VAT was introduced on 1st January 2018 in the United Arab Emirates (“UAE”). As a general consumption tax on the supply of goods and services, it applies to taxable supplies which take place within the territorial area of the UAE.
As per the UAE VAT law, the input VAT paid on the procurement of capital assets is allowed to be recovered. However, as per the Cabinet Decision No. (52) of 2017 on the Executive Regulations of the Federal Decree-Law No (8) of 2017 on Value Added Tax, articles (57) and (58), the Capital Asset which is eligible for the Capital Asset Scheme shall be monitored and the Input Tax incurred shall be adjusted through a special scheme known as ‘Capital Asset Scheme’ which is designed to regulate the input VAT recovery on the larger value of capital assets having long-term usage.
What are capital asset and capital asset schemes?
Capital asset: it is the business asset designated for long-term use. For instance, if your business purchases a machine for business purposes, it is considered a capital asset of the business. However, if a machine trader buys the machine to sell as part of its business, the same machine is counted as inventory. So, Capital Assets do not include Items of stock, which are for resale.
Capital asset scheme: A scheme by which initially recovered Input Tax is adjusted based on actual use during a specified time/useful life of the capital asset.
What is the eligible capital asset under the capital asset scheme?
As per Art. (57) of the regulations, A Capital Asset is a single item of expenditure of the Business amounting to AED 5,000,000 or more excluding Tax, on which Tax is payable and which has estimated useful life equal or longer than:
- Ten years in case of a building or a part thereof.
- Five years for all Capital Assets other than buildings or parts thereof.
Where costs are settled in stage payments for any of the following, the overall cost collectively amounted of AED 5,000,000 or more is considered as a single item of expenditure and one sum:
- For the purchase of a building;
- For the construction of a building;
- In relation to an extension, refurbishment, renewal, fitting out, or other work undertaken to a building, except that where there is a distinct break between any such works being undertaken, they shall be taken to be separate items of expenditure; and
- For the purchase, construction, assembly, or installation of any goods or immovable property, components are supplied separately for assembly.
What is the mechanism of the capital asset scheme?
- The initial recovery of input tax when a capital asset is purchased is subject to the standard rules. It will be fully or partially recoverable based on the actual use of the capital asset. So, the initial recovery is based on the first VAT year (Year 1) usage.
- This is the standard method for input tax recovery, but it is not appropriate to leave it for some capital assets. These are assets that will serve for a period of time, and therefore the use of assets must be monitored over a number of years.
- The recovered percentage of input tax in year one will be the base for the following years, after considering the change of the actual use of the asset compared to year 1. The first VAT year for an asset starts on the date it was purchased.
- Suppose there is a change in the actual use of the capital asset in the following VAT years comparing with year 1. In that case, an adjustment will be required either to reverse a percentage of the recovered input Tax or to recover more than the recovered VAT in year 1. The length of the adjustment period in years depends on the type of asset for buildings is ten years and for other capital assets is five years.
- Year 1 will always be the year of first use, and this recovery is calculated as normal. This effectively means we have to consider nine adjustments for buildings and 4 for other relevant assets.
- The formula for calculating the capital asset adjustment is as follows:
Total VAT on purchase / No. years (5 or 10) × (Initial % – Actual %) = adjustment
- No adjustment is required when there is no change in taxable use from the VAT year before.
- As per the Art. 58 (4), A record must be kept in a ‘capital asset register’, showing original input tax incurred and any adjustments, as well as how these have been calculated. Records relating to capital assets must be kept for a minimum of 10 years.
- VAT year could be changed; If a taxable person already holding capital asset registers for VAT, transfers its business, joins or leaves a VAT group, a new VAT year is triggered, starting that day.
- Where a capital asset is sold within the adjustment period, two adjustments must be made; the standard adjustment and the sale adjustment. Both adjustments would apply in the year of sale.
The standard adjustment is calculated in the usual way. The sale adjustment follows the standard capital assets scheme method for the remaining complete years of VAT life for that asset. If the sale is taxable, assume that the taxable /actual use for the remaining years is 100%. If the asset sale is exempt, assume 0% taxable/actual use for each remaining year. This adjustment should be made in the VAT return, which includes the date of disposal.
ABC company acquired a machine on 1st May 2020 for AED 40,000,000 exclusive of VAT (VAT is 2,000,000), the taxable use to date is as follows:
The machine was sold on 24 November 2023 for AED 7,000,000; the taxable use for 1st May 2023 was 54%.
Year of acquisition (first VAT year / year 1)
2,000,000 * 45% = AED 900,0000 – recovery
2,000,000/5 * (45%-40%) = AED (20,000) – payable
2,000,000/5 * (45%-58%) = AED 52,000 – recovery
The year of the sale ends on 30-04-2024; there are two adjustments required; firstly, the normal adjustment and secondly the sale adjustment, which will be as follows:
2,000,000/5 * (45%-54%) = AED 36,000 – recovery
As long as the sale is taxable, we will assume that the taxable use for the remaining years is 100%. ABC company has made an initial recovery in the first VAT year and three following adjustments, so only one year remains in the useful life of the asset on which the sale adjustment will be calculated.
2,000,000/5 * (45%-100%) * 1 = AED 220,000 – recovery
Therefore, the total adjustment for the sale year is AED 256,000 (220,000+36,000).
XB4 has a dedicated team of highly experienced VAT specialists experienced in all activities that require applying the Capital Asset Scheme and making the input Tax Adjustments in the UAE. XB4’s registered tax agents will analyze your books and records to check and validate your compliance on all levels regarding the capital asset scheme and its adjustments.