FTA Directive No. 5 of 2026

The UAE Federal Tax Authority (FTA) has issued a new Directive that finally clears up a long-standing grey area in VAT law: how to put a value on deemed supplies of services under Article 37 of the VAT Law.

LEGISLATIVE BACKGROUND – ARTICLE 37 DEEMED SUPPLIES

A deemed supply happens when a business uses something (goods or services) for a purpose that falls outside normal business activity, even though no money changes hands and there's no actual buyer. Common examples include:

• Business assets used for personal purposes
• Goods given away for free (where deemed supply rules apply)
• Free services provided for non-business reasons
• Assets a business keeps after deregistering from VAT

Because there's no sale price to work from, Article 37 says these supplies should be valued at cost not market value. But the law never explained how to actually calculate that cost, especially for services, which don't come with a simple purchase invoice the way goods do.

THE PRACTICAL DIFFICULTY BEFORE THE DIRECTIVE

Without clear rules, businesses and tax advisors were left guessing on several points:

1. Should employee salaries be included in the cost, even though salaries don't carry VAT?
2. How should shared costs like rent, IT, and management overheads be divided up?
3. Should a profit margin be added, or should the value be pure cost with no margin at all?
4. Should costs that never had VAT charged on them be included, given the whole point of Article 37 is to correct previously claimed input VAT?
5. What method should be used to separate the VAT-related portion of costs from the rest?

This lack of clarity meant different businesses calculated things differently, which created real risk, either businesses overpaid VAT to be safe, or underpaid and risked penalties during an FTA audit.

THE NEW FOUR-STEP METHOD

The Directive fixes this by introducing a clear formula. It starts with a market price and works backward to arrive at a cost figure for VAT purposes:

Step 1 — Find the Open Market Value (OMV) Determine what the service would normally sell for in the market. If there's no direct market value available, use the value of a similar comparable service instead.

Step 2 — Remove the Profit Element Take that market value and strip out the profit margin, using the business's own profit margin from the previous financial year. If the business doesn't have a usable margin (for example, a loss-making company or a brand-new business), it can use the average margin for its industry instead.

Step 3 — Work Out the VAT-Bearing Cost Ratio Look at the business's costs from the previous financial year and calculate what percentage of those costs actually had VAT charged on them. This step filters out costs like salaries and financing charges, which never carried VAT in the first place.

Step 4 — Apply the Ratio Multiply the estimated cost from Step 2 by the percentage from Step 3. The result is the final taxable value, on which 5% VAT is charged.

A Few Important Details

• If a business's own profit margin isn't available, it must first try to find one. The industry average is only a fallback.
• Both the profit margin and the cost ratio must come from the previous financial year, not the current year or the year the deemed supply actually happened.
• The Directive confirms that both direct costs and indirect/shared costs count toward the total, as long as they pass through the Step 3 VAT-bearing filter.
  

WHERE CHALLENGES REMAIN

Even with a clearer formula, applying it in practice isn't always simple:

• Finding a market value is hard for services that are unique to a business, like internal management services between group companies. There may be no real external benchmark to compare against.
• Calculating a specific profit margin is difficult for companies with multiple business lines, since their overall margin may not reflect the specific service in question.
• Splitting costs by VAT status requires detailed accounting records that many businesses don't currently maintain, especially where costs are partly VAT-bearing and partly not.
• Businesses must keep last year's cost and financial data on hand, even if their cost structure has since changed significantly.
• Companies will need strong supporting documentation such as records showing how the market value, profit margin, and cost split were each calculated - since the FTA hasn't published official guidance on acceptable comparables or industry averages.
• The new mechanism also overlaps with input tax apportionment rules, since both processes involve classifying costs by VAT status, just for different purposes.

This Directive turns a vague "value it at cost" rule into a structured, defensible formula a big improvement for businesses and their advisors. But it still requires judgment calls, particularly around market value and cost classification. Businesses that make deemed supplies of services should use this as a prompt to properly document their costing method now, rather than scrambling to justify it during an FTA audit.