The introduction of value-added tax (VAT) in the GCC could create operational and financial risks for companies and cash flows could come under pressures some industries as markets adjust, according to Fitch Ratings.

The governments in the GCC have agreed to levy VAT at the beginning of next year, which would create a very tight timetable in a region with little history of taxation of any sort, the rating agency said in its latest report, adding that uncertainty and operational challenges are expected to be more severe for GCC corporates than for companies in other regions with established tax cultures.

The GCC countries have already agreed to implement selective taxes on tobacco, and soft and energy drinks last year. Boosting non-oil revenues has been a priority for the GCC monarchies which have felt the financial squeeze after the prices of oil fell from mid-2014 peak of $115 to below $30 a dollar last year. They have recovered to $55 level since then. The governments had to run austerity measures and most have introduced plans to radically reform economies to cut dependence on oil. 

Withdrawing subsidies, spending cuts and introducing and increasing fees and taxes are part of the measures to control expenses and increase revenues.

Fitch said that collecting and remitting VAT to the government will also have notable set-up and compliance costs, and within highly competitive sectors or those with thin margins, companies could face cash flow problems from having to meet the cost of paying VAT on purchases before it can be reclaimed.

“Fierce competition in some sectors may also put pressure on companies to cut pre-tax prices and absorb some of the cost themselves. This is most likely in sectors like telecommunications, consultancy and contracting and will vary by country,” according to Fitch report

The need to renegotiate previously agreed contracts and conditions with customers would pose additional challenges in some industries. The introduction of VAT, alongside other government initiatives to cut spending, could also reduce disposable incomes, weakening demand in more discretionary corporate sectors.

The main long-term risk from the introduction of VAT is the potential for errors in collecting and accounting for the tax that could leave companies liable for the cost themselves. This impact will not be clear until each member state establishes its own national legislation to enact the agreement, which could make the timetable even tighter.

“We believe the lack of any significant historical taxation means it will take time for companies to fully pass on costs, but that they will be able to do so eventually,” Fitch said. “However, we expect GCC governments to recognise these challenges and show a degree of flexibility during the initial implementation.”

The additional cost including staff training update or replacement of IT infrastructure is liable to hurt businesses as well.

“This is particularly burdensome as it will add to costs when low oil prices and lacklustre economic growth are weighing on corporate performance, particularly for SMEs,” Fitch said, adding that companies involved in supplying goods and services between the six-member economic bloc, or those operating within or between free zones, are likely to face additional complexities, as agreements between individual GCC members could vary.