The UAE is well known as being a tax-free jurisdiction (save for a few specific sectors) and the benefits afforded by this tax-free status have played a significant part in attracting large volumes of foreign investment and talent to the region in recent times. However, that tax-free status is soon set to change with the introduction of a value-added tax (VAT) regime in the UAE from 1 January 2018. Given the additional financial and administrative burdens the tax will impose it would be prudent for businesses operating in the UAE, and in Gulf Co-operation Council (GCC) states generally, to start considering how their organisation might be affected and to start planning now for implementation day.
The New Regime
For some time the UAE and GCC governments have been exploring options for diversifying income away from oil revenues, including the introduction of tax regimes such as VAT and corporate tax. The need for diversification of revenue for countries whose economy is largely based on oil production (the UAE was the 7th highest oil producer in 2015) has been brought into sharp focus in recent times with the collapse of the oil price. The introduction of VAT has now been confirmed for 1 January 2018 for the UAE with the other GCC countries to follow, all to have implemented VAT by 1 January 2019.
Many of the details of the regime are not yet known. For example, the extent of cross-jurisdictional treatment (intra-GCC, international and between on-shore UAE and free zones) and the precise scope of the exemptions and reliefs available have yet to be revealed.
It is expected that a GCC common framework for VAT implementation will be agreed by June this year, effectively unifying the process across the region. Once the common framework has been agreed, we can expect UAE legislation to be enacted this year in good time for the UAE’s implementation in 2018. A great deal of work will be required from all sides before implementation; the government will need to establish a new tax administration system capable of overseeing the calculation, collection and inspection of the tax (no small task when starting from scratch); businesses on the other-hand will need to understand their obligations and the process for compliance, filing and reporting. The size of the task at hand is well understood by the government with the UAE Minister of State for Financial Affairs, Obaid Humaid Al Tayer, commenting at a joint press conference on Wednesday with the Managing Director of the International Monetary Fund (IMF) that “A lot of ground work needs to be done before implementing VAT. The private sector will need time to prepare for complying with tax rules that is the reason we are giving enough time for all.”
The rate of VAT to be applied has been confirmed at 5%, with exemptions on a number of staple food items and for healthcare and education. While the proposed rate is significantly lower than rates charged elsewhere (typically, European countries charge between 17-27% of value as a standard rate), the tax will generate significant extra revenues for the UAE Government, at Wednesday’s conference IMF Managing Director Christine Lagarde noted that “Even with a low tax rate of five per cent, with the introduction of VAT, it will not be difficult for GCC states to generate tax revenues up to two per cent to gross domestic product.” However, notwithstanding the relatively low rate, for many companies it will represent an additional burden and increase the overall costs of trading in the UAE for all. Companies establishing themselves in the UAE already have to deal with a significant amount of administrative red tape, which is usually off set by the other benefits of operating in a tax-free jurisdiction. Adding the further administrative burden of tax compliance will compound this and will need to be weighed up by each business to see where the balance lies and whether a UAE base is still an attractive option. While free zone companies in the UAE benefit from a “tax holiday” in relation to corporation tax and personal income taxes for employees (should they be introduced in the future), as VAT is an indirect tax they will not be shielded from its impact and will also need to start thinking about putting in place tax administration systems.
There will be businesses that have not previously dealt with the administrative nuances of tax compliance and do not have any institutional expertise or experience available internally to guide them through the process on implementation. For these organisations there is likely to be a steep learning curve, both for staff and management. In addition, effective tax compliance relies on robust internal financial accounting and reporting systems and audit processes which have not always been present in many businesses operating in the region. While the introduction of VAT in the UAE will certainly add to the administrative burden placed on these UAE businesses, it also represents an opportunity and incentive to review and improve financial accounting systems and processes and bring them up to international standards in companies that may previously have fallen short. More reliable standards of financial reporting across the region in turn may lead to greater market confidence.
Businesses will need to consider the VAT treatment that will apply at each stage of their supply chain; from paying VAT on supplies to charging VAT on sales. In particular, businesses should consider the following practical impacts of the implementation of a VAT regime:
- the impact on pricing and the corresponding effects this may have on customers and sales;
- creating internal processes to ensure that supplier invoicing and documentation is in the required format (i.e. the supplier’s VAT number and amount of VAT charged clearly noted) to enable the offset of VAT received from VAT paid (where possible);
- on the sales / supply side, it will be important to ensure a businesses’ own invoices and sales documentation are compliant with the relevant VAT invoices in order to avoid fines or penalties;
- internal systems, specifically in respect of record keeping, filing and payments are sufficiently robust to ensure compliance with the requirements of VAT returns;
- ensure the relevant staff and management are trained and fully acquainted with the requirements, including understanding exemptions and collection and payment processes. Depending on organisational familiarity with VAT systems, the level of work required to ensure a business is fully compliant may be significant and should accordingly be budgeted for well in advance;
- it may be worthwhile doing a dry-run test of a company’s VAT compliance systems ahead of implementation to ensure they are robust;
- existing business plans and opportunities may also need to be considered or revisited. For example, where significant capital purchases are anticipated in the coming years, where possible it would be prudent to consider whether such purchases should be made before the introduction of VAT; and
- where long term contracts are due to be entered, they should include mechanisms for price adjustment if VAT is required to be charged or otherwise deal with the possible change of law in this regard. Businesses will also need to consider or take advice on existing long term contracts that do not account for this potential change in law.
The introduction of VAT in the UAE is still a year or so away, but it is important that affected organisations are proactive and use the time available to get to grips with what will be required for their business and keep up to date with changes and regulations in order that the transition to taxation is smooth and that compliance costs are mitigated as far as possible. The introduction of VAT in a previously tax-free jurisdiction may also start to ring alarm bells for businesses in relation to corporation tax, which would likely be a much bigger disincentive for foreign businesses to base themselves in the UAE than VAT. For now at least some comfort may be taken from the Minister’s comments that “Implementation of corporate tax is not on our immediate agenda. We will study the impact of direct taxation on competitiveness before introducing such taxes.” However, that is also something to keep a close eye on.