Diversifying the revenue base: The government looks for new sources of non-hydrocarbons income

According to the “Qatar Economic Outlook 2011-12” report, issued by the General Secretariat for Development Planning (GSDP), the country will continue posting double-digit fiscal surpluses in 2011 and 2012 as a result of increasing hydrocarbons revenues. However, as the National Development Strategy 2011–16 (NDS) has pointed out, this hefty surplus figure hides a significant deficit if hydrocarbons revenue is subtracted, equivalent to roughly 17% of the country’s GDP in 2011. Perhaps for this reason, the GSDP has identified narrowing the non-hydrocarbons deficit as a long-term goal that can be achieved by broadening the country’s revenue base. The government is therefore analysing the possibility of introducing a value-added tax (VAT) to generate additional income. In 2010 local newspaper The Peninsula reported that global accountancy firm KPMG was predicting that this VAT would be in the range of 5-7%.

CURRENT TAX STRUCTURE: Qatar’s tax regime is streamlined and business-friendly. In 2010 the government revised its tax structure to impose a flat rate of 10% on all taxable corporate profits. Prior to 2010, the country had a tiered tax system that imposed increasingly higher rates on foreign companies depending on their earnings. The rates started at 0% for companies earning less than QR100,000 ($27,460) annually and rose to 35% for those generating more than QR5m ($1.4m) a year. While the recent reforms have benefitted businesses and consumers by simplifying the tax burden, it has also resulted in declining tax revenues for the government. Corporate income tax – paid by foreign companies and a major tax component – fell by 29.2% in 2010, according to the GSDP’s “Qatar Economic Outlook 2011-12” report. For consumers, there are currently no personal taxes, although income from commercial or business activities, such as property rental or self-employed consulting, is taxable. In addition, capital gains on real estate and securities are exempt. A Tax Exemption Committee at the Ministry of Economy and Finance has the authority to grant tax exemptions upon assessing specific criteria, including if the enterprise contributes to economic activities that are deemed necessary for the country and that are socially and economically beneficial.

VAT ADVANTAGES: A VAT system is generally adopted for three broad reasons, according to a report from KPMG. First, VAT is capable of raising significant amounts of revenue fairly easily because it is applied to a very broad base of goods and services. It is also a more stable revenue stream than income tax, which can vary more in comparison to consumption. Furthermore, it minimises the impact of taxes as a disincentive for savings and investment. Second, because VAT is applied at every step of the supply chain, it is more difficult to evade. Third, adopting VAT would bring Qatar in line with global standards. With the exception of the US and the GCC countries, every major economy in the world employs VAT. The European Union, for example requires member states to impose this form of taxation.

In addition, the IMF also encourages using VAT, although it no longer imposes it as a precondition for its loans. Indeed, it has consistently advised GCC countries to adopt the tax as a form of protection against volatile energy markets.

CHALLENGES: However, VAT would pose unique challenges for the regulatory authorities in Qatar. While this form of taxation might be easier than imposing a retail sales tax, adopting it would still represent a considerable shift for the government. Ensuring compliance, for example, would entail developing a much larger tax authority. Moreover, while VAT would increase the revenue base for the government in the short term, it could have important implications for Qatar’s broader economic diversification strategy. Imposing any type of consumer or retail tax would increase the cost of doing business and could make investing in the local economy less attractive to businesses. Moreover, a VAT system might dampen the growth of local enterprise, particularly outside the oil and gas sector.

Other common issues in administering VAT include a failure by businesses to register. In most VAT regimes, a company is exempt from collecting and remitting VAT if its annual sales are below a specific threshold. Businesses that operate just above this threshold may have incentives to avoid the tax by not registering their company. Moreover, even if a seller is registered to collect VAT, it might simply underreport its sales by falsifying its records or by keeping some transactions off its books. Finally, “missing trader fraud” is a potential concern. VAT requires traders at every step of the supply chain to charge and collect the tax. Missing trader fraud occurs when a trader collects VAT on a sale and then disappears, taking the VAT collected. Clearly many countries are able to manage these risks but, if implemented, this new system would place an additional burden on authorities and create some uncertainty within the local economy in the short term.

REGIONAL TREND: Qatar is not alone in evaluating the possibility of adopting a VAT system, with a region-wide initiative under way in the GCC. While the authorities have not released an official announcement, law or proposal for VAT, recent reports suggest the GCC is delaying the adoption of a VAT system, which was originally supposed to be implemented by 2015, while it continues to study the implications for member states. For example, Younis Haji Khouri, the undersecretary at the UAE’s Ministry of Finance, told Al Khaleej news agency in November 2011 that “after consultations among the various parties concerned in the six-member economic bloc, the GCC states have decided to defer the application of VAT until every member is ready with the internal systems and specialised staff required to implement such a tax.” Khouri added, “While the GCC as a bloc was keen to unify its taxation standards and procedures … the UAE would not impose any new tax in the country this year or the next, as the ministry had not submitted any bills or proposals for a new tax in the state during 2012.”

Key issues behind these delays likely include political considerations in the broader region and the impact VAT will have on prices of consumer goods and services. Political unrest elsewhere in the region will likely make governments cautious about implementing significant reforms that would affect citizens. Furthermore, while Qatar has been largely shielded from the global financial crisis, other GCC countries have implemented stimulus packages that seek to ease the financial burdens on citizens. Subsidies on range of goods and services would contradict the imposition of a VAT on the same products.

INFLATION: Taxes on goods and services would also ultimately drive up costs of those goods and services, and the GSDP already identifies inflation as a potential challenge going forward. While the country experienced mild deflation in 2009 and 2010, the economy had suffered from double-digit inflation in 2007 and 2008, and recent data from the Qatar Statistical Authority show that the consumer price index crept up 1.9% in 2011.

The local business community is starting to feel the pinch of increasing prices, according to Samir El Baba, the general manager of Qatar Star Services, which provides services such as catering and building management to both private and government clients. “Profit margins are falling due to the rising costs of imported goods and shipping combined with fierce competition,” he told OBG.

Indeed, the state is particularly vulnerable to increases in global food prices, as it imports almost all its basic requirements. An expansionary fiscal policy marked by large increases in public spending coupled with a weaker dollar is likely to increase inflation going forward, and a VAT system could further exacerbate the problem.

STATE-SPECIFIC ADJUSTMENTS: These factors, however, do not preclude Qatar from levying a VAT. The government has fiscal and monetary tools that could be used to slow inflation. It is also seeking to drive competition within the economy, which could reduce costs in the longer term. Additionally, a VAT system could be designed to target specific goods and services, excluding essential items, such as food and medicine, and subsidised commodities, such as petroleum. Moreover, while the GCC has contemplated a region-wide VAT, it is certainly possible that state-specific systems could be implemented.

As a regional tax expert at global consultancy and service firm Ernst & Young told Abu Dhabi’s The National newspaper recently, “Some [ governments in the GCC] will focus on oil and others on financial services. One size does not fit all and they have to decide what the impact will be on their national citizens and to make sure they are still attractive as a destination for foreign direct investment.”