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Implementation or Modification? Directive No. 5 of 2026 and the Statutory Value of Deemed Supplies

The introduction of binding directives on tax transactions is an important development in the UAE tax framework. Such directives can provide certainty, promote consistent treatment and resolve practical questions that the tax legislation does not address in sufficient detail.

At the same time, the binding character of a directive raises a related question: what are the limits of the Federal Tax Authority’s power to prescribe the manner in which a Tax Law must be applied?

Directive on Tax Transactions No. 5 of 2026 provides a useful case study. The Directive was issued on 20 July 2026 and published by the FTA on 22 July 2026. It prescribes a detailed method for determining the value of a deemed supply of services. Although the Directive describes that method as being applied “in accordance with Article 37” of the VAT Law, the prescribed calculation begins with the open market value of the services and can produce an amount materially different from the costs actually incurred by the taxable person.

This raises a principled interpretive question under Article 54 bis of Tax Procedures Law: does the prescribed methodology merely implement Article 37 of the VAT Law, or does it potentially modify the valuation consequence established by that Article?

The purpose of this article is not to question the importance or practical usefulness of the Directive, nor to suggest that taxpayers may disregard it. Rather, it is to consider respectfully how the Directive may be reconciled with the language of the VAT Law and with the statutory limits contained in Article 54 bis.

The valuation method introduced by Directive No. 5 of 2026

  1. Article 37 of VAT Law deals with the value of a deemed supply. It provides that “… in case of the deemed supply, when the taxable person purchases goods or services to make taxable supplies but he does not use the same for such purpose, the value of the supply shall be equal to the total cost incurred by the taxable person to make such deemed supply of goods or service”. Clause 1 of the Directive No. 5 of 2026 also states that “A Taxable Person making a Deemed Supply of Services shall determine the value of that Deemed Supply based on the total costs on which Input Tax was incurred (direct and indirect costs) to make that Deemed Supply, in accordance with Article 37 of the VAT Law”.
  2. However, instead of requiring actual “cost incurred by the taxable person”costs to be identified, Clause 2 the Directive prescribes the following mechanism:
    • The open market value of the services constituting the deemed supply must be determined. Where that value cannot be established, the open market value of comparable services must be used.
    • The “estimated total cost of the Services” must then be calculated by removing the profit element from the open market value. This is done by dividing the market value by one plus the taxable person’s net profit margin for the preceding financial year. Where the taxable person’s own net profit margin cannot be determined, the average net profit margin prevailing in the relevant sector may be used.
    • The taxable person must determine the proportion of its preceding-year costs on which input tax was incurred and apply that proportion to the estimated total cost.
    • The resulting amount constitutes the value of the deemed supply for the purposes of Article 37.

The Directive therefore establishes a market-derived estimated-cost method. It does not directly identify the costs incurred in producing the particular services. Instead, it starts with the price at which the services could be supplied in the market and works backwards to an estimated cost.

  1. The entire method though cannot be described as an “arm’s-length margin” method. The open market value element resembles an arm’s-length standard because it is based on market transactions or comparable services. The margin deducted from that value, however, is ordinarily the taxable person’s own preceding-year net profit margin. Only where that margin cannot be determined may a sector average be used. The FTA didn’t instruct that the amount is a transfer pricing benchmark based on comparable functions, assets and risks.

The statutory starting point: “total cost incurred”

  1. Article 37 of VAT Law provides that the value of the relevant deemed supply “will be equal to the total cost incurred by the Taxable Person to make this Deemed Supply of Goods or Services”. The ordinary reading of “cost incurred” points towards costs actually borne by the taxable person. Before considering how those costs should be identified or allocated, however, it is necessary to determine what constitutes the deemed supply being valued.
  2. Where an acquired service in respect of which input tax was recovered is itself diverted to a non-business purpose, its cost may ordinarily be identifiable from the supplier’s invoice. A more substantial attribution difficulty arises only under the broader interpretation apparently reflected in the Directive: namely, that the taxable person may produce an identifiable service using employees, management time, premises, software, equipment and other acquired inputs, and that the resulting output service constitutes the deemed supply.
  3. On that interpretation, some costs of making the service may be indirect or shared with the taxable person’s wider business, so reasonable allocation or estimation may be necessary. The words “to make” in Article 37 provide some support for this interpretation, but the point should not be treated as self-evident, because the deemed-supply provisions may also be read as referring to the acquired goods or services that were themselves diverted from their intended taxable use.
  4. Nevertheless, there is an important distinction between:
    • estimating the amount of costs actually incurred and attributable to the deemed supply; and
    • replacing those costs with a standardised amount derived from the market value of the service.

Article 37 expressly uses the first concept: the “total cost incurred”. It does not refer to market value, comparable services, an estimated market return or the taxable person’s net profit margin.

  1. This distinction is reinforced by the wider structure of the VAT Law. Article 34 expressly uses market value in several circumstances, including where consideration is partly non-monetary and in certain reverse-charge cases. Article 36 then provides that, as an exception to Articles 34, 35 and 37, the value of a supply or deemed supply between related parties is treated as market value where the specified conditions are satisfied.
  2. The reference to Article 37 in Article 36 is significant. It shows that the legislature contemplated the difference between:
    • the cost-based valuation under Article 37; and
    • the market-value treatment imposed under Article 36.

Where the legislature intended market value to displace the cost determined under Article 37, it expressly provided for that result.

  1. Article 25 of VAT Executive Regulation defines how market value is to be determined. It refers first to the consideration that a supply would generally achieve in similar circumstances between unrelated persons, then to the value of a similar supply and finally to replacement cost. However, Article 25 is a machinery provision. It explains how market value is calculated where the VAT Law requires market value to be used. It does not independently state that market value must be used to determine the “cost incurred” under Article 37 of VAT Law.
  2. Accordingly, neither Article 37 of VAT Law nor Article 25 of Executive Regulation appears, by itself, to prescribe the particular reverse-calculation method introduced by the Directive.

Article 54 bis: a binding power framed by statutory limits

  1. Article 54 bis was introduced into the Tax Procedures Law as part of the amendments taking effect from 1 January 2026. It provides that “without prejudice to the provisions of the tax legislations in force, the Authority may issue decisions that include directives on the implementation of the provisions of this Federal Decree-Law and the Tax Law in relation to tax transactions, which shall be binding on both the Authority and the Taxpayer.”
  2. Three elements of this provision should be read together:
    • The FTA may issue directives concerning tax transactions.
    • Those directives are binding on both the FTA and the taxpayer. This distinguishes them from general explanatory guidance that may assist in interpreting the law but does not itself have equivalent binding effect.
    • The power is framed by the expressions:
      • “without prejudice to the provisions of the tax legislations in force”; and
      • “on the implementation of the provisions” of the Tax Procedures Law and the relevant Tax Law.
  3. The binding-effect language answers the question of who is bound by a directive. The expressions “without prejudice” and “implementation” address the logically prior question of what a directive may validly prescribe. In other words, the fact that a directive is binding does not necessarily mean that Article 54 bis places the directive on the same hierarchical level as the Tax Law or authorises it to replace a substantive rule contained in that Law.

What amounts to “implementation”?

  1. The concept of implementation can properly encompass a broad range of measures. A directive may explain how a statutory test applies to a defined transaction. It may prescribe evidence, documentation or computational steps. It may select between different reasonable methods where the Tax Law establishes a principle but leaves the practical method open. It may also provide a standardised allocation mechanism where exact attribution is impossible and several approaches would otherwise be available. In all of those cases, the directive gives practical effect to the Tax Law without changing the legal consequence established by it.
  2. The position becomes more difficult where the directive:
    • replaces an express statutory measure with a different measure;
    • introduces an element that the superior legislation does not contain; or
    • produces a tax base that may be materially different from the tax base resulting from the statutory wording.

At that point, the issue is no longer merely whether the directive is clear or administratively convenient. The issue is whether the result can still reasonably be characterised as an implementation of the Tax Law.

  1. Article 54 bis can therefore be understood as conferring binding force on the FTA’s implementation of the legislation, but not as conferring an unrestricted power to amend the substantive consequences of that legislation through an administrative decision. This interpretation gives effect to all parts of Article 54 bis. It recognises the intended binding nature of directives while also preserving the words “without prejudice to the provisions of the tax legislations in force”.

The strongest basis for treating the Directive as implementation

  1. The strongest practical explanation for the Directive depends on how the deemed supply is identified. If the relevant deemed supply is merely a purchased service that has been diverted to a non-business purpose, its cost would ordinarily be available from the supplier’s invoice, and no market-derived estimation mechanism would appear necessary.
  2. The Directive appears, however, to adopt a broader construction. Its references to the “Services constituting the Deemed Supply” and to direct and indirect costs incurred “to make that Deemed Supply” suggest that the deemed supply may be an identifiable service produced internally by the taxable person using its employees, premises, software, equipment and other inputs. For example, a consultancy might use its own personnel and shared resources to provide private advice to its shareholder without consideration. Under the Directive’s apparent approach, the resulting consultancy service constitutes the deemed supply, while the purchased goods and services are inputs used to make it.
  3. In such a case, identifying the costs attributable to the resulting service may genuinely be difficult. The taxable person may not maintain a separate cost centre for the service, employee and management time may not be separately recorded, and shared premises, software and overheads may require allocation. The Directive’s formula can therefore be understood as an attempt to estimate the VAT-bearing part of the cost of that internally produced service.
  4. This explanation nevertheless raises a prior interpretive question. Article 11(3) of VAT Law may be read as treating the goods or services on which input tax was recovered, and which were subsequently used for non-business purposes, as the relevant deemed supply. It does not expressly state that those inputs and the taxable person’s own resources are to be aggregated into a separately identifiable internally generated output service. Article 37’s reference to costs incurred “to make” the deemed supply provides some support for the latter construction, but does not eliminate the ambiguity. The Directive may therefore do more than prescribe a valuation mechanism: it may also adopt a particular interpretation of what constitutes the deemed supply of services.

How the Directive has been understood in practice

  1. Practitioner commentary published following the Directive generally appears to adopt the broader, output-service interpretation. The reviewed publications treat the relevant deemed supply as an identifiable service produced or provided by the taxable person, while employees, premises, software and other acquired goods or services are treated as resources or inputs used to produce that service. This interpretation is generally assumed as the practical premise of the valuation exercise rather than separately derived from Article 11(3) of VAT Law.
  2. For example, VATupdate describes the problem addressed by the Directive as the difficulty of attributing overheads, shared staff time and other indirect costs to a particular service. It characterises the Directive as replacing a “bottom-up” construction of the cost base with a “top-down” method that begins with the market value of the service and works backwards to an estimated VAT-bearing cost.[1] This description is intelligible where the deemed supply is an internally produced output service whose resources are shared with the taxable person’s wider business. It would be less necessary where the deemed supply is simply an acquired third-party service whose actual cost is already evidenced by the supplier’s invoice.
  3. XB4 adopts a similar understanding. Its examples include free services provided for non-business purposes, personal use of business services, services provided to employees or related parties and, more specifically, free consulting services supplied to a related party.[2] These examples treat the service provided by the taxable person as the deemed supply. Importantly, however, the publication qualifies the examples by stating that the conditions for a deemed supply must first be satisfied. The fact that a service is provided without consideration or to a related party does not, by itself, establish that a deemed supply arises.
  4. ATTO’s commentary begins from language closer to the narrower statutory formulation: a deemed supply arises where an entity uses services in respect of which input tax was recovered for purposes outside its business. It then presents the Directive as determining the value on which VAT should be charged.[3] That formulation does not clearly resolve whether the acquired service on which input tax was recovered is itself the deemed supply or whether it is an input into a separately identifiable output service produced by the taxable person.
  5. The reviewed commentary therefore provides useful evidence of the Directive’s apparent intended operation. It supports the view that the prescribed methodology was designed principally for identifiable services produced by a taxable person using a combination of its own resources and VAT-bearing inputs. It does not, however, resolve the prior legal question. The publications generally assume, rather than demonstrate, that the resulting output service constitutes the deemed supply for the purposes of Article 11(3).
  6. Nor does the valuation methodology itself answer that question. The Directive applies to a taxable person already “making a Deemed Supply of Services” and requires the market value of the “Services constituting the Deemed Supply” to be established. It therefore presupposes that the relevant deemed supply has first been identified under the VAT Law. The formula may determine the value of that supply, but it cannot, by itself, establish that every internally performed non-business activity constitutes a deemed supply.
  1. The concern arises because the Directive is not expressly limited to cases in which actual costs cannot reasonably be identified.
  2. Its language is mandatory. A taxable person “shall” calculate the relevant costs using the prescribed mechanism. The Directive does not state that reliable actual-cost records take priority, nor does it allow a taxpayer to demonstrate that the formula produces an amount materially different from the costs actually incurred in making the deemed supply.
  3. A simple example illustrates the distinction. Suppose the costs actually attributable to a service are AED 100, of which AED 80 relate to inputs bearing VAT. The open market value of the service is AED 180. Applying a 20% net profit margin produces an estimated cost of AED 150. If the preceding-year input-tax cost ratio is 80%, the Directive produces a deemed-supply value of AED 120. The Directive would therefore produce a value of AED 120, although the actual VAT-bearing costs attributable to the service were AED 80 and its total actual cost was AED 100.
  4. In another case, the formula could produce an amount below the costs actually incurred. This may occur because the taxpayer’s overall net margin or input-tax cost ratio for the preceding financial year does not accurately represent the particular service supplied in the current period.
  5. The concern is not that the formula involves estimation. Estimation is often an unavoidable part of cost allocation. The concern is that a formula based on market value, an entity-wide or sector-wide net margin and a preceding-year cost ratio may produce an amount that is not an estimate of the taxpayer’s actual cost in any sufficiently direct sense.
  6. The use of Article 36 elsewhere in the VAT Law makes this question particularly relevant. Article 36 expressly overrides Article 37 where market value is intended to apply. If the Directive can require market-derived valuation in all deemed supplies of services, including where Article 36 does not apply, the distinction drawn by the VAT Law between cost and market value becomes less clear.

A possible reconciliatory interpretation

  1. The Directive and Article 37 of VAT Law could be reconciled more readily if the prescribed formula were interpreted as an estimation or safe-standard methodology for circumstances in which the relevant actual costs cannot be reliably determined or allocated. Under that approach:
    • directly identifiable costs would be taken from the taxable person’s records;
    • indirect costs would be allocated using reasonable and supportable allocation keys;
    • the Directive’s methodology would apply where such identification or allocation is not reasonably possible; and
    • the formula could also serve as a control or reasonableness check against the taxpayer’s cost calculation.
  2. Such an interpretation would preserve the statutory reference to “cost incurred” while giving the Directive an important practical function. It would also reduce opportunities for arbitrary or inconsistent cost allocation.
  3. The difficulty is that this limitation is not expressly stated in Directive No. 5. Clause 2 appears to prescribe the market-derived calculation generally rather than as a fallback method. The reconciliatory interpretation is therefore a possible way of reading the Directive consistently with Article 37, but it is not an express qualification contained in the Directive itself.

Binding effect does not eliminate the interpretive question

  1. The existence of this legal question does not mean that a taxpayer may simply disregard the Directive. Article 54 bis expressly states that directives on tax transactions are binding on taxpayers and the FTA. Until a directive is amended, withdrawn or authoritatively determined to exceed the scope of the enabling legislation, taxpayers face a direct compliance obligation.
  2. Nevertheless, treating the Directive as binding in practice is different from concluding that no question of statutory interpretation can arise. The binding effect of a subordinate instrument does not, by itself, determine whether every part of that instrument is consistent with the superior legislation under which it was issued.
  3. The appropriate question is therefore not whether the FTA may issue binding directives. Article 54 bis clearly confirms that it may. The narrower question is whether a particular prescribed result remains within the concept of “implementation” and operates “without prejudice” to the Tax Law.

Disclaimer

Pursuant to the MoF’s press-release issued on 19 May 2023 “a number of posts circulating on social media and other platforms that are issued by private parties, contain inaccurate and unreliable interpretations and analyses of Corporate Tax”.

The Ministry issued a reminder that official sources of information on Federal Taxes in the UAE are the MoF and FTA only. Therefore, analyses that are not based on official publications by the MoF and FTA, or have not been commissioned by them, are unreliable and may contain misleading interpretations of the law. See the full press release here.

The same reservation applies to the judicial issues addressed in this article. This study has not been commissioned, authorised, or endorsed by the Ministry of Justice, the Federal Supreme Court, or any other judicial authority in the UAE. It is not intended to convey, and should not be understood as conveying, any official position of those authorities. Nor does it purport to suggest that the interpretations, conclusions, or proposals set out in it are binding on the courts or must necessarily be adopted in judicial practice.

You should factor this in when dealing with this article as well. It is not commissioned by the MoF or FTA. The interpretation, conclusions, proposals, surmises, guesswork, etc., it comprises have the status of the author’s opinion only. Furthermore, it is not legal or tax advice. Like any human job, it may contain inaccuracies and mistakes that I have tried my best to avoid. If you find any inaccuracies or errors, please let me know so that I can make corrections.

[1] VATupdate, “UAE Flips the Valuation Problem Upside Down: A Top-Down Method for Costing Deemed Supplies of Services,” 24 July 2026.

[2] XB4, “FTA Issues New Directive on the Valuation of Deemed Supplies of Services for UAE VAT,” accessed 29 July 2026.

[3] Mohamed Abdelrazek, ATTO Group, “Tax Transactions Directive No. 5 of 2026: Determining the Value of Deemed Supplies of Services,” July 2026