The UAE appears to be getting closer to implementing a value-added tax (VAT), which looks increasingly viable with the new norm of low oil prices prompting the government to speed up fiscal reforms.
The UAE has long toyed with the idea of implementing VAT, but little concrete progress has been made. However with oil prices tumbling from a high of US$115 per barrel last year to less than $50 this year, the UAE, as well as other GCC states, are looking for alternative sources of revenue to ease pressure on their state finances. One viable option is to implement a VAT, also known as goods and services tax (GST) in many other countries.
The UAE Ministry of Finance (MoF) confirmed in mid-August that it has been conducting studies on the implementation of a VAT draft law, along with the other GCC countries. The move is based on a previous agreement between the UAE and GCC states to impose a VAT tax law simultaneously.
The MoF statement came after the International Monetary Fund’s (IMF’s) update on the financial status of the UAE, which recommended additional taxation among several options for the government to further strengthen its revenue base in order to minimise dependence on the fluctuating global oil price. The IMF suggested the UAE consider imposing a 5% VAT.
In what could be a precursor to the implementation of VAT, the UAE has become the first Gulf country to deregulate fuel prices from 1 August. Effectively, the UAE not only removed fuel subsidies but also made the price of petrol and diesel variable in line with average global prices. This move, which saw petrol prices rise by an average of 24%, is viewed as daring but necessary. Other GCC states are also expected to follow the UAE’s footsteps and liberate fuel prices.
VAT in the GCC
Member countries reportedly reached an agreement in May 2015 on the framework for VAT in the Gulf. However, no official announcement has been made.
There is still not enough information to predict how a VAT might impact on insurance services in the GCC, said Mr Finbarr Sexton, Partner, EY. “There is more than one way that financial services might be dealt with under a VAT system. Until we see a draft law, we cannot be certain about how things might proceed.
“Our best guess is that because the GCC operates as a customs union, the framework adopted here may be similar to that of the EU. In that case, insurance services provided by GCC insurers would be exempt from VAT.”
However, because of the way VAT systems normally work, this does not mean that insurance services would not be affected by VAT. He explained: “Many purchases made by insurers would be subject to VAT. This VAT on purchases would probably be unrecoverable, making it an additional cost of business. In addition, if the insurer also provides non-insurance services, it is possible that these may be taxable. In that case, some of the VAT on purchases would be recoverable, but the insurer would need to make an apportionment of that VAT between its taxable and exempt sales.”
Some implications for the UAE
At the moment, there has been no official announcement on the industries or sectors that will be subject to or exempt from VAT. “We also have no clear indication on tax rates for particular sector,” Ms Jyothi Kasi, Tax Partner at KPMG in UAE, said. “GCC states may decide to tax only certain types of insurance. Where VAT does apply to insurance, risk cover may also be taxed, as is seen in other VAT systems. If there is no bifurcation of allocation to risk and investment, the entire amount could be taxed, or it could be taxed at an abated value.”
Ms Kasi said alternatively all fee-based services could be subject to VAT or insurance services could be treated as VAT exempt. She said: “That could impact the ability of insurance companies to credit VAT on purchases. This would increase the cost base for the insurance sector and could lead to higher costs for businesses and private individuals taking insurance.”
International practice shows that countries where insurance services are exempted from VAT often levy a separate insurance premium tax, she said, noting that “not introducing such a tax could suggest certain insurance services will be subject to VAT”.
Business costs
The biggest effect of any introduction of VAT is likely to be on businesses, not necessarily due to the taxes themselves, but due to the extra time and money they have to spend to ensure that they are compliant with the new rules.
The financial services sector, including insurance, can be complicated with respect to the taxes, Ms Kasi said. “More generally, and in common with any other business that becomes subject to VAT, there will be an additional cost and time needed to administer the VAT process. In relation to that, staff may need to be trained, and there may be a need for extra personnel to maintain a new level of bureaucracy.”
She said that costs resulting from VAT will include the tax cost itself, the cost of complying with VAT filing and return requirements, and the impact on the company’s working capital and cash flow. The introduction of any new tax should, at the very least, lead companies to reassess their business models and will compel some to take appropriate action, she added. Furthermore, VAT will also affect normal business practices such as IT, and accounting systems will have to be updated to cope with tax collection and compliance requirements.
The other issue that may arise if VAT is implemented concerns documentation. Mr Sexton explained: “When VAT is introduced, it normally has special rules dealing with the requirements for invoices. Even if insurance services are VAT-exempt, it is still possible that special invoice requirements will be imposed.”
Ms Kasi said particular attention should be given to the VAT position of companies whose main business is not providing insurance services but nonetheless operate in the insurance sector, such as brokers and agents. She pointed out: “Companies providing related services, such as valuation services, inspection services and claims-handling services, may also be impacted. Finally, companies providing guarantees, warranties or extended warranties on products should review the impact of any VAT treatment on their business model.”
Finding a balance
The continued low oil prices is posing a long-term threat to state revenues – a recent report by Goldman Sachs said the global glut of oil could push prices as low as $20 a barrel. The IMF has already warned that the UAE could report a budget deficit of 2.3% of GDP this year, for the first time since the 2009 financial crisis, down from a 5.0% surplus last year.
Hence, with the constant decreases of oil prices, implementing a VAT looks like a good source for boosting a country’s revenue and would be a rational response by government.
To introduce an efficient VAT system, Ms Kasi recommended that “a balance must be found between the three major stakeholders: the government, businesses and tax residents. The UAE, in cooperation with the other GCC member states, should aim to implement a simple, efficient and broad based VAT system with a clearly defined scope”.
She added: “Simplified VAT compliance procedures and filing requirements will help companies remain compliant. Proper consideration should be given to VAT credit availability. Input credit should be made available for inter-GCC state procurements and transactions. The government should also consider providing an effective system to assess and process objections and appeals, as international practice shows that dealing with insurance services under a VAT system is complex.”
Moving with global trends
Globally, VAT is a popular fiscal tool for a range of reasons. It is considered efficient, cheaper to operate, less open to fraud, and less likely to distort investment decisions by businesses than any other form of direct tax, according to Deloitte in an article, “VAT in the GCC”. The last point is significant as the UAE is well-known for its tax-free regime, and the government will not want to generate new revenue at the expense of investment by the private sector.
While firm details are still pending, the latest draft law on VAT is already considered a step in the right direction. By adopting this new policy, the UAE is not only building a more robust economy that will be prepared for tomorrow’s challenges but also keep up with the current global trends, with as many as 169 countries having already implemented VAT or similar taxes.