Construction contracts are typically long-term in nature, often spanning several months or even years depending on the scale of the project. In the UAE, such projects are generally subject to VAT at the standard rate of 5%. Unlike short-term supplies, however, construction work is not completed in one go, making the timing and calculation of VAT more complex.
To address this, the Federal Tax Authority (FTA) treats construction as a continuous supply, where VAT becomes payable at specific stages rather than at final completion. Payments are usually linked to certified milestones, representing the value of work completed at a given point in time. This method, commonly known as progress billing, determines when VAT is triggered and on what value it must be calculated.
Understanding how VAT applies at each milestone, including the treatment of advances, retentions, and certified values, is essential for contractors to remain compliant. This guide explains the VAT rules governing construction contracts in the UAE and provides a clear, step-by-step approach to calculating VAT under the progress billing method.
What are the taxation rules for construction contracts?
Most construction projects operating within the UAE will be subject to a 5% VAT. These include major infrastructure projects, commercial buildings, and other industrial project undertakings.
The UAE’s FTA considers all types of construction to be a continuous supply process. But for tax calculation purposes, we must determine a specific time/date from which this continuous supply begins. According to the FTA, the earliest of the following dates should be considered as the time of supply for VAT purposes.
- The tax invoice issuing day
- Date of tax payment, with progress payment also considered
- And the date of completion of a set project milestone, predetermined by the project’s architects or engineers.
The progress billing system facilitates VAT liability on the certified value at each completed work milestone. Hence, contractors must charge VAT on the certified amount, even if clients are withholding retention.
How is VAT for progress billing calculated?
Tax calculation can seem an elaborate process, especially when the taxable amount varies at different stages of the project. Usually, you can deploy a dependable VAT calculator that is embedded within a VAT software to handle the tricky calculations. But we should understand the underlying mechanism, as it’s a critical pillar of running a hassle-free construction project.
The following is a step-by-step guide for accurately calculating VAT under the progress billing protocol in the UAE.
1. Ascertain the certified value
An accurate work valuation is the foundation of proper tax calculation. The engineer’s work completion certification at each stage should be reviewed, as it assigns a clear value upon which VAT can be charged. Any prior advance amounts that have been taxed will be excluded.
2. Calculate advances and retentions
During VAT calculation, include the entire certified amount, even if the client retains a certain percentage of the amount. For example, the total certified value of the project is AED 100,000, and the client has retained 10% of it. Calculate tax on the entire AED 100,000 amount, without deducting AED 10,000 (10% retention).
For any advances, as mentioned in the previous point, deduct them from the total certified amount, as it has already been taxed.
3. Apply VAT on the final amount
Once you consider all the above, the resulting amount is the final certified value. Calculate VAT of 5% on this amount, and we will get the taxable amount.
Common mistakes while calculating VAT
When progress billing is handled manually or without dedicated VAT software, it requires extra care and attention. Contractors, business owners, and tax consultants often encounter the following common areas to watch out for.
- Deducting retention from the base value: Many contractors deduct the client’s retention percentage from the total certified value. This results in an inaccurate base amount, upon which they calculate VAT.
- Producing inaccurate or incomplete tax invoices: The tax invoices provided must be up-to-date and contain all the valuable business information. These include the full VAT calculation breakdown, retention amounts, the company’s TRN number, and certification date.
Calculating VAT for construction projects is a layered, yet straightforward procedure. Having a clear understanding of progress billing and calculating factors like advances and retention helps negotiate the tax liability with ease. It’s a bonus if you do it through a specialised VAT software like TallyPrime, which takes care of the entire process seamlessly.
