VAT Treatment of Rent Free Lease Period

A Real Estate company enters into a long term lease agreement with a client. To make the lease arrangement more lucrative and competitive, it offers the client a “rent- free” period of first two months, thereby resulting in a reduced rent for the entire lease tenure. There can be two ways of collecting this reduced rent from the client:

1. No rent collected for first two months from the lease start date and then the agreed upon rent for the remaining lease duration; or

2. Reduced rent for the entire period of lease duration by spreading the agreed rent (with zero rent for 2 months) over full lease duration. So instead of taking rent from third month onwards, the total rent amount was reduced and was charged from first month itself.

Question is how to account for VAT when such "rent free" period is involved.

The UAE VAT law states that VAT is applicable on supply of Goods/Services for which consideration is received by the supplier, where the term ‘consideration’ has been defined under Article 1 of the VAT Law to mean “all that is received or expected to be received for the supply of Goods or Services, whether in money or other acceptable forms of payment”.

Further Article 11 of the VAT Law states that under certain circumstances goods/services which are supplied without any consideration would be deemed as taxable supply and would therefore be subject to VAT at the applicable rate.

In such types of lease contracts where rent free period is involved, it’s important to understand that the mode of collecting rent - no rent for two months or reduced rent for entire lease term , does not in any way change the intent of the parties involved, which is "to enter into a lease agreement at an agreed price". Further this reduced rent or rent free period is offered only when the contract of the entire lease duration is signed between the lessor and the lessee.

In my opinion, the supply of lease of property where no rent is collected for first two months is not a supply which is separate from the overall lease contract. So VAT should be accounted based on the actual rent charged during the lease term. The period for which no rent has been collected would not fall within the ambit of deemed supply and will be considered as part of overall supply of services at a reduced price allowing the Real Estate Company to deduct the input VAT incurred during the rent free period.

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