This move will be the GCC’s first step towards implementing direct taxation, which has never been a necessity in the region until the recent drop in revenues that stemmed from lower oil prices.
The Minister’s announcement has given businesses in the UAE an additional challenge to consider alongside increased production costs. Concerns have also been raised about how VAT might affect the GCC’s demographics, given the region’s predominantly expatriate population, which has historically been attracted and retained by the tax-free living and working environment.
This said, economists have also predicted that the benefits that come with the introduction of VAT will outweigh the fear reaction that came with the announcement.
Managing Director of the IMF Christine Lagarde has gone on record to say that the introduction of VAT in the GCC could raise revenues equivalent to 2% of GDP. She is confident that GCC economies can implement the necessary financial adjustments to cope with a sustained period of low global oil prices.
“Oil prices have fallen by two-thirds from their most recent peak, but supply and demand factors suggest they are likely to stay low for an extended period,” she added as a warning.
As oil prices have plunged, the IMF has played an increasing role advising GCC governments on reforms to shore up their finances. Lagarde noted that the IMF had helped Kuwait to study the design of taxes such as VAT and a business profit tax.
VAT is a consumption tax applicable on both manufacturers and consumers. It is therefore likely to be levied at each stage of the local construction process as well.
Niall Hughes, Senior Consultant for Construction at Morgan McKinley says that local building firms are likely to bear the immediate effects of VAT in the form of administration costs. “VAT is levied at all stages of the construction supply chain and each supplier would normally pass these costs on to the next person in the chain.
“The consumer is ultimately the last person in the line and therefore absorbs the majority, if not all, of the cost impact. It will mean more administration costs for companies, but as far as taxes go, it is probably the most preferable tax of the different options available.
“One potential benefit to the construction industry is that VAT revenues may be used by governments to improve services for citizens, with infrastructure high on this list,” Hughes continues. “This could in turn result in opportunities for the construction companies.”
The construction industry in the region will therefore have to educate itself about the implications of VAT, how and when these opportunities arise. Tim Whealy, Vice President at Hill International, says he believes an interim period could be established for the region to identify the supply chain dynamics of VAT.
“It will be interesting to see how the tax is phased in, the exemptions on it, whether there’s a consultancy period for companies to prepare, and how various industries deal with it. At the moment, we know healthcare and education will be exempted, but we’ll have to see how main construction projects are handled,” he said.
VAT is also likely to impact the supply of materials in the GCC and this may potentially result in some firms trying to evade paying VAT on construction products by hoarding materials within their purchasing and supply chain processes. However, some experts believe that, after the VAT culture settles in, firms will generally find that it may not be worth this kind of knee-jerk reaction.
Justin Whitehouse, Managing Director for Indirect Tax Services at Deloitte, says that while “there will always be people who will not pay the required taxes”, it is likely that the low rate of VAT will reduce the motivation to evade its payment.
“All markets with VAT and tax systems have these concerns and the key is to make sure that evasion doesn’t impact business. This means a strong enforcement capacity and harsh penalties, as well as educating payers about why the tax is being implemented. The motivation to avoid tax payment is only at the consumer level,” he continues, adding the construction industry, as well as similar business sectors, could benefit from the implementation of VAT.
“It might present administrative challenges, but companies should not bear VAT costs and it should be passed on to the consumer at the bottom of a very long chain. So, compared to retail, where you’re dealing directly with consumers, you’ll hopefully have a less challenging environment,” Whitehouse adds.
As local economies get to grips with reduced funds in the light of declining petrodollars, international investments will hold the key to vitality in the region. While the industry has voiced concerns about taxation reducing investor interest in the GCC, experts believe VAT is unlikely to hurt the region’s standing as a local hub for foreign firms.
“The VAT rate being discussed is exceptionally low at the moment,” Whitehouse says.
“It may have an inflationary impact – it typically does in the first year of its introduction, but it doesn’t tend to have a sustained inflationary impact. The question is not so much about whether people will come – it is whether businesses will come to the region,” he adds.
Morgan McKinley’s Hughes echoes this opinion, adding that the UAE’s 5% VAT suggestion “shouldn’t cause a large change in sentiment.”
“Most skilled workers from abroad will have grown up paying income tax and VAT on goods. Whilst the no-tax policy has played a big part in attracting people to work in the region, a small VAT levy will have much less of an impact in attracting people to move here,” Hughes adds.
Whitehouse predicts that regional economies will attract investors even after the implementation of VAT. He says that typically, VAT is very low on the list of priorities held by businesses while making a location decision. Most companies make this decision based on the availability of labour and when it comes to tax, they consider corporate tax and possibly even personal income taxes, but VAT is low on that list.