Questions over exemptions add to complexity of GCC-wide VAT

The UAE and GCC countries will implement a zero-rate levy on key sectors such as education and health care, following an in-depth study. Above, A hospital in Abu Dhabi. Silvia Razgova / The National

With less than a year to go before a GCC-wide value added tax (VAT) is levied, several uncertainties are creeping in over what type of items will be exempt ahead of its implementation.

In the UAE, a federal tax authority has been created to deal with VAT, which will be 5 per cent, and which may also include excise taxes on cigarettes and energy drinks.

But the Ministry of Finance is giving businesses an unspecified grace period to deal with implementation of the law, which is expected to be issued some time this year, according to Saeed Al Yateem, the assistant undersecretary of resources and budget sector at the ministry.

“We are currently in the preparation phase to implement the VAT law in 2018,” Mr Al Yateem said. “Once it’s issued, the law includes a grace period to allow the institutions and companies from the private sector to align their financial systems to cope with the taxation system in the UAE. The law is expected to be published during 2017.”

None of the six GCC countries have published local VAT laws and there is ambiguity about the type of products and services that will be taxable.

The issue gets more complicated because some sectors are expected to be exempt, while others, such as exports and international transport, will be zero-rated.

Businesses exempt from the VAT will not be able to recover the tax incurred on the cost of an item or a service that is not exempt from the Government and it will be up to the business to decide whether to pass on the VAT cost to the consumer. But when businesses have zero-rated services and goods they can reclaim from the Government any VAT they have paid on costs.

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Value Added Tax in the GCC

Pawan Singh / The National

■ Analysis: All in the details for value added tax in the GCC

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■ Q&A: Sultan Al Mansouri, the UAE Minister of Economy, and his views on VAT, infrastructure spending and the investment law

■ Comment: The basics of value added tax

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“An in-depth study was conducted on local and GCC levels to determine the tax exemptions,” Mr Al Yateem said.

“Therefore, the UAE and GCC countries have moved towards achieving balance by implementing VAT at its lowest rate of 5 per cent, and subjecting zero percentage on key sectors such as education and health, as well as other sectors that affect the global competitiveness and investments’ attractiveness, such as exports, and sectors covered by international agreements, such as the international transport sector.”

However, the difficulty is in the details of which specific products and services within these sectors will be either exempted or zero-rated.

This difference is a positive or a negative depending on which party is being affected.

“It [zero rating] is always preferable to an exemption as it allows the recovery of the VAT incurred on expenses, which means that no VAT is passed on to the consumers,” said Jeanine Daou, a Middle East indirect tax leader at consultancy PwC. “From a government perspective, the zero rate is more costly and is not the most desirable result from a VAT revenue perspective. That’s why a number of governments may prefer to apply exemptions rather than a zero rate.”

The issue gets more complicated when it comes to some industries such as the financial sector.

“Sectors such as financial services, health care, education and real estate are likely to have VAT exempt supplies and, therefore, tend to be more complex from a VAT perspective than other sectors,” said Clare McColl, a partner at KPMG Lower Gulf. “Where businesses have a mix of both exempt and taxable supplies, they are required to directly attribute certain costs and apportion others, which leads to the additional complexity.”

Interest is usually not taxed, but other financial services could be subject to a levy. It is also common to have exported financial products, such as those for offshore clients and businesses, to be in effect, zero-rated.

“We are anticipating that the GCC treaty will allow for exemptions and then it will be up to individual countries to implement those exemptions,” said Justin Whitehouse, the VAT leader at Deloitte Middle East. “Those businesses that have special rules applied to them like exemptions actually end up having a complicated business because they have to decide what is exempt, what is taxable, what VAT is recoverable and what VAT is not recoverable.”

Despite the confusion over which products and services will be exempt or zero-rated, one thing for certain is that government revenue is expected to increase with each year of implementation.

The UAE could generate up to Dh20 billion in revenue from the levy in its second year of implementation, up from Dh12bn in 2018, according to Sultan Al Mansouri, the Minister of Economy.

“VAT is a transaction tax, therefore revenue is generated based on the value of the transactions. The higher the consumption, the higher the revenue,” Ms McColl said.

“Economic growth will result in increased VAT revenue. VAT revenue is also influenced by the number of VAT-registered taxpayers and, therefore, over time it can be expected that more companies will fall within the VAT net.”

For a country such as the UAE, and the GCC as whole, introducing a consumption tax is a new endeavour. Other countries around the world tend to switch from one tax system to another. For example in September, Egypt replaced its general sales tax with VAT.

“Having a brand-new system from scratch is significant and quite a transformational change to the business operating models that we will have,” said David Stevens, a VAT implementation partner at EY.

“It will have pervasive impacts on businesses and the way they do business and so it requires a lot more effort from businesses than just changed tax arrangements.”

The fact that the tax will be GCC-wide will not necessarily make it easier for implementation. Each country may decide to take different approaches to certain goods and services.

“Whereas VAT applies on a transaction-by-transaction basis, so at an individual level the nature of transaction is infinitesimal, at the legislative level it is much more on a higher definitional basis,” Mr Stevens said.

“So you have to convert those broad individual definitions into individual transactions and it may not be entirely clear which of the rules apply in the circumstance of that transaction or that product or offering.”

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