With the implementation of the UAE Corporate Tax under Federal Decree-Law No. (47) of 2022, business owners and finance teams are seeking clarity on the treatment of Value Added Tax (VAT) input tax under the new tax regime. One of the common questions is whether VAT input tax — the VAT paid on purchases and expenses — can be considered a deductible expense when computing the taxable income for corporate tax purposes.
This article explores the interaction between VAT and corporate tax in the UAE, focusing on the deductibility of VAT input tax under corporate tax rules and highlighting practical considerations for businesses to remain compliant and tax-efficient.
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1. Understanding VAT Input Tax in the UAE
Under the UAE VAT regime (Federal Decree-Law No. (8) of 2017), businesses registered for VAT can recover the VAT paid on eligible purchases and expenses — known as input tax — as long as those purchases are used for making taxable supplies.
For example, if a VAT-registered business purchases raw materials worth AED 10,000 plus AED 500 VAT, it may reclaim the AED 500 input VAT in its VAT return, provided the purchase relates to taxable business activity.
However, the ability to recover input VAT does not necessarily mean it is also deductible as a business expense for corporate tax purposes.
2. What Is Deductible Under UAE Corporate Tax?
The UAE Corporate Tax law allows for the deduction of expenses incurred wholly and exclusively for the purposes of generating taxable income. This includes operating expenses such as rent, salaries, utilities, and cost of goods sold — provided they are not capital in nature or specifically disallowed under the law.
The question arises: can the VAT element of those expenses also be claimed as a deduction?
3. Treatment of VAT Input Tax Under Corporate Tax
Here’s how input VAT is generally treated under UAE Corporate Tax rules:
- If input VAT is recoverable under VAT Law: It is not deductible as an expense for corporate tax purposes, because it does not constitute a cost to the business (it is refunded or credited through VAT returns).
- If input VAT is non-recoverable: It may be considered part of the expense and could be deductible for corporate tax purposes.
This treatment aligns with the principle that only actual costs borne by the business are deductible under corporate tax computation.
Example:
A company incurs AED 5,000 in marketing expenses plus AED 250 VAT. If the AED 250 is recoverable via the VAT return, only the AED 5,000 is deductible under corporate tax.
If the VAT is not recoverable — for example, due to exempt activities or entertainment expenses — then the entire AED 5,250 could be deductible under corporate tax.
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4. Non-Recoverable VAT That May Be Deductible
Certain types of input VAT are not recoverable under VAT law. These include:
- Entertainment expenses
- Passenger vehicles used for personal or mixed purposes
- Staff benefits not required under UAE labor law
In these cases, the business cannot recover the VAT via the VAT return, and the full amount — including VAT — may be treated as a deductible expense when calculating the corporate tax liability.
Businesses should carefully document the nature of such expenses and retain all relevant invoices and contracts.
5. Documentation and Recordkeeping
To justify the deductibility of any expense (with or without VAT), businesses must maintain proper records. This includes:
- VAT-compliant tax invoices
- Expense ledgers and vouchers
- Proof of business purpose
- VAT returns showing input recovery status
During a corporate tax audit, the Federal Tax Authority (FTA) may request these records to verify whether the claimed deductions are legitimate and whether VAT was recoverable or not.
6. Free Zone Companies and VAT-Corporate Tax Interaction
Free zone entities benefit from corporate tax exemptions on qualifying income, but they are still subject to VAT unless specifically exempt. These companies must be extra cautious in determining whether their input VAT relates to taxable or exempt income, and whether it is recoverable or deductible.
For example, if a free zone company earns both qualifying (exempt from corporate tax) and non-qualifying income, they may need to apportion input VAT and evaluate deductibility under corporate tax rules.
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7. Best Practices for Compliance
Here are some best practices to ensure compliant and efficient handling of VAT input tax under the UAE corporate tax framework:
- Reconcile VAT returns with corporate tax ledgers
- Maintain a clear segregation between recoverable and non-recoverable VAT
- Use accounting software that flags non-recoverable VAT for tax reporting
- Work with a tax consultant to optimize recovery and deduction claims
8. Conclusion
In summary, VAT input tax that is recoverable under UAE VAT law is not deductible under corporate tax rules, as it does not constitute a business expense. However, non-recoverable input VAT — such as that related to exempt activities or entertainment — may be treated as a deductible cost.
Proper classification, calculation, and documentation are key to ensuring your VAT and corporate tax filings are accurate and defendable in case of audit.
Unsure whether your input VAT is deductible or recoverable? Consult with PEAK Business Consultancy Services — one of the most trusted VAT and Corporate Tax consultants in the UAE. We provide end-to-end tax solutions, from registration and planning to return filing and audit readiness.
