In the last series, I had written about GCC members discussing about the VAT framework for member states which in all likelihood could include:
- Each member have its own VAT law and common rules on VAT
- Simultaneously implementation of VAT in all GCC member states
- Initial VAT rate of 5% with certain goods exempted from VAT
I had also stated that VAT system ensures that the tax is neutral, regardless of the number of transactions and hence it is not really inflationary in nature.
Designing an efficient VAT regime
If we look at the international experience in VAT implementation, the VAT is paid on a net basis on the difference between sales and purchases (of inputs) and there should be no break in the VAT chain (through exemptions) to avoid tax cascading. Another notable feature of VAT implementation is the ‘destination principle’ which means that goods and services are taxed for VAT only in the jurisdiction where they are consumed.
The success of VAT rests on ease of rolling out, managing the implementation and generation of revenue for the State. The collections from VAT depend primarily on self-assessment of taxes by taxpayers and an effective monitoring of tax compliance. A simple design of the VAT would help reduce the compliance burden on tax-payers. Based on international experience, it can be stated that four factors that are critical for successful implementation of VAT include rate and structure, the base, registration thresholds and exemptions.
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Evidence from countries that have implemented VAT shows a strong support for a single VAT rate. Multiple VAT rates lead to administrative complexities and gains are insignificant. In majority of countries that have implemented VAT, the VAT system is of the consumption-type, destination based, and implemented through the invoice-credit mechanism. In such a scenario, VAT is charged on sales invoices of registered taxpayers, a tax credit is allowed for VAT charged on inputs, and the VAT tax is applied to all imports while exports are zerotaxed. Accordingly, the VAT registered suppliers can claim tax credits/refunds on VAT paid on purchases of inputs.
If we look at EU member states, the following transactions are subject to VAT:
The supply of goods by a taxable person within the territory of a EU Member State
Intra-Community sale(An individual or entity from EU member state sells goods to another individual or entity in another EU member state)
The supply of services if the recipient is established within the EU
The importation of goods from outside of the EU
We can expect GCC countries to follow similar principles when introducing VAT.
VAT on exports
In the EU, VAT is applied to goods imported into the EU and this will be payable at the time and place of import. Exports (of goods to countries outside the EU member state) will not be subject to VAT (generally zero-rated). We can expect GCC to adopt policy similar to EU while applying VAT on exports.
Case study
Export to another GCC member
If a UAE – based company exports goods to a VAT registered company or individual in Saudi (GCC member state) then VAT is not collected by the UAE company as it is an intra community sale and is subject to zero VAT rate. The buyer in Saudi will report the applicable VAT, pay VAT to Saudi VAT authorities at the applicable VAT rate and take input credit on VAT paid. However, If the buyer in Saudi is not VAT registered in Saudi, then the UAE-based company will charge VAT in UAE from the Saudi buyer, even though it is intra-community trade.
Export to outside GCC member
If a UAE – based company exports goods to India, non GCC member state, the UAE exporter will show shipment as outside GCC member state and will export at zero VAT rate. In this case UAE – based company does not have to bother whether the buyer in India is VAT registered or not.
Temporary transfer of goods to another GCC member state
In case of EU, when a company temporarily moves its own goods from a EU member state to its own warehouse in another EU member state, with no intention of selling the goods to a third party on arrival, it is effectively treated as an intra – community transaction. The company that exports goods will pay VAT at the destination country (it will have VAT registration in destination country) and can claim input credit on VAT paid in subsequent sale. I would expect the GCC law to be similar to EU.
Installation, delivery and assembly in another GCC member state In
In case of EU, there are exceptions in case of delivery of goods that are subject to assembly or installation in the buyer’s country in another EU member state. If the buyer requires an assembly or installation of the goods, the acquisition is not subject to VAT. In such cases the supply (including installation) is deemed to have been made in the country where the goods are installed and is subject to VAT in that country. In this case, the liability on VAT payment shifts from the seller to the buyer. The buyer will be responsible to pay VAT and seller need not have to have VAT registration in the country where the item was delivered and installed.
Chain transactions
There can be situations where transaction can happen between more than two EU member states in many permutations. I shall cover this in detail subsequently.
Also Read : DEMYSTIFYING VAT Series 1 – VAT Basics
Deciding threshold for VAT
In the initial phase of VAT implementation, usually there is a tendency on the part of governments to set a high VAT threshold. Such situation though results in reduced administrative and compliance costs will lead to competitive distortions arising from the difference in treatment among taxpayers on the two sides of the VAT threshold. Many countries tend to address these distortions by allowing voluntary registration for tax-payers below the VAT threshold, and/or the application of a presumptive tax on companies falling below the VAT threshold.
VAT and Inflation
I believe the impact of VAT on inflation to be limited. Since VAT does not have cascading effect its maximum direct effect on the prices should not exceed the tax rate. Additionally, in GCC we can expect the zero VAT rate and/or exemption of certain groups of goods/services would reduce the inflationary impact.
Conclusion
For the GCC members, VAT is an effective tool in raising revenue to achieve government’s social objectives whilst preserving the neutrality for businesses. If Tax in UAE is designed and implemented correctly, it can provide significant revenues to the government in the UAE, with limited administrative costs and insignificant impact on business and marginal impact on end consumers.
