Detailed Guidance on the Application of the Valuation Method under Transitional Rules

The Federal Tax Authority (FTA) has released a new guide titled “Application of the Valuation Method under the Transitional Rules”, providing crucial clarification on how taxpayers should determine the value of supplies and transactions that span transitional tax periods — for instance, supplies made before and after the effective date of UAE Corporate Tax or similar tax regime changes.

The guide serves as an essential reference for businesses that entered into contracts or transactions before the effective date of taxation but continued to perform or receive consideration afterwards. It clarifies how to determine which portion of the consideration relates to the period before the law became effective (non-taxable) and which portion relates to the period after (taxable).

Understanding Transitional Rules and Valuation

The transitional rules are designed to prevent double taxation or non-taxation when a new tax (such as Corporate Tax) becomes applicable. They ensure that income and expenses are correctly attributed to the appropriate tax periods.

The FTA guide provides detailed guidance on how to determine fair market value and allocate consideration in transactions that overlap the transition. The principle is that each portion of a transaction should be valued according to the time and extent to which goods or services were supplied or performed.

The guide emphasizes that valuation and apportionment must reflect commercial reality and be supported by evidence, such as contractual terms, performance milestones, or accounting records.

Key Technical Clarifications in the Guide

1. Fair Value as the Core Principle

The fair value concept is central to the FTA’s guidance. Taxpayers must determine the fair value of goods, services, or rights supplied before and after the transitional date.

This requires:

Applying a market-based approach, considering normal pricing practices for similar supplies.
Ensuring arm’s length consistency when transactions are between related parties.
Avoiding arbitrary or purely accounting-based allocations without economic substance.

Fair value is not merely the invoiced amount—it must represent the actual value of what has been delivered or performed during each tax period.

2. Apportionment of Consideration

When a contract or transaction covers both pre- and post-transition periods, the total consideration must be fairly allocated between the two.Businesses can use one or more of the following bases for apportionment:

Time-based allocation (e.g., for continuous services such as leasing or management contracts).
Completion or progress-based allocation (e.g., for construction or long-term projects).
Usage-based allocation (e.g., where consumption or access rights determine value).

The method chosen should be reasonable, consistent, and supported by documentation. The FTA expects the same method to be applied across comparable transactions unless justified otherwise.

3. Continuous and Composite Supplies

For continuous supplies (such as ongoing services, subscriptions, leases, or maintenance contracts), the portion relating to the period after the transition date will be taxable.

For composite supplies — where multiple elements (e.g., goods and installation services) form part of one contract — taxpayers must unbundle the transaction and value each component separately according to when it was performed.

This ensures that only the part relating to the post-transition period is subject to taxation, avoiding overstatement or understatement of taxable income.

4. Adjustments and Post-Transition Modifications

The guide clarifies that subsequent adjustments such as rebates, discounts, or credit notes should follow the tax treatment of the original supply.

If the original supply occurred before the transitional period, any related adjustment remains non-taxable.
If the adjustment relates to a post-transition supply, it should be treated under the new tax regime.

Taxpayers should maintain traceability to demonstrate how each adjustment is linked to its underlying transaction.

3. Contractual and Accounting Evidence

The FTA underlines that businesses must substantiate their apportionment or valuation method with proper documentation, including:

Contract terms specifying timing, deliverables, and milestones;
Invoices or progress certificates;
Work completion reports;
Accounting records showing recognition of income and costs; and
Any internal valuation workings used for determining fair value.

Failure to maintain such documentation could result in the FTA rejecting the taxpayer’s valuation approach and imposing reassessments or penalties.

Illustrative Examples of Valuation under Transitional Rules

The guide provides examples demonstrating how the valuation should be applied practically:

1. Construction Project Example

A construction company entered into a project worth AED 20 million in 2023, with 40% of work completed by 31 May 2024 (before the Corporate Tax effective date) and 60% afterward.
Only AED 12 million (60%) of the contract value is subject to Corporate Tax, reflecting work completed post-transition.

2. Leasing Example

A company rents a warehouse from January to December 2024 for AED 1.2 million. Corporate Tax applies from June 2024.

The rent covering June–December (AED 700,000) is subject to tax; the January–May portion remains pre-transition.

3. Advance Payments Example

A service provider received AED 100,000 in 2023 for a 12-month maintenance contract that extends to June 2024.

The income for services performed after 1 June 2024 must be recognized and taxed in the first Corporate Tax period.

These examples reinforce that timing of supply performance — not merely payment or invoicing — determines taxability.

Common Errors Observed in Practice

The FTA cautions against several recurring errors in applying valuation during transitional periods, such as:

Treating all payments received before the transition as pre-transition income, regardless of when the service was delivered;
Failing to split long-term contracts between pre- and post-transition portions;
Using arbitrary percentage splits not supported by evidence;
Ignoring fair value when related party transactions are involved; and
Not updating tax reporting when adjustments (e.g., credit notes) occur after the transition.

Compliance Expectations and Recordkeeping

Taxpayers are expected to:

Maintain transparent valuation workings and documentary support;
Ensure consistency between financial statements, tax returns, and contractual milestones;
Apply fair value methods aligned with IFRS 15 and UAE tax rules;
Retain evidence for at least seven years as per UAE tax recordkeeping requirements.

In case of FTA review, the taxpayer should be able to clearly demonstrate how the valuation and apportionment were determined, with references to factual data and supporting documentation.

How XB4 Can Help

At XB4, we understand the challenges businesses face in applying valuation principles across transitional tax periods. Our tax advisory team assists clients in: