transportation contract. Demurrage is not a standalone charge but one that arises solely under the terms of the Charter Party, under which the transportation service is provided. It is defined, quantified, and invoiced solely under the terms of that transport contract. This demonstrates that demurrage arises exclusively in connection with the transportation service.
  • Profit from Shipping. As per Article 8 of OECD Model Tax Convention read with the Commentary, profits directly obtained from transportation of cargo by ships and from activities directly connected/ ancillary to the operation of ships shall be considered as Profits from operations of ships in international traffic. The Commentary recognizes that income from container leasing, short-term storage, and detention charges is usually directly connected with or ancillary to operation of ships in international traffic—the common thread being the use/retention of transport assets. By the same logic, the extended use of the vessel (and berth/equipment) beyond laytime to finish cargo operations, for which demurrage is paid, is not a separate business activity but income directly connected with/ ancillary to the operation of ships in international traffic.
  • Approaches of other jurisdictions. Group 8 of Schedule 8 of the UK VAT Act, 1994, titled “Transport” includes services of handling or storage of goods carried in a ship, aircraft or railway vehicle. It has been clarified by HM Revenue & Customs in the Guidance on zero rating for ships, aircraft and passenger and freight transportation under VTRANS070300 and VAT Notice 744B, that demurrage falls under this. This reinforces the view that demurrage is to be treated as a service closely related to transportation.
  • In light of the above, Demurrage Charges may be characterized as consideration for services that are closely related to the transportation of goods, and therefore fall within the statutory scope of “transport-related services” under Article 1 of the VAT Law.

• Consideration for services necessary for conducting transportation service.

Transportation of goods necessarily includes cargo-handling—loading to commence the voyage and discharge to complete it. Both are integral to the transport service. Demurrage arises only when these essential steps overrun laytime and it funds the continued availability of the vessel, berth, equipment, and crew to finish them. In substance, it is the contractual mechanism that enables transportation to commence, proceed, and conclude in practice. Therefore demurrage constitutes consideration for transport-related services, specifically those necessary to conduct transportation within the meaning of Article 1 of the VAT Law.

Article 30(8) of the VAT Law provides that, for transport-related services, the place of supply is where the transportation commences. Since, in the situation under discussion in this Article, the transport-related service is carried out between two locations outside the UAE, the place of supply will be outside the UAE.

Consequently, demurrage charges fall outside the scope of UAE VAT Law.

Compensation/ Liquidated damage approach

Demurrage charge can alternatively be characterized as a form of contractual compensation for loss/ liquidated damages, as it becomes payable when Charterer fails to complete loading/ unloading with the agreed laytime. This characterization finds support in:

• Article 390 of the UAE Civil Code, which deals with liquidated damages provides that “two contracting parties may fix, in advance, the amount of damages either in the contract or in a subsequent agreement subject to the law provisions.” Demurrage can be said to be the damages amount fixed in advance by the contracting parties.
• UK Supreme Court’s ruling in Fronsdal & Co. (Owners of SS "Hansa") v. William Alexander & Sons [1919] UKHL 611, which referred to demurrage as compensation and damages.
• Decision in the Eternal Bliss case ([2021] EWCA Civ 1712 (Para 1)), wherein it was held that it is established that “failure to complete cargo operations within the laytime is a breach of contract by the charterer for which demurrage is liquidated damages”.
• Scrutton on Charterparties (24^th edition, 2000, Art 170), which states that demurrage is “liquidated damages paid for delay beyond a stipulated or reasonable time for loading or unloading, generally referred to as the laydays or laytime”.

Under VAT Law, VAT is attracted only on a Taxable Supply i.e. supply of goods or services for consideration. Compensatory payments/ liquidated damages do not constitute considerations. This is supported by FTA Public Clarification VATP001, which clarifies that contractual payment to compensate for loss like liquidated damages is not consideration for supply and is outside scope of VAT.

In light of the above, demurrage charges, when characterized as liquidated damages/ compensatory payments would fall outside the scope of VAT Law and would not attract VAT.

Despatch

Laytime Definitions for Charter Parties 2013 defines “Despatch Money or Despatch” as ‘an agreed amount payable by the owner if the Vessel completes loading or discharging before the Laytime has expired’.

Potential Characterizations and VAT Treatment of Despatch

Transport-related service

Despatch can be viewed as consideration for transport-related services under Article 1 of VAT Law based on the following two complementary arguments:

• Consideration for loading and unloading services

Despatch is directly triggered by the early completion of loading or unloading operations relative to the laytime allowed in the Charter Party. In substance, despatch represents the economic value to the shipowner of receiving the vessel back earlier than expected, made possible by the efficient completion of loading/ unloading.

Accordingly, despatch can be characterized as consideration linked to loading and unloading services, since its payment depends entirely on the manner and timing in which those services are performed.

• Consideration for other closely related services:

The transportation service cannot commence without loading, nor conclude without unloading. Where these operations are finished earlier than the contractual allowance, the shipowner is able to despatch the vessel and conclude the transportation sooner, thereby improving the efficiency and timing of the overall transportation service. The despatch payment is the contractual recognition of this transport benefit.

Accordingly, Despatch can be alternatively characterized as consideration for services closely related to transportation.

Article 30(8) of the VAT Law provides that, for transport-related services, the place of supply is where the transportation commences. Since, in the situation under discussion in this Article, the transport-related service is carried out between two locations outside the UAE, the place of supply will be outside the UAE.

Consequently, dispatch would fall outside the scope of UAE VAT Law.

Rebate/ Discount

Freight charges, as noted above, include not only the carriage of goods between ports but also the contractual availability of the vessel, berth, and equipment for loading and unloading during the agreed laytime.

Where cargo operations are completed within that allowance, the owner regains use of the vessel sooner than anticipated. In recognition of this, despatch is paid to the Charterer. In commercial substance, this payment functions as a rebate or discount against the freight, reflecting that the carrier’s resources were occupied for less time than originally priced into the freight rate.

This finds support in:

1. Scrutton on Charterparties (24^th edition, 2000, Art 170), wherein despatch is defined as: “a rebate of freight allowed to the charterer at a daily rate for loading or discharging in less than a stipulated or reasonable time.”
2. Decision of Navico AG v Vrontados Naftiki Etairia PE, [1968] 1 Lloyd’s Rep 379, at 383 lhc, wherein despatch was characterized as a rebate of freight at a daily rate for time saved.
3. Australian Taxation Office’s public ruling under the Taxation Administration Act 1953, wherein it was found that “Demurrage and dispatch amounts are considered to be additions or refunds of the charter rate under contract.”

Despatch would fall outside the scope of UAE VAT for the following reasons:

1. Despatch is not payment made for any separately identifiable Supply. Since VAT is attracted only on Taxable Supplies, i.e. Supply of goods or services for consideration, despatch would not attract VAT.
2. Despatch is a rebate against the Freight Charges. Therefore, it will not attract VAT and will be out of scope of UAE VAT Law. This finds support in Public Clarification No. VATP001 of the FTA, which states: “VAT is a tax on supplies of goods and services. Therefore, no VAT is due if no supply takes place. ….. Where a payment is not consideration for supply, no VAT is due on the payment.” It also finds support in the treatment adopted by Australian Taxation Office, which found that Despatch, being a refund, is an adjustment under GST legislation.
3. If Despatch is characterized as a downward adjustment to the Freight Charges, it could be treated as a discount, which would reduce the taxable value of the underlying freight under Article 39 of the VAT Law and Article 28 of the VAT Executive Regulations. In such case, it would not give rise to a separate VAT liability but instead operate to reduce the consideration payable for the transportation service.

Taxable services performed abroad – zero-rating

In this article, we consider the cases where all the activities for which demurrage/ despatch is paid are performed outside UAE. As pointed out in our earlier publication, where performance of supply is fully outside of UAE, regardless of the location of the recipient, 0% VAT rate could be applicable under Article 31(1)(b) of the VAT Executive Regulations.

In light of the above, even if despatch/ demurrage are characterized as consideration for taxable supplies, they would attract only 0% VAT.

However, as noted in the said publication itself a contrary position is also possible and therefore there is uncertainty in respect of interpretation of Article 31(1)(b) of VAT Executive Regulations.

In the absence of the UAE VAT Law, Regulations and FTA Guidance expressly addressing VAT treatment of Demurrage and Despatch, there is uncertainty with respect to the above treatments. There is also uncertainty with respect to application and interpretation of Article 31(1)(b) of the VAT Executive Regulations as noted above. Therefore, there is a possibility that FTA could take positions contrary to the above findings. Accordingly, a Private Clarification from the FTA is advised to obtain certainty.

The disclaimer

Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.

The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law. See the full press release here.

You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have the status of the authors’ opinion only. Furthermore, it is not legal or tax advice. Like any human job, it may contain inaccuracies and mistakes that we have tried our best to avoid. If you find any inaccuracies or errors, please let us know so that we can make corrections.