A perfect storm comprising low government fiscal revenues due to persistent low oil prices and the need to fund very ambitious economic growth plans leaves regional governments with little option but to adopt taxation.

“If pumping more oil or injecting cash are untenable long-term alternatives, then taxation offers a credible alternative [to grow top line revenues],” suggests US consultancy Deloitte.

The Washington-based IMF has openly suggested in recent reports that Saudi Arabia and the UAE in particular must adopt fiscal reforms, among them the introduction of value-added tax (VAT) in addition to removing energy subsidies, if they are to address gaping revenue gaps, which will become apparent starting this year.

The introduction of VAT, among other forms of direct or indirect taxes, is also considered by Deloitte as the most rational option since it is more efficient, cheaper to operate, less open to fraud and less likely to distort investment decisions by businesses.

VAT, which usually starts at 5 per cent, is levied on consumption. As such, it disincentives excess consumption, but unlike corporate or personal income taxes, does not disincentive private sector investment. Governments do not want to generate revenue at the expense of investment by the private sector, according to Deloitte.

The firm acknowledges that the introduction of VAT will not sit well with the tax-free branding of most GCC states, particularly among consumers. It also adds that VAT is regressive in that in relative terms, it affects those on a lower income more than those on a higher income, even though those earning more would be affected more in absolute terms.

However, certain mechanisms can be put in place to temper the regressive impact of VAT, such as exempting certain goods from taxation. When properly implemented, Deloitte argues that a VAT-based tax regime not only presents an additional long-term revenue source for governments, but could also put the brakes on excessive spending. This will enable governments to achieve other ambitions such as reducing carbon dioxide emissions and other green initiatives.

“Implementing such a tax does appear to be an appropriate approach, given the range of needs that need to be balanced,” says Stuart Halstead, indirect tax leader at Deloitte Middle East. “Policymakers do not necessarily want to trade any economic growth for public revenues, but if you have to do it, VAT is more likely to offer more bang for its buck.”

The introduction of VAT also engenders changes in the back-end systems of businesses, which are put in charge of charging and collecting the VAT and remitting these to the government at agreed times.

These changes range from analysing the impact of VAT on demand for goods and services, and competitor responses, understanding VAT registrations obligations, to revising or updating enterprise resource planning (ERP) or other financial systems to ensure they can cope with the charging and recovery of VAT.

In May this year, MEED reported that GCC officials had adopted a draft agreement to implement VAT. Each GCC member agreed to issue a separate VAT law that includes the principles of the draft agreement. At the time, no timetable was given for its implementation, with the UAE set to be the first to press ahead.

Two months later, in July, the UAE government announced drafting laws that will look to implement a new taxation system. This development seems to indicate the government has overcome its reluctance to unilaterally adopt VAT-type taxes for fear of hurting its competitiveness in the region.