What will be the impact of Saudi’s VAT hike on businesses and consumers?

The sudden hike in value added tax (VAT) in Saudi Arabia, from 5 per cent to 15 per cent, will probably lead to price inflation in the country in the short-term, experts have suggested.

Earlier this week, the kingdom announced a slew of austerity measures including the increase in VAT – effective from July 1 – and a cut in its monthly cost of living allowance which is granted to government workers. The kingdom also foresees spending cuts in some of its landmark projects.

The move comes even as the Saudi economy deals with the double blow of low oil prices as well as the impact of the Covid-19 pandemic.

“While the measures that were taken may be painful, they are necessary and beneficial to protect fiscal and economic stability in the short and long term,” finance minister Mohammed Al-Jadaan said in a statement on Saudi Press Agency.

Read: Saudi Arabia triples VAT, cuts cost of living allowances

VAT was introduced in Saudi Arabia on January 1, 2018, and generated an estimated $12bn for the government in its first year of implementation.

Impact on taxpayers

“This VAT rate increase will require businesses to act swiftly, with less than two months to ensure that their systems are ready to charge 15 per cent, they have discussed the rate increase with their various stakeholders and have updated their internal tax procedures and controls,” stated Joanne Clarke, tax director for Pinsent Masons.

Taxpayers in Saudi Arabia will have to “immediately” act to adjust their systems in order to be able to issue invoices and charge VAT at the new rate, agrees Reggie Mezu, senior counsel at Baker McKenzie Habib Al Mulla.

“The VAT rate increase would increase cash flow costs in the short-term, and increase operating costs – particularly for those who are unable to fully recover VAT they pay on their expenditure.”

In the long-term, businesses may need to reconsider their structure, contracts and transaction flows to mitigate the impact of the rate increase, he opined.

“The need for businesses to have sufficient documentary evidence to support the VAT treatment of their transactions has become more critical, because of the increased financial consequences. Errors or non-compliance will not only lead to significant VAT payments that may not be recovered from the customer, but also result in increased penalty amounts (since the penalties are applied to the VAT base),” Mezu added.

Impact on consumers and the economy

“The burden of VAT is generally borne by the end consumer and so it is expected that Saudi Arabia will experience price inflation as a result of the rate increase, together with a reduction of spending on luxury items,” said Clarke.

Businesses undertaking exempt activities and unregistered businesses will also feel the impact of the VAT rate increase on their profits, she added.

According to tax advisor Aurifer, the increase of VAT generally causes a short term rise in spending before the increase, and a short term decrease right after the implementation.

“The VAT rate hike then gets gradually absorbed by the economy and should theoretically be neutral,” it said in a report.

“A hike in the VAT rate does impact consumer confidence though. From a business perspective, those businesses which may have cared less about a mere 5 per cent VAT, will now increasingly turn their attention to transactions subject to VAT to ensure compliance and, more importantly, no VAT leakage.

“The economy is currently in a fragile state and therefore this measure will have been carefully weighed,” the report added.