Abu Dhabi's new VAT to bring in more state revenue

The February 2016 announcement by Obaid Humaid Al Tayer, the UAE minister of state for financial affairs, that the UAE will introduce a value-added tax (VAT) is one of the most significant economic developments in the country in recent years. While the UAE has been a strong proponent of VAT for some time, the prospect of reducing the competitiveness of its economy with unilateral implementation has long been a stumbling block to the introduction of the tax. After years of speculation, in June 2016 GCC ministers signed an agreement on VAT, bringing some welcome clarity regarding the introduction of the tax across the Gulf region.

Under the new agreement, all six GCC states will begin implementing VAT on January 1, 2018, after which time they have a year to fully establish the system. The UAE plans to be an early adopter of the tax, introducing it on the first day of the implementation window at a rate of 5%, with limited exceptions in areas such as basic food items, health care and education. In March 2017 the UAE’s Federal National Council approved a draft law on the introduction of taxation procedures.

Revenue Variety

For a government keen to diversify its revenue base away from hydrocarbons, VAT is attractive. It is simpler to implement than most other indirect taxes, and the fact that it is broad based and targets consumption reduces opportunities for tax evasion. It is also transparent in nature, and the burden on consumers is mitigated by the fact that it is collected in portions at numerous stages of production and distribution. Lastly, by not taxing business inputs, VAT avoids cascading – which is when a good is taxed more than once as it progresses from production to end user – thereby removing the incentive for businesses to vertically integrate to avoid paying taxes on production inputs. According to the UAE Ministry of Finance (MoF), in its first year VAT is expected to raise Dh10bn-12bn ($2.7bn-3.3bn) for the federal government.

Challenges

The proposed rate of 5% represents a low tax burden compared to the rates being implemented by other emerging markets. Egypt, for example, was in the process of introducing a VAT system in 2016 at a general rate of 13% in the first year, which will rise to 14% after June 2017. The average VAT rate in the economies of Western Europe, meanwhile, is around 20%, according to the IMF. The introduction of VAT to the UAE is therefore unlikely to result in a significant inflation spike, with many staples and essential services being protected by the exclusion list.

However, the high-end and luxury segments may be subject to a greater impact, which is likely to be felt more keenly because, unlike markets such as Egypt, the economy did not have a pre-existing sales tax to transition from. Goods and services that will be subject to the new levy include electronics, smart phones, cars, jewellery and watches, restaurants and entertainment.

Planning

The biggest challenge associated with the new tax, however, is more likely to be a practical one. In February 2017, with less than 12 months left until VAT’s introduction, Abu Dhabi’s businesses were faced with the task of updating their enterprise resource planning platforms to include VAT functionality, or introduce manual VAT accounting procedures. Achieving VAT readiness includes changes as varied as ensuring invoice templates contain the relevant fields for VAT accounting, to altering the business structure to avoid unnecessary cash-flow or absolute VAT costs arising, particularly on inter-company transactions. Firms were also faced with the requirement to register, and the federal MoF announced in mid-February 2017 that its website would be accepting online registration applications from qualified businesses starting three months before the VAT rollout. However, the Department of Finance has said that only companies that meet a minimum annual turnover will be required to implement VAT, with the threshold set at annual revenue of Dh375,000 ($102,000) or more. Firms with taxable supplies between Dh187,500 ($51,000) and Dh375,000 ($102,000) may register, but are not required.