Value Added Tax (VAT) is an important part of managing business finances, affecting costs, pricing, and compliance. Since its introduction in 2018, VAT has shaped how companies handle transactions, especially in payroll and HR services. For businesses, understanding VAT ensures smooth operations and legal compliance.

Let’s talk about VAT for businesses in 2025, covering its basics, rules, payroll impacts, and practical steps to stay compliant.

Understanding VAT Basics 

VAT is a tax added to goods and services sold by registered businesses, collected for the government. It’s an indirect tax, meaning companies charge it on sales but can reclaim it on purchases. Introduced at a 5% rate, VAT ensures the final consumer pays the tax, while businesses recover costs.

VAT applies across the supply chain, with businesses charging VAT on sales (output VAT) and reclaiming VAT on expenses (input VAT). For HR-focused companies, VAT ties into payroll outsourcing, aligning with labour law requirements and supporting efficient employee management.

Key Features of VAT

• Standard Rate: 5% on most goods and services.

• Recoverability: Businesses reclaim VAT on business-related purchases.

• End Consumer: Pays the 5% tax added to the price.

• Compliance: Requires accurate records and timely filings.

How does VAT work?

To understand how the VAT system operates, let’s take an example with furniture:

A carpenter sells a dining table to a wholesaler for AED 1,000. Under the VAT system, the carpenter charges 5% VAT (AED 50) on behalf of the government. The wholesaler therefore pays a total of AED 1,050.

The wholesaler raises the price to AED 2,000 and sells the table to a retailer. They collect 5% VAT (AED 100) from the retailer but are refunded the AED 50 VAT previously paid to the carpenter. The retailer pays a total of AED 2,100.

The retailer then increases the price to AED 3,000 and sells the table to the final customer. They collect 5% VAT (AED 150) from the customer and reclaim the AED 100 VAT paid to the wholesaler.

In the end, the customer pays AED 3,150 for the dining table.

VAT is therefore applied at every stage of the supply chain, but businesses registered for VAT can reclaim the tax paid at the earlier stage.

VAT Rules for Businesses in the UAE

VAT rules help businesses stay compliant and manage taxes effectively. Overseen by the Federal Tax Authority (FTA), these rules cover registration, taxable supplies, and record-keeping.

VAT Registration Requirements

• Mandatory Registration

Businesses with sales or imports over AED 375,000 must register.

• Voluntary Registration

Businesses with sales above AED 187,500 can register to reclaim VAT.

• VAT Grouping

Related companies can register as one entity, simplifying tax accounting.

Taxable and Non-Taxable Supplies

VAT applies differently depending on the type of goods or services.

• Standard-Rated Supplies

Most goods and services are taxed at 5%. This includes things like consulting fees, non-life insurance, or retail products. For example, if a business sells office supplies or offers paid training, it adds 5% VAT to the price. Businesses can recover VAT paid on related purchases, like materials or equipment, which keeps costs down.

• Zero-Rated Supplies

These are taxed at 0%, meaning no VAT is charged to the customer, but businesses can still recover VAT on related costs. Examples include goods exported outside the GCC, international transport services, or specific education and healthcare services, like school tuition or hospital care. For instance, a company exporting electronics doesn’t charge VAT on those sales but can reclaim VAT paid on manufacturing materials.

• Exempt Supplies

These are non-taxable, so no VAT is charged, and businesses cannot recover VAT on related expenses. Common examples include renting or selling residential properties, public transport, undeveloped land, life insurance, and certain financial services like bank account fees.

For example, a real estate company renting apartments doesn’t add VAT to the rent, but can’t reclaim VAT on property maintenance costs. Businesses dealing with exempt supplies need to plan their finances carefully since they bear the full cost of VAT on related purchases.

• Partial Exemption

Some businesses sell a mix of taxable and exempt supplies, like a company offering both consulting (taxable) and residential rentals (exempt).

VAT and Payroll Outsourcing

VAT affects businesses outsourcing HR tasks like payroll, a core part of human capital management. When a registered company uses payroll services, a 5% VAT is added to the fee. This VAT is usually recoverable if the company’s services are taxable.

How VAT Applies to Payroll

Outsourcing payroll means a third party handles salary payments, compliance, and reporting. The VAT on these services is an input cost, recoverable if the business’s outputs, like consulting services, are taxed. For example, a firm offering taxable services can reclaim VAT on payroll fees, lowering costs.

Cross-Border Considerations

Outsourcing payroll to a provider outside the country adds complexity:

• GCC Countries

VAT depends on regional tax agreements.

• Non-GCC Countries

Recovery relies on tax treaties and the supply location.

Businesses should check contracts to confirm VAT is applied correctly, ensuring compliance during FTA audits. A payroll management system for tax automates VAT tracking, integrates with financial records, and reduces errors, making audits smoother.

Why VAT Compliance Matters in 2025

Staying VAT-compliant avoids fines and boosts financial efficiency. With stricter FTA oversight in 2025, businesses need accurate records and timely filings. For HR-focused companies, VAT compliance supports payroll outsourcing and employee management, ensuring smooth operations.

BSH’s HR services simplify VAT management, from compliant contracts to automated payroll. Their expertise helps businesses meet tax rules while optimizing costs in sectors like hospitality or technology.