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VAT in the UAE – Outlook

Guiding Principle
The UAE and the other member states of the Gulf Cooperation Council (GCC) are planning to introduce Value Added Taxes (VAT) by 2018. An Outlook:

A. Background
The International Monetary Fund (IMF) has recommended for years that the GCC member states introduce VAT and for quite a few years, there have been similar talks here in the UAE. Up until now, as we all know, no VAT has been introduced in the UAE. The reason can be found in the general economic and political situation in the Gulf throughout the more recent past. For quite a long time the oil price has been comparatively high while the Arab Spring has seen a number of long-standing political leaders being toppled by their respective people at the same time. Hence, while the economic pressure of introducing VAT was low, given generous income that was generated by very lucrative oil sales, the political pressure not to introduce anything that is likely to be less than popular with the people was high.

The recent boom in shale oil and gas production that has led to significantly lower oil prices, and presumably also the aftermath of the Arab Spring have changed matters dramatically, however. Even some of the GCC member states are now struggling to contain their budget deficits. The exploration of new sources of income, such as the introduction of VAT, has suddenly become more of a priority.

B. What to Expect
Up until now, not too much information on the details of how VAT will be introduced has been made publicly available. VAT is expected to be introduced starting 1st January 2018, and the VAT rate is likely to be set at 5%.

Even without more detailed information being available, however, the introduction of VAT is likely to have a significant impact on the UAE economy, which most probably will reach far beyond the fact that products and services will become more expensive.

   I. Businesses as Tax Collectors
One of the corner stones of the VAT system generally is that VAT is a tax that is collected by businesses, as opposed to being collected directly by the government. Businesses are required to add the appropriate amount of VAT to their invoices and charge their customers accordingly. Subsequently, businesses are required to pay all amounts of VAT charged to the UAE Federal Tax Authority. While it is not yet clear how the UAE’s VAT system will be structured in detail, in most jurisdictions applying VAT, businesses are required to pay to the tax authority the total amount of VAT they have charged their customers with in regular intervals. This applies even if corresponding payments from their customers have not been received. In practice, this may very well mean that a business will have to front VAT for its customers. This, in turn, may create a significant burden on a business’ cash flow, which should not be underestimated. Hence, businesses are well advised to use the time up until 1st January 2018 to create additional cash reserves in order to prepare for the likely impact of VAT on their cash flow.

   II. VAT Tax Credits
In most, if not all jurisdictions that levy VAT, businesses can offset the VAT they have paid for business related expenses from their VAT liability towards the tax authority. The purpose of this general rule is that VAT should ultimately only be paid (in a sense of being paid without option to reclaim such VAT) by the end-consumer.

Some businesses, such as those who operate in a low margin environment with comparatively high production costs, are even likely to generate tax credits in a sense that the amount of VAT such businesses have paid for their business related expenses is higher than the amount of VAT they have charged their respective customers. Such businesses would usually qualify for a tax credit from the tax authority.

In practice, administering such tax offsetting / tax credit regime requires a tax authority to employ experienced personnel that can rely on guidance on which expenses exactly qualify as being “business related” (and hence, tax deductible). Needless to state that businesses will have a significant interest in having ideally all their expenses recognized as being “business related” in order to minimize their tax burden.

In the UAE, as in any other jurisdiction introducing a VAT system, it is rather questionable whether the UAE Federal Tax Authority (being a newly created authority) will have the benefit of experienced personnel and/or reliable guidelines. This, in turn, will almost inevitably result in a certain period of time during which businesses will have comparatively little certainty as to which expenses are acceptable and which are not. Similarly, it is likely that those businesses who qualify for a tax credit will have to wait longer for their cheque from the tax authority than they would in other jurisdictions where VAT have been levied for a longer period of time.

This, too, is likely to create uncertainty and uncertainty is generally not good news for businesses.

   III. Traceability
Another possible impact of the VAT system that should not be underestimated is traceability. Up until now, the commercial activities of businesses in the UAE are subject to relatively little governmental control. The introduction of the VAT system is likely to change this dramatically.

As briefly described above, businesses can decrease their tax burden by offsetting VAT they have paid for business related expenses from their VAT liability towards the tax authority. This is done by presenting all relevant invoices to the tax authority. Presenting such invoices, however, means that the tax authority will be able to trace who is doing which type of business with whom. Hence, the commercial activities of a commercial entity become the subject of governmental scrutiny.

The commercial reality in the UAE is such that it is not uncommon that probably a comparatively large faction of all businesses does not 100% comply with all applicable rules and regulations. The reasons for this are manifold:

An increasing number of authorities in the UAE, the regulations of which quite often interfere with one another, are leaving those who are supposed to be governed by such regulations somewhere in between;

Unawareness of legislation, a large part of which is still often treated as being of a “confidential” nature; or simply certain customs that, while never having been “legal” in a strict sense, have never faced serious governmental investigation, such as free zone entities doing business “onshore”, for example.

In light of the above, it should be expected, in the medium term at least, that UAE authorities will take a closer look at UAE businesses’ commercial operations. Hence, at the very least, UAE businesses should expect significantly more interactions with various authorities.

C. Conclusion
As mentioned before, not many details of the proposed VAT system have been made public, so none of the above is certain to occur. However, the purpose of this article is to demonstrate that the introduction of VAT in the UAE is likely to have much more of a practical impact than just making goods and services a little more expensive.

Bottom line, we strongly encourage our clients to carefully follow all VAT related developments and to gauge the possible impact on their businesses.

January, 2017 Dr. Michael Krämer
Meyer-Reumann & Partners, Dubai Office
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