Learning the value of VAT

08 August 2008
The introduction of value added tax in the UAE next year could set a precedent for the rest of the GCC, but retailers and consumers have less to fear than they may think.

Gulf consumers feeling the pinch at the checkout could be excused a collective groan on hearing plans for the introduction of a GCC-wide value-added tax (VAT). While cosseted from punitive sales taxes, the average Gulf resident has still born the brunt of sharp increases in the price of goods and services over the past couple of years, so shoppers may feel they are being unfairly punished.

GCC leaders are seeking to introduce VAT across the six member states in 2012 and this could pave the way for other taxes in the Gulf. Plans are also being considered for a new, 100 per cent tax on luxury goods such as private planes, yachts and top-brand cars.

“To make VAT fair, a number of luxury goods will probably be taxed at a higher rate than goods consumed by low and middle-income consumers,” says Abdelaziz Aluwaisheg, director of the GCC economic integration department, on the GCC’s tax plans. “The exact list and the rates are yet to be decided.”

The UAE will be the first Gulf state to introduce VAT when it brings in a 3-5 per cent rate in 2009. Such a low rate should help to calm anxious consumers, but its intro-duction still represents a significant cultural shift for the federation, ending its status as a ‘tax-free’ haven.

Federal divisions

However, GCC-wide VAT and luxury tax rates are not a foregone conclusion. The UAE’s VAT programme is already causing divisions between government bodies. Whereas Dubai Customs is pushing strongly for the new revenue-raising measure, there are reports that the federal Economy Ministry has objected to the plans because of concerns that they would jar with existing free-trade pacts between the GCC states. Some at the federal level may feel Dubai is interfering in a matter of federal jurisdiction.

The VAT issue goes beyond concerns over territory. It is intrinsically linked to the changing regional trade regime. An indirect tax on goods and services is designed to replace customs duties of 5 per cent, which the UAE is obliged to phase out as part of the free-trade agreements it has struck with key trading partners. VAT would offset the loss of earnings once the trade agreements take effect.

Other Gulf states will be closely watching the UAE’s progress. Oman has already hinted that it could opt for VAT. Without the fiscal resources of the UAE, it perhaps has a stronger incentive to do so.

The positive benefits of VAT in diversifying state income streams will soon outweigh concerns over their effect on retail sales. “As the tax will only be levied at a 3-5 per cent rate, it will have a negligible impact,” predicts Mary Nicola, senior economist at Standard Chartered bank in the UAE. “Look at Europe, the average is 17-20 per cent there.”

The International Monetary Fund (IMF), which has lobbied long and hard for VAT to be introduced in the Gulf to widen sources of revenue, says the inflationary impact of the new tax will be limited to a couple of percentage points at most.

Major retailers appear sanguine about the impact of VAT on retail sales. Francis McAuley, international director of UK retailer Debenhams, says VAT will not make a material difference to sales if Gulf states introduce it at a low rate, but adds a caveat for Dubai. “Most shoppers in Dubai are people coming specifically to shop there, so purchases are discretionary,” he says.

Minimal impact

The relatively calm reaction among retailers indicates that the UAE has yet to fully register the possible ramifications of VAT. “Inter-national retailers are familiar with VAT as a concept and a very low VAT rate is likely to have a minimal impact on retail prices, especially as reductions in customs duty are proposed,” says David Stevens, indirect taxes leader at accountant PricewaterhouseCoopers Middle East.

Stevens says there is a general lack of awareness on the subject or engagement with it from businesses. “Indeed, it is possible that retailers could find that the reductions in customs duty may be sufficient to fully offset a very low VAT rate if they occur simultaneously,” he notes.

The UAE authorities are aware of the risk of introducing VAT at an inopportune moment in the economic cycle. Although they claim the delay in introducing the tax is due to structural and technical issues, it is likely that they have postponed the introduction of VAT from its original planned start in the first half of 2008 to allow inflation to subside.

“Introducing VAT at a very low rate makes a lot of sense for the UAE, especially in the current inflation environment,” says Stevens. “Any impact on retail sales will be temporary and will depend on consumer attitudes and retailer pricing responses to the VAT effects.

“The drivers of retail sales growth, such as rising incomes and wealth, a competitive and expanding retail sector, plus increasing tourism and population growth, will not be affected by a low VAT rate. Also, small retailers will not be required to register for, or charge, VAT.”

Small businesses with revenues of less than $1m are likely to be exempt. But there is a possibility that distributors may seek to exploit the new tax with significant mark-ups on goods. Many retailers could be forced to pass on these additional costs to the consumer, providing an added pinch at the checkout till.

Mitigating effects

In terms of sectors, international experience shows that durable goods are more likely to be affected by VAT than others, but that with a very low rate, any impact will be minimal and short-lived.

Furthermore, retailers can do much to mitigate any adverse impact on sales. “Retailers, like other businesses, need to effectively plan for, and efficiently implement, the required VAT changes,” says Stevens. “They should start this process now and include assessing the cost and price effects, and through this the competitiveness, for their business, in addition to the systems and process changes that are necessary.”

One important issue, says Stevens, is a ‘tourist refund scheme’, which allows foreign visitors to claim back tax paid on goods. He says retailers should seek to participate in and advertise this to their customers if they rely heavily on tourist sales. This is particularly appropriate for Dubai, which has a significant number of foreign visitors to its malls.

Concerns that VAT is only the thin end of a potentially burdensome tax wedge may be hard to shift, even if they are overplayed. As VAT is really intended as an alternative to other forms of tax, its introduction may alleviate the need for other tax options, says Stevens.

“Moreover, as VAT is based on price, the higher the price, the higher the tax,” he adds. “Therefore, more expensive goods will yield higher tax anyway - this feature being one of the many advantages of a VAT scheme.”

Plans for a GCC-wide VAT are still in the gestation period. VAT has been approved only at the expert level and not by heads of state.

Aluwaisheg says the price effects of VAT will be negligible for two main reasons. First, as the project now stands, its introduction is proposed for 2012, by when most tariffs will have been eliminated by virtue of various free trade agreements under negotiation with trading partners such as the EU, China, Japan, India and Pakistan. As such, VAT will simply replace customs tariffs.

Second, the project calls for streamlining the tax structures. VAT will replace various ‘nuisance taxes’ currently being levied at great cost to businesses, consumers and governments.

The architects of a GCC-wide VAT are quick to downplay the likely impact on retail sales, but the real significance of such initiatives is the steady erosion of the region’s hallowed tax-free status - one of its key draws for expatriates and tourists alike.

The reality is that as the six-member bloc becomes more deeply entwined in the global economy, its ability to steer its own course will be circumscribed. Once introduced, VAT is likely to be here to stay - and consumers and retailers alike will have to get used to it.

Key fact

3-5 per cent: The proposed rate of VAT to be introduced by the UAE in 2009.

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