MIDDLE EAST TAX ALERT | UAE | Valuation of Deemed Supplies of Services
Federal Tax Authority Directive on Tax Transactions No. 5 of 2026 | Issued 20 July 2026
Executive Summary In a welcome development for businesses that provide free or complimentary services, the Federal Tax Authority has issued a clear methodology for valuing deemed supplies of services — one that will, in most cases, reduce the amount of VAT payable. Rather than applying VAT to the full market value of a free service, the mechanism begins with the open market value, removes the profit element to arrive at an estimated cost, and applies only the proportion of costs on which the business actually incurred VAT. The outcome is a lower and more equitable VAT base that reflects genuine input-taxed costs. For sectors where valuing a ‘free’ service has historically been difficult, the Directive brings both long-awaited certainty and tangible benefits when implemented correctly. |
What Does It Say?
- A taxable person making a deemed supply of services must determine the value based on the total direct and indirect costs on which input tax was incurred in making that deemed supply.
- The Directive sets out a four-step valuation mechanism:
- Identify the open market value of the service (or use market value of comparable services, if it cannot be determined).
- Remove the profit element using the net profit as per financial statements of the business’s previous year or, using average net profit margin prevailing in the industry sector, if own net profit cannot be determined.[1]
- Determine the percentage of costs on which input tax was incurred, based on the preceding financial year.
- Apply that percentage to the estimated cost.
- The resulting amount is the value of the deemed supply for Article 37 of the VAT Law. In effect, the output VAT base is not the full sales value but the portion of the estimated cost that carried input VAT.
The Formula In Simple Terms
Deemed Supply Value Open market value ÷ (1 + Net Profit Margin) × Percentage of costs that incurred VAT |
What Does ‘Percentage of Costs That Incurred VAT’ Mean?
This is the most important, and easily misunderstood, element of the Directive. The FTA does not tax the full estimated cost of the free service. Instead, under Clause 2(c), a business must determine what proportion of its overall cost base actually incurred UAE VAT based on the previous financial year and apply that proportion to the estimated cost of the service.
In plain language: costs such as staff salaries, depreciation, and certain other charges do not carry VAT. The FTA therefore wants the deemed supply value to reflect only the part of the cost base that bore VAT in the first place. The higher a business’s non-VAT costs (for example, salary, depreciation, zero-rated procurements), the lower this percentage and, in turn, the lower the deemed supply value.
A few questions taxpayers must consider while calculating the percentage:
- Does ‘incurred Input Tax’ include blocked input tax?
- How should partially recoverable input tax be included correctly?
- How should VAT be included where the assets fall within the capital asset scheme?
Why This Matters in Practice
The Directive resolves a common practical challenge: valuing complimentary or free-of-charge services where businesses do not ordinarily track a standalone cost per service event. This has been a recurring issue across industries.
| Industry | Typical Free Service | Historic Valuation Challenge | How the Directive Helps |
| Hotels | Complimentary room nights, upgrades, or influencer stays. | Actual cost includes housekeeping, utilities, staff costs, depreciation, and overheads, making valuation difficult. | Uses room market value and a prescribed formula to determine the VAT-relevant cost value. |
| Gaming/Arcades | Free game credits or complimentary plays. | Costs are spread across machines, licenses, rent, staffing, and utilities. | Allows the market value of credits or games to be converted into a VAT-relevant cost value. |
| Theme Parks/Attractions | Complimentary tickets, passes, or promotional access. | It is difficult to isolate the cost per visitor due to significant fixed costs. | Provides a practical cost allocation methodology. |
| SaaS/Digital Platforms | Free premium subscriptions or trial access given where the supply qualifies to be a deemed supply as per the FTA. | Service costs are embedded in cloud infrastructure, development, and support functions. | Uses subscription value and the business’s cost profile to establish a deemed supply value. |
| All Sectors | Any service supplied with no consideration (and not bundled with another element of a supply). | It is difficult to allocate a specific cost from overall overheads to the free service. | Provides a practical cost allocation methodology. |
Worked Example – Complimentary Hotel Stays
A hotel provides a complimentary two-night stay for non-business purposes (with no barter implication). The published room rate (open market value) is AED 4,000. The hotel’s net profit margin is 20%, and 30% of the hotel’s total costs incurred UAE VAT.
| Step | Calculation/Outcome |
| 1. Remove the Profit Element | AED 4,000 ÷ 1.20 = AED 3,333 (estimated cost of providing the stay) |
| 2. Apply the % of Costs That Incurred VAT | AED 3,333 x 30% = AED 1,000 |
| Deemed Supply Value | AED 1,000 |
| VAT Impact | Output VAT is calculated on AED 1,000, not on the AED 4,000 published room value. |
Recommended Actions for Businesses
- Map all free-of-charge, complimentary, promotional, or non-business services that may potentially trigger deemed supply rules.
- Establish how the open market value will be determined and evidenced, including the use of comparable pricing where direct pricing is unavailable.
- Validate the net profit margin used, preferably from prior-year financial statements, and document any industry benchmark to be used as a fallback. Our transfer pricing specialists will be able to support an industry-specific net margin benchmarking analysis, which is crucial to arrive at a reasonable and defendable deemed supply value.
- Determine the percentage of costs that incurred VAT using prior-year cost data, and ensure exempt, blocked, and non-VAT costs are treated consistently.
- Update VAT procedures, ERP tax codes, promotional approvals, and documentation templates so that deemed supplies are captured at the point of issue.
A&M View
The Directive is a welcome development because it provides a practical proxy for industries where the cost of a service cannot easily be isolated at the transaction level. Importantly, it does not tax the full market value or even the full estimated cost of the free service. By applying only the percentage of costs that incurred VAT, the methodology is likely to reduce the deemed supply value for most industries. The trade-off is an increased documentation burden: businesses should be ready to support the open market value, the profit margin, and the percentage of costs that incurred VAT in the event of an FTA review.
Immediate Next Step Businesses that regularly provide complimentary services should perform a quick impact assessment to identify affected scenarios, quantify potential VAT exposure, and update controls before the methodology is tested in practice. |
Link:
[1] In the absence of specific industry benchmarking guidance, transfer pricing principles could be utilized to benchmark net profit margins, ensuring the margin measure applied is consistent with the net profit margin used in the deemed supply value calculation.
