For businesses operating under the UAE VAT framework, particularly those making a mix of taxable and exempt supplies, also known as being partially exempt, accurately managing input tax recovery is crucial. When costs are incurred for both activities, a methodology must be applied to determine the recoverable portion of VAT paid. This process, governed primarily by Article 58 of the VAT Law and Article 55 of the Executive Regulation, is called input tax apportionment.
Below is a breakdown of the standard and alternative apportionment methods available under UAE VAT law.
The Fundamental Principle of Apportionment
Input tax must be categorized into three baskets:
- Wholly Attributable to Taxable Supplies: Fully recoverable (FR), provided all input tax conditions are met.
- Wholly Attributable to Exempt Supplies (or Non-Business Activities): Not recoverable (NR).
- Residual Input Tax (Overheads): Costs incurred for both taxable and exempt supplies (e.g., office rent, utilities). This residual input tax must be apportioned.
1. The Standard Method (Input Tax Based)
The default method stipulated in the Regulation is the Input Tax Method. This method determines the recoverable percentage of residual input tax based on the ratio of input tax incurred on recoverable supplies (taxable supplies) versus the total input tax incurred on supplies that are wholly attributable to the business activities (both taxable and exempt).
This calculation excludes input tax that is specifically blocked from recovery (such as certain entertainment services).
Formula (Apportionment Percentage):
Recoverable Percentage = FR / (NR + FR) x 100
The resulting percentage must be rounded to the nearest whole number (e.g., 83.1% rounds to 83%).
2. Alternative Apportionment Methods (Special Methods)
A taxable person may apply to the Federal Tax Authority (THE AUTHORITY) for permission to use an alternative method if they consider that the standard method does not accurately reflect the actual use to which the input tax is put in the business. Generally, the standard method must have been used for at least six months before applying for an alternative basis.
The Federal Tax Authority provides a list of accepted alternative mechanisms. These include:
A. Outputs-Based Method (Revenue Method)
This method calculates the recovery ratio using the value of taxable supplies as a proportion of all supplies made by the business. This can be particularly suitable where costs closely correlate with sales volume.
Formula
Recovery Percentage = Value of Taxable Supplies \ Value of Total Supplies (Taxable + Exempt) X 100
B. Transaction Count Method
This method determines the recoverable percentage by taking the number of taxable transactions in a tax period over the total number of transactions in that period.
Formula
Recovery Percentage = Number of Taxable Transactions \ Total Number of Transactions X 100.
C. Floorspace Method
The Floorspace Method is based on the floor area used for taxable supplies compared to the total floor space of the business premises. This method is often useful when apportioning costs related to property, such as utilities or rent.
Formula:
Recovery Percentage = Floor Area used for Taxable Supplies \ Total Floor Space X100
D. Sectoral Method
For businesses conducting activities through discrete divisions where different expenses relate to these divisions, a Sectoral Method may be appropriate. This involves applying an appropriate method (like Outputs-Based or Floorspace) to calculate the input tax recovery
Correct input tax apportionment is vital for VAT compliance and optimizing cash flow in the UAE. Businesses with significant exempt supplies must ensure the default Standard Method is reflective of their actual input use, and if not, seek approval from The Federal Tax Authority for a more representative alternative method. This detailed diligence, coupled with the mandatory annual adjustments, ensures VAT recovery accurately reflects business reality.
This article contains general information only regarding the UAE VAT framework and its underlying legislation (such as the Federal Decree-Law No. 8 of 2017 on Value Added Tax). It does not constitute specific tax or legal advice, and should not be acted upon without consulting a qualified professional. While every care has been taken to ensure the accuracy of the contents of this work, no responsibility for loss occasioned to any person acting or refraining from action as a result of any statement in it can be accepted by the author.
