By now most of you must be aware that the government will be implementing VAT in UAE (value added tax) from Jan-2018. The rate of VAT would be about 5%. Amongst the GCC member countries, UAE is not alone to go ahead with implementation of VAT.Other GCC members have also agreed to implement the VAT around the same time as UAE. I plan to share with our readers through our quarterly newsletter about various aspects of VAT rollout in the UAE as it unfolds.
In this Series, I begin with basic outline of VAT and in subsequent issues will be covering the regulatory and procedural aspects of VAT, similarities and differences between the VAT that is implemented in EU versus what is being unfolded in the GCC and the UAE, impact of VAT on certain categories of business, notably the gold business in the UAE and lastly a VAT primer which will help our clients to transition to VAT regime with ease.
VAT in simple terms is:
A tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the provision of services
A consumption tax because it is borne ultimately by the final consumer
Charged as a percentage of price (in UAE it will be 5%), which means that the actual tax burden is visible at each stage in the production and distribution chain
Collected fractionally, via a system of partial payments whereby taxable persons ( VAT-registered businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities. This mechanism ensures that the tax is neutral regardless of how many transactions are involved
Paid to the revenue collection agency of the government by the seller of the goods, who is the “taxable person”, but it is actually paid by the buyer to the seller as part of the price. It is thus an indirect tax
As of now, the GCC countries such as Saudi Arabia, UAE, Qatar, Oman and Bahrain do not have VAT or sales tax as part of their indirect tax kitty. The indirect taxes currently levied by these countries include customs duty (GCC), excise duty (GCC) and in some cases tourist/ hotel tax and few other indirect taxes. In the UAE only customs duty is levied on CIF value of import of goods which varies based on the nature of goods imported and averages to about 5%. One of the key reason for the GCC countries to implement VAT is to converge with the international tax regime on indirect taxes and be in line with the suggestions of the IMF.
The other key motivations for the GCC countries to implement VAT is to help improve revenue side of the respective countries’ budget, provide cushion against volatile hydrocarbon pricing and as a consequence bring stability to non-oil revenue. For the UAE government the revenue from VAT is expected to about AED10 billion to AED12 billion in 2018, according to the Ministry of Finance. The introduction of VAT can also be expected to improve the ratio of non-oil to oil revenue from the present ratio of 1:2.
The history of VAT began in Europe in the 50’s. VAT was first adopted by France in 1954. By the 1990’s VAT had been adopted throughout the European Union and in many countries in Africa, Asia, and South America. At present, over 150 countries have included VAT as part of their indirect tax collection. About 70 countries in Africa and Asia have implemented VAT. However, one may note that two notable exceptions are the USA and Canada which have not implemented VAT. VAT as stated earlier is a consumption tax, as it is a tax on commodities purchased, ultimately for consumption, rather than on the income of an individual or corporate entity.
The idea behind the VAT is that each step in the production chain pays a tax on how much value it added to the product. It is a levy on the amount a business adds to the price of goods during the stages of production and distribution. The tax is levied on the value added to the product at each stage of its manufacturing cycle as well as the price paid by the final consumer. Commonly, the seller at each stage subtracts the sum of taxes paid on items purchased from the sum of taxes collected on items sold; the net tax liability due to VAT is the difference between tax collected and tax paid.
VAT is collected by the tax credit method; each firm applies the tax rate to its taxable sales, but is given a credit for VAT paid on its purchases of goods and services for business use, including the tax paid on purchases of capital equipment under a consumption-type VAT. As a result, the only tax for which no credit would be allowed would be that collected on sales made to you and me as individuals, rather than to business.
Let me illustrate the mechanism of VAT with a simplified transaction involving production, processing and sale of Dates to end consumer. I have chosen VAT rate of 10% (UAE VAT would be 5%)
Many economists believe that VAT is a regressive tax and impacts the lower income people harshly. Countries that have implemented VAT have learnt from their experience and have come up with improvements that lighten the burden on lower income people. As a consequence in many countries, necessities are often taxed at a lower rate than luxury items. Advocates of the VAT contend that it is an efficient method of raising revenue. In the UAE the proposed VAT rate of 5% from 2018 would exempt education, healthcare and about 94 common consumption food items.
I believe that the competitiveness of the UAE as preferred destination for global business entities would not be affected by the implementation of VAT. However, in the case of few businesses such as gold trade in the UAE, there may be a marginal impact on trade volumes though this may need further analysis. I shall be covering such select aspects subsequently in my series of writings on “Demystifying VAT.”
This article was originally published in Kreston Menon April- June 2016 Newsletter.
