Riccardo Ubaldini, Partner for international tax law at BonelliErede deliberates on the implications of VAT on the economies of UAE and Saudi Arabia.
The much-discussed new Value Added Tax (VAT) legislation in the United Arab Emirates (UAE) and the Kingdom of Saudi Arabia (KSA), which has been modelled around its European counterpart, went live on 1 January 2018. The new legislation mandates a general five per cent levy applicable (with certain exceptions) on supplies of goods and services made by a taxable entity.
VAT’s introduction is being closely watched by both the revenue-collecting authorities and the taxpayers (i.e. those subject to paying and collecting the VAT). While the relevant authorities will be able to raise money by an easy-to-collect levy, VAT-able persons (both established and non-established) will have to face unprecedented challenges when dealing with both the tax and the new compliance associated with the legislation.
In principle, VAT is seemingly an easy tax to assess and collect. VAT is imposed at any stage of the value chain by the VAT-able person that charges VAT to its client (so-called ‘output VAT’), who then pays it to the fiscal authorities before deducting the amount of VAT its supplier has charged to him (so-called ‘input VAT’).
As a result, effectively only the value that is ‘added’ by any VAT-able persons along the chain is actually subject to the new levy. By charging VAT to the client and deducting VAT paid to the suppliers, the tax ends up being ultimately only borne by the final consumer (who pays the tax and cannot deduct it). At any intermediate stage of the value chain the tax is, in effect, neutral, as any excess of VAT paid to suppliers over VAT charged to clients is then claimed as a refund from the revenue. (In the reverse situation the VAT-able person pays the excess to the Government, i.e. the excess of output VAT over input VAT.)
Such neutrality however, is guaranteed so long as there are no limits to deduct the input VAT. That right of deduction is pivotal for a European Union VAT-style system in order to properly operate, i.e. so it may be limited in specified circumstances only. For example, the VAT-able person carries on exempt supplies that bears no right of deduction of input VAT charged on supplies obtained to provide the exempt supplies.
As such, the introduction of VAT in the UAE and KSA brings about a number of economic implications.
Firstly, any entities having to manage and pay VAT will see their costs increased on both a once-off and ongoing basis in order to meet compliance regulations. This will place an additional financial burden on businesses against a backdrop of often rising costs and increasing customer price sensitivity.
However, Government coffers will be increased via this additional revenue, which are expected to be ploughed back into spending on national development programmes. (VAT-related revenues from imported goods are expected to represent a large portion of the total revenues raised, given that both national economies are heavily import-related.)
Ultimately, the end consumers who are paying VAT and not able to reclaim it will face across-the-board price increases for the goods and services they consume. In simple terms, their daily cost of living will go up. Both the UAE and KSA are home to large resident populations of expatriates, many of whom are highly cost-conscious.
span style="font-size: small;">Various research studies are already showing evidence of a ‘tightening of belts’ in spending terms among many citizens and expatriate residents especially, which is having economic knock-on effects, particularly in discretionary purchasing (such as eating out and luxury goods).
It may also be that some expatriates decide that the heightened cost of living no longer justifies the reasons they had to move to the country in the first place and relocate elsewhere.
This has the potential to remove valuable skills from the job market as well as other economic impacts associated with decreased consumer spending.
Looking at the history of VAT’s introduction in Europe we can consider that compliance costs for those liable to pay them will be diverse. The most obvious financial implications will be the costs incurred with compliance with the new legislation, such as reporting obligations, but there are less obvious costs associated with the new system which will place potential burdens on VAT-liable businesses.
For example, there will be costs associated with likely supply chain restructuring, cash-flow issues (if the refunds of excess input VAT over output VAT is not returned in a timely manner), changes in contractual agreements (linked to provisions which provide that prices must be VAT-inclusive both in B2C pricing but also in B2B), and constant monitoring of contractual counterparties in order to avoid being involuntarily implicated in any fraudulent or other illegal scenarios that may occur in an international setting
Additionally, costs will also be incurred as a result of the need to have the new legal framework studied and interpreted with relation to the individual VAT-liable entity. Among others, these costs will arise from the individual entity’s need to clarify its ‘objective value’ as its taxable base (when supply is made to a VAT-able person with no full right of deduction) determination of the place of supply of goods (especially in complex ‘chain transactions’ when right to dispose over the goods is transferred almost simultaneously to many acquirers), and VAT grouping.
span style="font-size: small;">In summary, the logistical challenges ahead are numerous, and many stakeholders will be impacted by the new VAT legislation. However, given that that VAT in the Gulf states is modelled along the EU VAT system, European experience should provide useful guidance in order to minimise the impact of the new rules on established, as well non-established, companies doing business with and in KSA and the UAE.