Composite supplies: how contract drafting shapes the VAT treatment

Why it matters

Not all supplies are treated the same way. Some are standard-rated at 15%; some are zero-rated, such as exports and certain services supplied to non-residents under their conditions; and some are exempt, such as residential rent, certain financial services and real estate supplies that are subject to Real Estate Transaction Tax. When one contract combines elements from two different categories, the amount of tax depends on how the supply is characterised.

The effect of getting it wrong goes beyond the tax difference: it may bring a penalty for an incorrect return, and it carries through to every period in which the same treatment was applied.

The governing principle

The VAT Implementing Regulations do not set out a detailed general test for distinguishing a single supply from multiple supplies. The characterisation therefore turns on the nature and economic substance of the transaction, and on the treatments set out in ZATCA's sector guidelines for particular cases.

The settled principle in VAT systems is that a transaction is treated as a single supply where one element is the principal one in the customer's eyes and the others are ancillary to it, a means of better enjoying the principal element rather than an aim in themselves, or where the elements are so closely linked that separating them would be artificial. Where each element has an independent purpose for the customer and can be obtained on its own, the better view is that there are multiple supplies, each with its own treatment.

Indicators to consider

1. 01Economic purposeWhat is the customer actually buying, and which element is the contract really for?
2. 02SeparabilityCan each element be obtained on its own, or from another supplier?
3. 03PricingDoes each element have its own price reflecting a reasonable market value, or is the split only on paper?
4. 04InterdependenceWould removing one element affect the rest of the contract or its value to the customer?
5. 05PerformanceAre the elements actually delivered as the contract describes?

Examples from practice

1. 01Residential lease with servicesAn exempt residential lease that includes cleaning, maintenance and internet access. Are the services ancillary to the accommodation and treated in the same way, or separate standard-rated supplies? The answer changes the tax on a significant part of the contract value.
2. 02Equipment with installation and maintenanceA supply of equipment together with its installation, commissioning and maintenance over several years. Here the characterisation affects when tax becomes due, and how the consideration is split between what is due on delivery and what is due over the life of the contract.
3. 03Services to a non-resident customerServices supplied to a customer outside the Kingdom with an element performed or enjoyed inside it. The zero rate may apply to one part and the standard rate to another, and the 2025 amendments to the Implementing Regulations clarified when the standard rate applies where a person connected with the customer benefits from the service in the Kingdom.
4. 04Property with movable itemsA real estate supply is exempt from VAT because it is subject to Real Estate Transaction Tax, while the RETT Law treats as real estate any movable items intended to serve or be used with the property on a permanent basis. How the contract describes those items and allocates the price therefore affects which tax applies to each part.

What drafting can do

• Describe the elements precisely, and state how they relate: are they independent, or ancillary to a principal element?
• If the elements are independent, price each at a reasonable market value and document the basis for the pricing.
• If the supply is single, avoid an artificial split that suggests otherwise.
• State expressly how VAT is treated in the price, and how the price is adjusted in long-term contracts.
• Reflect the agreed characterisation in the e-invoice, line by line and rate by rate, and then in the return.

Above all, consistency matters. An audit does not read the contract alone; it compares it with the invoices, the returns and what is actually performed. Any mismatch between them weakens the treatment, however well the contract is drafted.

In summary

Characterising a supply is a matter of professional judgement that requires an understanding of both the business and the contract. Reviewing the drafting of key contracts before they are signed, especially long-term and high-value ones, costs far less than defending their treatment after an assessment.