The introduction of Value Added Tax (VAT) in the UAE on January 1, 2018, marked a significant transformation in the financial operations and tax obligations of businesses across the region. For VAT-registered businesses, understanding the scope of input tax and VAT input recovery is essential for ensuring proper tax compliance, avoiding penalties, and maximizing the benefits of recoverable tax.

One area that often leads to confusion and non-compliance is input tax apportionment—especially for businesses involved in both taxable supplies and exempt supplies. This guide unpacks the legal framework, calculation methods, and recordkeeping obligations surrounding input tax apportionment in the UAE, helping businesses make accurate and compliant claims in their VAT returns.

Understanding Input Tax and Output VAT

Input tax refers to the VAT paid by a business on goods or services purchased for business purposes. When used to make taxable supplies, such as selling goods or offering services that attract VAT, this input VAT can be reclaimed from the Federal Tax Authority (FTA) through the periodic VAT return process.

Conversely, output VAT is the VAT collected by businesses on their sales of taxable goods or services. The VAT liability for any tax period is calculated as the output VAT collected minus the input VAT recovery.

However, not all input VAT is recoverable. For instance, VAT incurred on entertainment expenses or private expenditures is considered non-deductible under UAE VAT regulations. Recoverability depends on whether the purchase directly contributes to making taxable supplies or also supports exempt activities, which brings us to apportionment.

Why Input Tax Apportionment Matters

When a business engages in both taxable and non-taxable supplies, such as exempt supplies like residential property leasing, certain financial services, or local passenger transport, it cannot recover the full amount of VAT paid on shared expenses. This dual-use nature of business operations necessitates input tax apportionment.

For example, a taxable person running a financial services company may incur VAT on rent, utilities, and office equipment. If these assets support both taxable advisory services and exempt loan services, only a proportion of the input VAT paid is recoverable. This ensures VAT recovery aligns with the business's supply chain and actual use of goods or services.

The UAE’s VAT legislation mandates that businesses must apportion VAT input correctly using either the standard method or an FTA-approved special method, depending on the nature of operations.

Categories of Input Tax under UAE VAT Law

The UAE VAT framework divides input tax into three distinct categories:

1. Fully Recoverable Input Tax

Input VAT on goods and services used solely for taxable business activities is fully recoverable. For instance, a courier company charging VAT on deliveries can recover the VAT incurred on vehicle fuel and repairs.

2. Non-Recoverable Input Tax

VAT on expenses that relate only to exempt supplies or non-business use—like entertainment or personal expenses—is non-recoverable. Similarly, if a business fails to collect VAT on its taxable supplies, it may not be entitled to input tax recovery.

3. Apportioned Input Tax

When an expense supports both taxable and exempt supplies—such as office supplies, rent, or internet services—the input VAT must be apportioned according to UAE VAT rules.

Proper classification of expenses is not only a best practice in tax compliance, but a requirement for every VAT registered business under UAE VAT legislation.

Methods of Input Tax Apportionment in the UAE

Under the UAE’s value added tax (VAT) regime, businesses engaged in both taxable and exempt activities must determine how much input VAT is recoverable. As a type of indirect tax, VAT applies to most goods and services, and accurate input tax apportionment ensures that businesses only recover VAT related to taxable outputs. The Federal Tax Authority (FTA) recognizes two main approaches to this: the Standard Method and Special Methods, each with its own compliance framework.

A. Standard Method (Turnover-Based Apportionment)

The standard method is the default apportionment formula under UAE VAT law. It calculates the recoverable portion of total input VAT by using the ratio of taxable turnover to total turnover, as follows:

Recoverable Input Tax = (Taxable Turnover ÷ Total Turnover) × Total Input VAT

For example, if a business incurs AED 100,000 in input VAT during a tax period, and 70% of its total income comes from taxable goods and services, then:

(70 ÷ 100) × 100,000 = AED 70,000 recoverable VAT

This method aligns with the principle that business purposes must drive VAT recovery. However, it may be unsuitable in industries where output VAT is low, yet a significant portion of expenses supports taxable activities—such as healthcare, education, and residential real estate. In such cases, using the standard method could understate the recoverable VAT and inflate the tax liability unfairly.

B. Special Methods (FTA-Approved Alternatives)

When the standard method causes distortions or fails to reflect actual input-output usage, businesses registered for VAT can apply to the FTA for a special apportionment method. These special methods aim to align VAT recovery more closely with real economic usage and business purposes.

Common FTA-approved special methods include:

1. Transaction Count Method :
   This calculates recoverable input VAT based on the number of taxable vs exempt transactions. It’s suitable for service-based businesses where transaction volume reflects operational output more accurately than value.

2. Floor Space Method :
   Common in sectors like real estate development, this method allocates VAT based on the physical usage of space for taxable and exempt purposes.

3. Input-Based Method :
   This directly attributes input VAT based on the actual consumption of resources per supply category. It’s highly precise and suited to organizations with robust accounting systems.

The Importance of Proper Recordkeeping

Accurate recordkeeping is essential for complying with VAT in UAE and justifying input tax apportionment to the Federal Tax Authority (FTA). Businesses must retain proper records for at least five years to prove how much input VAT was recovered and on what basis.cHere’s what every VAT-registered business must maintain:

1. Separate Accounts

Keep distinct records for taxable, exempt, and mixed-use business purchases to support the apportionment of VAT input.

2. VAT-Inclusive Invoices

Ensure all relevant purchases have proper VAT invoices that clearly show value added tax paid.

3. Calculation Sheets

Prepare apportionment sheets each tax period to explain how VAT recovery was calculated.

4. Supporting Documents

Retain supplier contracts, business-use justifications, and the supplier’s VAT registration number.

These documents help defend your tax position during audits, minimize penalties, and show compliance with tax authorities. Proper recordkeeping also supports the broader purpose of registered businesses, ensuring the correct tax is collected and paid to fund high quality public services.

Annual Adjustment Requirement

Under the UAE’s indirect tax system, all VAT-registered businesses must perform an annual adjustment to reconcile estimated and actual input VAT recovery. This process ensures that business purposes are accurately reflected in the VAT claimed, maintaining integrity across all tax periods.

The adjustment is not optional—it is mandated by the Federal Tax Authority (FTA) to correct any discrepancies in the input and output VAT declared throughout the year. The goal is to avoid overclaiming or underclaiming VAT payable, thereby aligning your VAT position with actual goods and services used for taxable activities.

Steps to Perform the Annual Adjustment

1. Recalculate Input VAT Recovery :
   Use actual annual turnover figures to determine the correct recovery ratio for input VAT related to both taxable and exempt supplies.

2. Compare with Prior Estimates :
   Assess how the actual recovery percentage differs from the estimate used during the year.

3. Adjust in the Following VAT Return :
   Reflect any difference—whether overclaimed or underclaimed VAT—in the first VAT return of the next financial year.

Example

If your business estimated an 80% recovery rate but your actual output VAT from taxable turnover was only 65%, the 15% excess must be adjusted in the next VAT return. This ensures that output tax and VAT payable figures remain compliant.

Penalties for Non-Compliance

Failure to make the annual adjustment may lead to:

• Administrative fines

• Repayment of overclaimed VAT

• Interest on delayed payments

• Loss of credibility during future FTA inspections

Since registered businesses pay VAT not only on inputs but also collect it as output VAT on sales, aligning both sides is crucial. The added tax mechanism relies on businesses acting as intermediaries in collecting and remitting taxes correctly, whether the business pays VAT on expenses or charges it on sales.

By completing annual adjustments diligently, businesses uphold transparency, minimize risk, and maintain trust with the tax authorities.

How Young & Right Supports VAT Compliance in the UAE

At Young & Right Accounting and Tax Consultancy, we help businesses navigate the complexities of VAT in the UAE with absolute clarity and confidence. Whether you're a growing SME or a large enterprise, staying compliant with FTA regulations is critical to avoiding penalties and optimizing your tax position. Our team delivers structured, expert-driven support across every phase of the VAT lifecycle—ensuring accuracy, recoverability, and peace of mind.

1. Input Tax Apportionment Strategies

When your business engages in both taxable and exempt activities, determining the recoverable portion of VAT becomes essential. We design and implement effective input tax apportionment strategies that comply with UAE VAT law and help you maximize VAT recovery, reduce audit risk, and improve cash flow management.

2. VAT Registration and Deregistration

Whether you're registering a new entity for VAT or need to deregister an inactive one, we handle the entire process—ensuring accurate documentation, timely submission on EmaraTax, and full compliance with FTA thresholds and timelines.

3. VAT Return Filing and Input/Output VAT Management

We manage the preparation and submission of periodic VAT returns with precision. Our services include calculating output VAT on taxable supplies, validating input VAT eligibility, and reconciling your VAT position to ensure that every dirham is correctly accounted for.

4. Accurate Bookkeeping, Financial Reporting, and System Audits

Reliable records are the backbone of VAT compliance. Our team maintains accurate bookkeeping aligned with VAT documentation standards, prepares detailed financial reports, and conducts internal audits to identify compliance gaps before they become liabilities.

Conclusion

For any VAT registered business in the UAE, proper handling of input tax apportionment is not just a procedural requirement, it's a cornerstone of effective tax management. Inaccurate classification or recovery of VAT input can have serious financial consequences.

Understanding your obligations under the UAE VAT law, choosing the correct method, and maintaining proper records can significantly improve your tax position and reduce exposure to fines.

If you need a reliable partner to help ensure accurate VAT compliance from end to end, Young & Right is here to support you. Because when it comes to VAT, getting it right the first time truly pays.