One year on, how has Dubai adjusted to the introduction of 5% VAT?

One of the major economic changes in Dubai and the UAE in 2018 was the introduction of a 5% value-added tax (VAT). Dubai and other jurisdictions on the Arabian Peninsula have long been popular for their lack of personal and corporate income taxes, and while they remain low-tax jurisdictions overall, this new levy is expected to add sustainability over the long term. The move comes one year after an excise tax was introduced on some products, including cigarettes and drinks that are high in sugar.

VAT came into effect on January 1, 2018 and has applied to most – but not all – economic activity. The move has caused some inflation, which was expected. In the month VAT was implemented consumer inflation rose to 2.7%, up from 1.5% in December 2017, but it had only a moderate impact on spending. As shown in the 2018 Business Barometer: UAE CEO Survey, the introduction of VAT also had a minor impact on business sentiment, with 79% of participants indicating positive or very positive expectations for the local economy for that year.

Clearing up Confusion

In the first year since VAT was implemented the federal tax authority has stepped in multiple times to clear up confusion over how the levy applies. A ruling in early 2018 specified that, for insurers, policies for which the coverage period includes parts of 2017 and parts of 2018, and were therefore sold in 2017 before the tax applied, are still subject to it. Insurers were instructed to prorate the tax for the value of the coverage occurring in 2018, which means some may need to go back to customers and ask for that money, or pay it themselves instead. This is expected to create a drag on profits for the year for the sector.

Another question fielded by the federal tax authority addressed public transport, which is exempt from the tax. Some owners of private sector transport services argued that their offerings, though they target a specific category of people, should not be defined as private transport; however, they do not fit within the authority’s narrow definition of public transport, which are exempt from VAT, and thus are mandated to pay the 5%.

The IMF expected the tax to generate $3.3bn worth of public revenue in 2018 and estimated that it would increase to $5.4bn in 2019. While there are no plans in Dubai or the UAE to introduce income taxes, indirect taxation is seen as an important tool to diversify government revenue and plan for a future in which petroleum revenues may not be as large or reliable as they are now.

Group Effort

Additional taxes have long been on the cards for the UAE and are part of the ongoing debate at the GCC level. In December 2015 each member state agreed to introduce VAT in concert; however, the UAE and Saudi Arabia were alone in implementing the tax in 2018. This has created challenges for businesses due to the regional integration efforts of the GCC, such as its Customs union. A seamless implementation of VAT requires each state to have its own electronic tax system to link with a centralised GCC system, something that has yet to happen. In the meantime the UAE and Saudi Arabia are considering setting up transactions between themselves, separate from the GCC. Transitional issues are expected to fall away once all GCC members have established VAT. In January 2019 Bahrain became the third GCC state to implement VAT.

Once the region-wide system is up and running, businesses – particularly small and medium-sized enterprises (SMEs), which make up 95% of total companies in Dubai – are expected to reap indirect benefits. Compliance with the VAT process means collecting and remitting tax revenue, receiving refunds, and, overall, creating a profile and a paper trail that many SMEs currently lack. These records could boost access to credit by offering banks a more detailed picture of their funds and cashflows.