Has VAT been a taxing experience?

20 February 2019
VAT regimes require consistent investment from the government to ensure full compliance
By Joanne Clarke, VAT tax director at Pinsent Masons

The introduction of VAT is just one of the many fiscal strategies that will enable the UAE to achieve its medium to long-term objectives to become an economic powerhouse and word-class business hub.

A VAT system by its nature is a flexible tool for governments to regulate their annual budgets, contributing to higher revenue intake and a healthier ability to influence economic growth. This is evidenced in numerous OECD, IMF and domestic Central Bank financial and economic reports. These indicate significant increases in tax-to-GDP ratios as a result of the introduction of a new VAT regime and/or the fluctuation of rates within mature regimes.

The UAE and indeed the GCC’s rationale for the introduction of VAT, together with the related revenues it hopes to generate, give some context to our consideration of whether it has impacted activity in the region, and in particular the construction industry.

VAT has the essential characteristic of an economically neutral tax—ie, it flows through businesses and tax supplies to final consumers. Once a new VAT system has been introduced and businesses have adjusted, VAT should not be a direct cost for businesses and careful management of associated compliance, cash flow and administration costs should limit the indirect impact. Associated inflation is also generally short lived.

For a VAT regime to be successful in its aim of neutrality for businesses, and therefore limit the impact on trade, there are a number of key contributing factors: the VAT rates and structure; VAT thresholds and phased introduction; administration of the system; and exemptions.

Transitional challenges

If we look at these in the context of the construction industry, they give us a clearer picture of some of the challenges that businesses may have faced during the first year of implementation in the UAE and Saudi Arabia, and the resulting impact on the industry across the region.

For such an important, high-value sector, the application of a considerably low rate of 5 per cent was crucial in aiding the industry to adjust to this new demand on working capital. Also, the implementation of a simple VAT system was tactical in supporting comprehension and early adoption, especially in the UAE where businesses did not historically have experience with federal tax regimes.

With the thresholds for delayed/voluntary registration rarely applicable to players in this sector, transitional transactions were a key area of dispute for businesses, with the transitional rules in VAT law providing little relief from the commercial challenges faced. However, the application of (differing) exemptions/zero-ratings for bare land and residential properties in the UAE and Saudi Arabia, can be a fairly complex concept for businesses in the real estate sector.

As in all markets, when new regulations are introduced there can be confusion around scope and clarifications are always required. It is extremely difficult to prevent such misunderstandings. Consequently, some of these challenges are likely to be replicated in other GCC countries, particularly as other nations, such as Bahrain, will introduce their own rules for exemption/zero-rating to construction services and the real estate industry. Generally speaking, exemptions can challenge the healthy functioning of a VAT system.

Conclusively, increased costs were created for businesses in a number of areas (such as irrecoverable VAT associated with exempt supplies—bare land and residential, cash flow burden due to large refunds pending from the tax authorities on up-front costs of construction, and so forth), which placed short-term additional pressure on the sector.

However, these are expected costs of implementation for businesses, which would have been considered by the UAE in its decision to implement VAT in the region.

Settling in

As with all VAT implementations across the globe, this impact is mitigated over time as businesses adjust to the new regime, communications with and clarifications from the tax authorities become more fluid, refunds are settled quicker and the region adjusts to the revised pricing. The pace of adjustment will be wholly dependent on the increased ease of administration, the application (and level) of penalties post audit and the frequency of changes to the VAT regime over time.

VAT regimes do not sleep and are known to continuously evolve and develop over time. It is an area that will require consistent investment from the government and the construction industry alike to ensure a smooth transition and full compliance.

Joanne Clarke is the VAT tax director at Pinsent Masons

This article is extracted from a report produced by MEED and Mashreq titled Regulating Construction: Adapting to New Standards. Click here to download the report

To know more about the MEED Mashreq Partnership, get in touch with us at MEEDMashreqPartnership@meed.com or find more info on www.meedmashreqconstructionhub.com

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