To tax or not : How VAT will impact the UAE

With oil prices halving from a high of $115 per barrel last year to a low of $45 per barrel in January, Gulf Cooperation Council countries have been forced to tighten their belts and look for alternative sources of revenue.

One such revenue bolstering measure that the Gulf countries – specifically the United Arab Emirates – are mulling over is the implementation of value added tax.

Although the region has been toying with the idea of VAT since 2007, little concrete progress had been made.

That was until a meeting of all under secretaries of the ministries of economy earlier this year.

The GCC indicated a willingness to move ahead with VAT after the committee ordered a general framework to be formulated. Following this, the UAE took the first step. Ministry of Finance undersecretary Younis Haji Al Khouri said the country will complete the drafting of laws to introduce VAT and corporate tax by this year. Although officials are still studying the social and economic impact of the law, the drafting process is likely to be finished by the third quarter of 2015, he said.

The annoucement has been met with praise from some analysts.

“An indirect consumption tax regime like VAT is a natural progression of GCC government fiscal policy moving towards more effective and efficient tax systems in a competitive and integrated global economy,” says EY’s Middle East and North Africa tax leader Sherif El-Kilany.

“Given the current oil prices, the implementation of VAT by GCC governments is likely to be accepted as a positive measure to diversify and strengthen their revenue base and enhance economic stability. In this regard, it should be noted that the International Monetary Fund has long urged GCC countries to introduce VAT.”

Despite the obvious benefits to the UAE’s coffers in the long-term, there are also risks-particularly to the country’s perception as a low tax destination.

KPMG UAE partner and head of tax Nilesh Asbar believes the move will “certainly increase” the cost of doing business and compliance for firms in the UAE and GCC. He believes the incremental costs and requirements associated with VAT will need to be carefully budgeted in business models to offset any financial pains.

“For consumers, this will be an additional cost but if VAT rates are kept low, this could lead to a one- off marginal inflation impact. The implementation of a lower VAT rate will not have a recurring inflation impact unless the VAT rates are increased. Plus it may well be that some businesses may choose to absorb the VAT cost wholly or in part, at least initially, to limit the impact on consumers.”

There has also been little information about the proposed VAT rates with hints from officials suggesting between 3 to 5 per cent. Experts argue that the initial VAT rate will need to be kept low to limit the financial pain for consumers.

“The UAE is already regarded as the most expensive place in the GCC from a cost of living perspective. Unless the VAT rates are introduced at a low level – under 5 per cent – and businesses ‘share the pain’ at least initially, there is a risk of consumers seeking bargains elsewhere, thereby impacting businesses adversely,” says Ashar.

Impact on FDI

The UAE has long been considered a safe haven for investors fleeing other tumultuous parts of the region such as Egypt, Libya and Syria. The country’s low tax environment and ease of doing business has also attracted a number of large multinationals to set up regional headquarters. But with VAT and a corporate tax on the way, will it impact foreign direct investment in the country?

“Governments in many developing countries are relying increasingly on indirect taxes to bolster revenues and to fund infrastructure projects. Globally, there has been a shift from indirect taxes to direct taxes,” says El-Kilany.

“The introduction of VAT in the region should not be viewed as an event that will discourage foreign direct investment. The region will continue to be an attractive place to do business with low corporate tax rates and a favourable business environment. Multinational companies are familiar with consumption taxes such as VAT and goods and services taxes, which exist in over 150 countries worldwide.”

The UAE’s appeal also stretches much further than its tax-free status. Infrastructure development, access to high-potential growth markets in Africa and Asia, free trade zones, competitive labour costs, few trade barriers and economic and political stability are all factors to be considered, says Ashar.

“In the current environment, companies are looking for lot more than mere tax-free destinations to establish their businesses. Economic and political stability is a key factor and the UAE ranks particularly high on this index.”

He claims that revenues gained from VAT could help the government to improve business conditions and maintain its reputation of being business friendly.

Marching ahead, but too soon?

Although VAT could prove beneficial to the UAE in the longer term, the country could be at a competitive disadvantage if it is implemented this year.

“The negotiations for GCC-wide common VAT framework have happened jointly to avoid any one GCC nation losing out in competition with others in the region,” says Ashar.

“The added requirement of getting the laws drafted and approved through the member states’ legislative process, and development of the tax administration system to support the VAT law, means the process of a coordinated execution across the GCC member states will be a challenge. It may lead to a separate timeline of VAT implementation for each of the GCC member nations.”

As a result, the UAE could lose out to its Gulf peers despite its business friendliness.

“The implementation of VAT in the UAE alone could reduce its competitiveness as a destination for investment and to do business in compared to other GCC states,” Ashar claims.

But he also points out that VAT might not necessarily force investors to seek alternatives. Factors such as a strong economy, a forward- looking government, the ease of doing business and the concept of free zones could still make the UAE a business friendly destination.

Although, incentives for investors and entrepreneurs looking at setting up their businesses in the UAE may be necessary, he adds.

“Globally, the UAE’s free zones are a huge attraction for investors and keeping these zones exempt from VAT will be a good way to ensure that investor interest in the UAE and the region still stays high. Practical implementation and impact on local businesses will of course require consideration.”

Clearly UAE officials will need to engage in a delicate balancing act when it comes to VAT implementation.