Oman continues with tax system reforms

Parliament’s vote to raise corporate taxes in May 2016 is among the most significant financial developments in Oman in recent years. A low-tax environment is a key incentive to invest across the GCC, and the tension between drawing growth-promoting investment and maintaining state revenues has made such increases a contentious issue for decades.

The financial crisis of 2007-08 renewed the debate around taxation, but it was not until oil prices began a sustained fall in mid-2014 that GCC economies began seriously to consider a hike in corporate taxes. In Oman, the prospect of this drew closer in December 2015, when the Majlis Al Shura – the lower house of the Council of Oman – first voted to approve the hike. The upper house – the Majlis Al Dawla, or State Council – soon followed suit, making revision a near-certainty, though as of November 2016 no Royal Decree formalising this had been issued.

Proponents say the increase – from 12% to 15% – is relatively modest and brings the sultanate in line with other GCC economies. Saudi Arabia, for example, has a similar rate; Kuwait’s stands at 20%. Some estimate that, combined with a proposed removal of a tax-free ceiling of OR30,000 ($77,900), it will add OR125m250m ($324.6m-649.3m) to annual state revenues, a significant amount given the expected 2016 budget shortfall of OR3.3bn ($8.6bn). To reassure those concerned about stunted business growth after the vote, Saleh bin Said Masan, head of the Majlis Al Shura Economic and Financial Committees, clarified that SMEs with a capital investment of OR50,000 ($130,000) and an annual turnover of OR100,000 ($260,000) will pay only 3%, provided they meet Omanisation requirements.

Others suggest the net effect will be detrimental to the economy in the long term. Anchan C K, managing director of Muscat-based investment advisor World Wide Business House, questioned the timing of the move, telling local media: “It’s the right time to raise levels of confidence to enhance the business rather than making it stiffer and competitive.”

Focus Shift

The ramifications will become apparent over the course of 2017, but the taxation debate looks unlikely to end there. Much of the business community has already turned its attention to the next big tax reform in the pipeline. In October 2016, after years of mulling the issue, GCC ministers signed a framework agreement to introduce value-added tax (VAT) at a rate of 5%. Member states are now drafting local legislation, with the intention to start on January 1, 2018, after which they will have a year to fully implement the new tax. The precise timing of the rollout is for each country to determine, and details have not yet been published on which goods and services will be subject to the tax. However, there is little doubt that it will soon become a reality for Oman’s businesses and consumers. Assessing the effects on the national economy has therefore much preoccupied economic observers in 2016.

By the standards of many emerging markets, the 5% rate is modest. Egypt, for example, is preparing to introduce a VAT system, probably at a rate of around 10%. The average VAT in the advanced economies of Europe, meanwhile, is around 20%. However, Egypt can institute VAT largely as a transition from its existing sales tax, which Oman lacks. Adopting a similar framework from scratch will require businesses to make significant adjustments.

Potential Benefits

Fiscally, there is a strong case for departing from the low-tax paradigm that has dominated Oman’s economic policy since its creation as a modern state. More than 150 countries have adopted a VAT system, bringing in around 20% of state revenues on average, according to the IMF. The proposed 5% levy for the GCC will come nowhere near that level, but may still be substantial. Accounting firm EY calculates that the government stands to earn OR250m ($649.3m) per year, about 1.4% of GDP.

Other gains would be less visible but still profound. VAT is by nature broad-based, and is simpler to implement than other indirect taxes. By targeting consumption, it reduces opportunities for tax evasion, to which a simple sales tax is vulnerable. Because it is collected in small fragments at numerous stages of production and distribution, its burden on consumers is mitigated. Last, by not taxing business inputs it avoids “cascading” – whereby a good is taxed more than once as it progresses from production to final retail – thus removing the pressure for businesses to vertically integrate in order to avoid the added cost on inputs to production processes.

Challenges

While the official GCC-wide implementation date is January 1, 2018, comments by senior members of Oman’s Majlis Al Shura Economic and Financial Committee suggest it could be introduced to the sultanate in mid-2017 or earlier. If Oman presses ahead with early implementation, it must ensure VAT readiness across its economy.

For many businesses, adjusting to the practicalities will be a challenge. Larger firms that use enterprise resource planning (ERP) frameworks will need to revise these to include VAT charges. Those without ERP systems will be compelled to incorporate VAT accounting processes manually. This will include everything from altering invoice templates to include VAT-related fields, to altering business structures to avoid unnecessary cash flow and limiting the amount of absolute VAT paid, particularly on intercompany transactions. All firms will need to revise their terms of business with clients to ensure that VAT correctly becomes a cost to customers and not to suppliers.

Preparedness for VAT can be vital, according to Jennifer O’Sullivan, director of tax advisory services at EY. “It shouldn’t represent a tax cost to businesses, but if it’s not implemented properly then it could become a tax cost,” she told local media after the VAT announcement. “It’s a transactional tax. It’s not a tax on profits. It will apply on all sales or all purchases and after the “go live” date there will be VAT implications for each and every single transaction. That’s why businesses need to prepare themselves and quickly configure their IT systems. It’s not something you can achieve in a short timeframe.”

The government faces similar challenges. Oman has recently rolled out a new IT system whereby companies can file tax returns online; adapting this to accommodate VAT requirements is likely to be complex. A final snag is inflation. A new VAT could cause a spike in consumer prices, an unwelcome side effect at a time when subsidy cuts are already raising the cost of living. While the government has yet to release findings on a VAT effect on inflation, some estimates see the cost of fuel rising by 5%. Both the public and private sector, therefore, must make careful adjustments to mitigate the potentially disruptive effects of coming changes in the tax environment.