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In the digital era, where businesses are increasingly dependent on robust IT infrastructure and seamless data management, co-location of server services are gaining significant importance.

Co-location is a facility where a business can occupy a space for its servers and other IT hardware infrastructure at the service provider’s location.  The ownership of the IT hardware is of the recipient and is only deployed at the service provider’s location.  In addition to the space, the supplier (service provider) provides uninterrupted power supply, cooling, day-to-day support, etc. services for the functioning of the IT hardware.  This arrangement also known as off-site data storage, which ensures no pressure on the recipient to create a secured real estate to upkeep and operate the IT infrastructure, which is cost beneficial.

The concept of a place of supply determines the applicability of VAT.  The general rule for the place of supply in the UAE is the supplier’s location. Thus, if the supplier is in the UAE, all transactions should be subject to VAT at 5%, unless otherwise specified.  Further, in case the recipient of the supply is outside the UAE, the transaction should be classified as an export which entails 0% VAT, subject to certain conditions.  The zero rating ensures input VAT does not become a cost to the supplier and the recipient is not burdened with an additional cost of VAT (as the recipient is not present in the UAE).  However, there are stringent conditions for availing of the concessional VAT rate.  A few cases where the zero rating would not be applicable even if the recipient is outside the UAE, are mentioned below:

• If the supply is directly related to real estate, the place of supply shall be where the real estate is located. The FTA through its VAT guide has provided a broad overview of classifying real estate-related transactions, one of them being the granting of a right to real estate. In addition, the supply of storage of goods in a property with a right to a specific area for the exclusive use of that customer may also trigger real estate-related supply as it may take the colour of leasing.
• For services which are directly in relation to the goods, such as the installation of goods, is the place of location of goods where said services were performed. Although practised since the inception of VAT in the UAE, this rule is specifically applicable from 15 November 2024 vide the latest amendment.  Further, if the services are treated as storage services, the services could amount ‘services in relation to goods in the state’ when the services are provided.

Considering the above exclusions, there can be multiple business models for co-location services which could result in VAT issues.  A few of them are mentioned as below:

• In case the warehouse, the goods (servers and related equipments) and the supplier are located in the UAE and the customer is outside the UAE, how will the VAT be determined? In the normal scenario, the transaction should qualify as an export and will be subject to 0% VAT. However, in case of real estate-related service, as a specified place is provided for securing and keeping the IT products in the larger warehouse or services in relation to goods in the state when the services were provided, the transaction will become liable to VAT at 5%.
• This issue will also create complexity in case the supplier and the recipient are in the UAE; however, the data centre is outside the UAE. In a normal scenario, the transaction will attract 5% VAT, whereas, in the case of real estate or the activity in relation to goods, the transaction should qualify as outside the scope of VAT, as the real estate and the goods are outside the UAE.
• In case the supplier and the facility are outside the UAE and the recipient is in the UAE, will such supply attract a reverse charge mechanism?
• Lastly, in case the supplier is outside the UAE, however, the facility and the recipient are in the UAE, will it trigger the supplier to apply for a VAT registration in the UAE or will the recipient be required to treat it as subject to reverse charge mechanism?

While there is little clarity on co-location services in the UAE, it has been discussed in a few other jurisdictions.

• In the EU, services consisting of providing customers with cabinets for storing servers in a data center, providing energy, and maintaining order in this respect do not constitute real estate services. Thus, the default rule of supply may be applicable.
• In India, co-location services are like hosting and information technology (IT) infrastructure provisioning services.
• In US, based on the guidance from the Washington courts, the Department of Revenue concluded that a taxpayer’s co-location services cannot be treated as a real estate lease unless it conveys exclusive rights to the space.

With the growing demand for co-location services, it is imperative that businesses providing/ receiving such services are cautious while drafting the contracts.  VAT is a transaction tax and thus any error can result in double taxation, non-taxation, compliance risks, penalties etc. Therefore, businesses should evaluate the tax treatment and apply accordingly including rectification of any past errors.