VAT What do we know now
Businesses in the UAE and KSA know that Value Added Tax (VAT) will be imposed with effect from 1 January 2018. However, not all of the details of the way in which VAT will be imposed have been published in final form.
In this briefing, we will look at the legislation which has been published to date, and some of the key facts to enable businesses to prepare for VAT. This includes the recently published UAE Tax Procedures Law.
We also cover some of the back to basic principles of the application of VAT in the GCC. This builds on our briefing in March 2017 (click here).
Pan GCC legislation the Framework Agreement
The GCC Framework Agreement is an important source of rules. It sets out the common basis and definitive rules which apply to the imposition of GCC VAT by the member states.
Basis of charging VAT The GCC Framework Agreement sets out the basis on which VAT is charged. In essence, VAT will be charged on:
supplies of goods and services by a taxable person (a person who is registered or required to be registered for VAT) where the supplies are made within the same GCC member state in the course of carrying on a business;
the importation of goods from outside of the GCC;
the exportation of goods or services to outside of the GCC although these supplies will be zero rated;
the receipt of good and services cross border within the GCC by the application of the reverse charge mechanism (see below Reverse charge mechanism);
the receipt of services from outside of the GCC by a VAT registered customer by the application of the reverse charge mechanism (see below Reverse charge mechanism).
The basic rate of VAT will be 5% of the value of the supply. Generally, the supply value will be the consideration paid for that supply, in cash or kind. As explained below (Exempt or zero rated?), some supplies will be exempt or charged at the rate of 0% - known as zero rated supplies.
Input and output VAT VAT which a business is required to account for on its sales is called "output tax". VAT which it suffers when it purchases taxable supplies of goods or services is called "input tax".
In general, if a business makes only standard rated or zero rated supplies, it is likely to be able to offset the input tax that it suffers (where it is directly attributable to buying in goods and services to make its taxable supplies) against its output tax. It must pay to the Tax Authority only the difference between its output tax and its input tax (or claim a credit or refund if the input tax exceeds its output tax). In this situation, VAT is largely a cash-flow cost for a business and the person who ultimately bears the cost is the final customer.
Exempt or zero rated?
The difference between zero rating and exemption is crucial to understand.
Zero rating: as noted above (Input and output VAT), if a supply is zero rated, the supplier will be able to reclaim the input VAT it has paid to buy the goods and services directly attributable to the zero rated supplies that it makes. Both for suppliers and the end consumer, this is beneficial. The base cost of the supply is reduced for the supplier by reclaiming the VAT it has paid. This reduced base cost is passed onto the customer and no supply VAT at 5% is levied on top.
Exempt supply: for an exempt supply, the supplier does not usually have the advantage of reclaiming its associated input VAT. The input VAT is therefore a real cost for the supplier which it will usually try to recover by increasing the sale costs of its goods or services. Therefore, although the customer does not pay VAT on the supply at 5%, it is likely that the supplier has already passed on its input VAT cost to the customer by way of an increased sale price.
The GCC Framework Agreement allows the GCC member states to decide whether to exempt or zero rate certain supplies and also allows them to choose not to provide any concessions at all. However, the sectors to which exemptions or zero rating apply are clearly set out, with no ability for a GCC member state to apply benefits to any other sector. Those sectors are:
Education Health Real Estate Local transport Oil, petrol derivatives, gas
Zero rate or exemption possible; or no concession
Zero rate or exemption possible; or no concession
Zero rate or exemption possible; or no concession
Zero rate or exemption possible; or no concession
Zero rate; or no concession
Certain agreed food stuffs
Medicine and medical equipment
GCC and international transport of goods and passengers fares etc
Supply of transport means supply of the vehicles etc
Precious metals for investment
Zero rate; or no concession Zero rate no choice offered Zero rate no choice offered
Zero rate; or no concession Zero rate Free choice of tax treatment
The KSA government proposals for the specific concessions in Saudi Arabia are explained below (Saudi Arabia the story so far zero rating and exemptions).
Reverse charge mechanism
The reverse charge mechanism eases the administration of the GCC VAT scheme in relation to cross border supplies, in which the customer and supplier are not registered for
VAT in the same member state. Under the mechanism, the person buying the services or importing the goods from another GCC member state is treated as if it supplied the goods or services to itself. In effect, it situates the place in which both the input and the output VAT are recorded together, to the place where the customer is located. It also means that supplies from overseas attract the same VAT rate as domestic supplies.
In economic terms, if the person importing the goods or buying the services is fully taxable (a person who makes supplies of goods or services at the basic rate or zero rate of VAT), the input tax and output tax are offset against each other as described above. In other words, the reverse charge mechanism becomes an accounting exercise. However, if the relevant business makes exempt supplies (and cannot recover related input VAT costs), the operation of the reverse charge will trigger a real VAT cost for the importer of the goods or services.
Who should register for VAT? VAT is generally only payable on supplies made by a taxable person (a person who is registered or required to register for VAT). Under the Framework Agreement, the mandatory registration threshold is set at SAR (or AED) 375,000 of annual VATable supplies. However, businesses may elect to register if they have an annual turnover of VATable supplies of at least SAR (or AED) 187,500.
The advantage of a voluntary VAT registration is the ability to reclaim input VAT to keep prices competitive. However, this benefit has to be weighed against the cost of preparing VAT filings and maintaining necessary records.
UAE the story so far
The UAE government has currently published three relevant pieces of legislation:
Decree No. 31 of 2017 approving the GCC VAT Framework Agreement.
Decree No. 32 of 2017 approving the GCC treaty on Excise Duty (known also as the "selective tax" or, more colloquially, "the sin tax").
Federal Law No. 7 of 2017 on tax procedures (the Tax Procedures Law).
The first two Decrees implement into UAE law the GCC wide agreements.
In relation to VAT, we are expecting UAE implementing legislation shortly. The UAE Ministry of Finance has stated that it will publish the laws on its VAT webpage when they are issued: https://www.mof.gov.ae/En/budget/Pages/ VATQuestions.aspx
Tax Procedures Law The UAE government announced the publication of the Tax Procedures Law on 31 July 2017.
The Law sets out certain obligations on UAE businesses in relation to the administration and payment of tax, including VAT.
The key obligations are as follows:
Record keeping of accounting records and commercial books, together with tax related information, for a period to be determined in the Executive Regulations to the Law. This obligation applies to all persons operating a business activity in the UAE, regardless of whether they are a taxable person (such as under the VAT legislation).
Submission of all required documentation in relation to tax helpfully, this information may be provided in any language provided that an Arabic translation is produced on request.
Inclusion of the unique tax registration number (TRN) on all correspondence and transactions this will be essential for the operation of the VAT scheme, particularly in relation to the reverse charge mechanism, under which you would expect the sales invoice to state the TRN of the recipient for VAT purposes.
Various obligations in relation to updating information held by the Federal Tax Authority (FTA), to correct incorrect information, and to pay.
The Law also sets out the penalties for breach. Deliberate failure to pay tax, and types of tax fraud (such as deliberate understatement of liability and false records), may be subject to a custodial sentence and a fine of up to five times the amount of the relevant tax liability.
Tax evasion is subject to the same penalties, and any person who is directly involved or instrumental in the tax evasion may also be subject to penal sanction and is jointly and severally liable with the taxpayer for the tax due and any administrative penalties. Tax evasion is defined as the use of illegal means resulting in lowering the amount of tax due, non-payment of tax due or a refund without any entitlement. As in all jurisdictions, the divide between lawful tax avoidance and illegal tax evasion will be subject to close scrutiny.
The Law sets up a Tax Disputes Resolution Committee. The scope of jurisdiction of this Committee includes to rule upon disputes concerning any decision of the FTA on tax liability. Any request for a ruling from the Committee must be submitted within 20 business days of receiving notification from the FTA of its decision on tax due. The Committee has a maximum of 40 business days to reach a ruling. The rulings of the Committee will be final if the disputed amount is up to AED 100,000 (other than in limited circumstances). Above that threshold, the ruling of the Committee may be appealed to a court within a further 20 business days, but only if the Committee has first ruled on the dispute.
The Law also specifies a limitation period on tax audits by the FTA. This has been set at five years from the end of the relevant tax period, other than in the case of tax evasion or non-registration. This will be particularly relevant in M&A transactions in the context of the appropriate time limitation on any tax warranties and covenants given by the seller to the buyer.
Saudi Arabia the story so far
The KSA government has brought into local law the GCC Framework Agreement and the law on excise duty.
In relation to VAT, the KSA is ahead of the UAE. To date, the KSA has passed into law the KSA VAT Law on 1/11/1438 (corresponding to 24 July 2017). A draft of this Law was published by the General Authority of Zakat and Tax (GAZT) in May 2017. However, the final form of the Law is simpler than the draft as originally published, with much of the detail deferred to the KSA VAT Implementing Regulations.
A draft of the KSA VAT Implementing Regulations was published by the GAZT on 19 July 2017. It is available in dual language on the GAZT website.
The following are some of the key points we can take away from the draft:
Not 1 January 2018 for everyone - there will be a one year grace period for VAT registration for any person whose annual turnover of VATable supplies is between SAR 375,000 and SAR 1 million. The deadline for VAT registration for these smaller businesses is 1 January 2019, although they may voluntarily register before this date. This is a helpful adjustment period for companies with fewer resources, and to also enable the GAZT to better manage volume registrations.
Registration timeframe any KSA entities which have an expected annual turnover of VATable supplies next year of at least the mandatory registration threshold of SAR 375,000 must register by 20 December 2018 (subject to the grace period mentioned above for smaller businesses). Otherwise, KSA businesses are required to assess their likely annual turnover on a monthly basis and register within 20 days of the end of the month in which they assess that their annual turnover is expected to exceed the mandatory threshold. They will be expected to charge VAT with effect from registration, or 1 January 2018 for larger businesses and any smaller entity opting to register before the end of the year.
Business transfers the KSA VAT Implementing Regulations carve out transfers of a going concern (TOGCs) from the scope of VAT, subject to certain conditions. In other words, when a sale of a complete business occurs, VAT is not chargeable on the value of the individual assets comprised in that business. The conditions include that an entire economic activity is transferred and is carried on in the same way by the buyer immediately after the transfer. An interesting further condition is that both seller and buyer must agree to treat the transfer as a TOGC. This differs from the UK VAT regime where a business sale is either a TOGC or not, as defined by law. The KSA approach suggests that the default position is that VAT is levied on the relevant assets if an agreement cannot be reached between the parties.
Zero rating and exemptions the KSA government has signalled the following concessions on which it had a choice under the GCC Framework Agreement:
If you would like further information on any issue raised in this update please contact:
Ray Smith Partner T: +44 20 7876 6145
Phil O'Riordan Partner T: +971 4 384 4580
Justine Reeves Head of Knowledge T: +971 4 384 4251
Clyde & Co LLP PO Box 7001 Level 15, Rolex Tower Sheikh Zayed Road Dubai, United Arab Emirates T: +971 4 384 4000 F: +971 4 384 4004
Clyde & Co accepts no responsibility for loss occasioned to any person acting or refraining from acting as a result of material contained in this summary. Clyde & Co LLP is a limited liability partnership registered in England and Wales. Regulated by the Solicitors Regulation Authority. Clyde & Co LLP 2017
certain financial services, including:
the provision or transfer of life insurance and reinsurance
issues or transfers of equity and debt securities and bearer instruments
other than services for which the consideration is a fee, commission or commercial discount, which services will be subject to standard rate VAT. For example, although the provision of a life insurance contract is VAT exempt, the broking of life insurance for a commission will attract VAT at 5%;
residential leases and licences note that it does not appear that any concessions are given in the KSA VAT Implementing Regulations in relation to the grant, transfer or surrender of other real estate interests (residential or commercial). So, the sale of a residential freehold interest by a taxable person will be subject to a standard 5% VAT charge, in addition to fees associated with the transfer. This will affect the sale price of residential properties bought from a developer, or potentially from a corporate landlord. It should not affect sales of residential property by private individuals (who, generally, would not be conducting an economic activity independently for the purposes of generating income and therefore not a taxable person). In addition, GCC citizens are granted an exemption from VAT registration in relation to houses built for private use.
Zero rate -
International transport of goods
International transport of passengers by certain means and against a published schedule
Services incidental to the international transport of passengers so airside services, etc
Medicines and medical equipment these are required to be zero rated under the GCC Framework Agreement. However, the KSA government has specified conditions related to this supply for the concession to apply in particular, that a prescription must be issued by an authorised prescriber, and the prescription must be for personal use. The medicines subject to this concession will be specified in a list by the KSA Ministry of Health, and medical equipment by the KSA Food and Drug Agency.
Note that there are no concessions set out in the draft KSA VAT Implementing Regulations for education or health services (other than drugs and equipment). Therefore school fees and doctor/hospital charges will be subject to VAT at the standard rate.
VAT under pre-existing contracts VATable supplies made pursuant to a contract entered into before 30 May 2017 and which does not provide for the treatment of VAT under its terms may be zero rated by the supplier. This is a concession to the default position that VAT is included in any prices quoted. The default position is disadvantageous to the supplier because it reduces its profit, and it is not in the customer's interest to agree to a variation which otherwise results in a 5% price rise. The concession will apply only to supplies of goods or services made from one business to another (B2B supplies), where the customer may reclaim the input VAT and provides a certificate to this effect to the supplier.
The effect of this measure is that VAT will not be chargeable in addition
to the quoted price until the final supply to the end consumer. This concession
ends on the earlier of the contract expiry and 31 December 2022, thereby
allowing 5 years for businesses to adjust any long term contracts. How this
concession will apply to cross border supplies where the reverse charge
mechanism applies is not clear.
J393914 - August 2017