UAE VAT: How should businesses handle deductible expenses?

In April 2023, we highlighted in ‘Gulf News’ that the list of non-deductible expenses under the UAE corporate tax law refers to such input VAT that is ‘recoverable’ as compared to the input VAT ‘actually recovered’ under VAT laws.

A debate arose if an expense deduction would be allowed for such input VAT -  recoverable under VAT laws - but has not been claimed in VAT returns?

The tax consultancy fraternity is recently abuzz with a view that such input VAT would not be allowed as an expense deduction. Businesses are being advised to separately account for all VAT on the purchases/expenses where the input credit has not been recovered.

As the input credit eligibility is based on multiple factors, the input VAT may not be recoverable for various reasons. Identification of recoverable VAT and non-recoverable VAT could consume significant administrative and manpower cost. It will also be difficult to maintain an audit trail for tax audit purposes. Such a literal interpretation of the UAE corporate tax provisions could also impact the scope of other deductible expenses.

Non-deductible expenses also include fines and penalties, other than amounts awarded as compensation for damages or breach of contract. The usage of the expression ‘awarded’ could be have a bearing on the scope of compensation expenses incurred by UAE businesses.

Many businesses often pay compensation for damages or breach of contract.

The compensatory payment could be in the form of ‘liquidated damages’, i.e. a predetermined amount agreed amongst the parties at the time of agreement itself for specific breaches. Examples include early termination/late performance, flight cancellation charges, cheque bouncing penalties.

Even where ‘liquidated damages’ are not pre-agreed, businesses often negotiate among themselves for compensation for various lapses such as damaged packaging, delayed deliveries etc.

In all such cases, the compensation is technically not ‘awarded’ but are mutually agreed. Based on a literal interpretation, a question would arise if such compensatory payments – if not awarded by a court or dispute resolution authority – could still be claimed as a deductible expenses?

The scope of ‘fines and penalties’ could impact car rental companies which - being the vehicle owners - regularly pay fines for traffic violations committed by their customers. The rental companies could possibly approach the authorities to transfer the responsibility to actual drivers. However, if paid by the rental companies, such fines are neither awarded nor compensatory payments.

The recovery of these fines from the lessee/customers is in fact in the nature of income and not a reversal of expense incurred by the rental companies. Claiming a deduction of such fines incurred by rental companies could result in a similar conundrum.

The context of tax policies is important for interpreting the tax laws.

Globally, a business is generally discouraged from claiming a double tax benefit of VAT by claiming an expense deduction while recovering input credit in its VAT returns. If VAT credit has not been recovered by a business, the expense deductibility should not result in double benefit to the businesses.

To avoid any administrative penalties, businesses could seek an official clarification to determine whether VAT would be allowed as a deductible expenditure.