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Jul 19, 2016

VAT in UAE – What to Expect, How to prepare …………..

Posted by : CA Vineetha Jose

The UAE will start implementing the VAT at a rate of five per cent from January 1, 2018

 

On June 15, 2016, the Undersecretary of the UAE Ministry of Finance, Younis Al Khoury, announced that companies in the UAE that report annual revenues over Dh 3.75 million will be obliged to be registered under the GCC VAT system. Al Khoury also confirmed that companies whose revenues fall between Dh 1.87 million and Dh 3.75 million will have the option to register for VAT during the first phase of the VAT implementation.

Business get together’s to kitty parties today slips into the discussion on the arrival of VAT in UAE and the limited knowledge of many part takers bounces the discussion to a whole new level to the utter shock of the many uninformed in the group. An overheard conversation in a recent gathering prompted me to share some details on the VAT to be introduced and I am sure that this article will give needed information to business class and to the general public to understand the meaning and relevance of VAT.

Let me tell you, it is not an Income tax on individual Income nor a corporate taxation and the authorities of GCC haven’t mentioned anything about any plans on Individual Income tax to be rolled out. As of now tax under implementation is called Value Added Tax (VAT). Yes, the real fact is that this VAT will inevitably be charged to the end consumer.

Now let me take you through the background of its introduction and the recent developments.

Governments have been considering the need to diversify income sources like any mature economy should think, as they progress and this thought was accelerated given the new developments in the oil industry, negatively affecting the government revenues in the region.

This also has to be read along with the fast paced growth ambitions of UAE and the region and the introduction of VAT and excise tax constitute an important policy reform aiming to help GCC governments to achieve medium to long-term social and economic policy goals and to reduce the reliance on hydrocarbon revenues which traditionally has been its sole driver.

VAT is seen as an effective tool in raising revenue to achieve government objectives whilst preserving the neutrality for businesses. Majority of the global economies, be it developing, or developed countries with multiple sources of revenue still do levy direct and indirect taxes in seemingly higher percentages for its sustenance and future development.

With the approval for the introduction of Value-Added Tax (VAT) by the GCC ministers recently, Gulf businesses are on a narrow timeline to prepare for the first phase of its implementation by January 1, 2018. As there is less than 18 months to go, businesses need to start preparing in advance to be able to comply with the new tax obligations. Businesses should start adopting VAT and excise tax-compliant strategies now to ensure a smooth transition at a later stage.

Following an extraordinary meeting of finance ministers in Jeddah on June 16, 2016 the GCC chairman, Bahrain’s Finance Minister Shaikh Ahmad bin Mohammed Al Khalifa announced that the VAT Framework Agreement is expected to be finalised at the next meeting of the GCC Financial and Economic Cooperation Committee in October 2016.

It is widely estimated that the excise tax and VAT treaties constitute the common framework for the introduction of these taxes in the GCC which is expected to occur by January 1, 2017, and January 1, 2018 respectively. The treaties will form the basis for the issuance of national VAT and excise tax legislation by each GCC member state.

Upon the ratification of the treaties, each member state would need to issue its own national VAT and excise tax legislation based on agreed common principles.

The UAE will start implementing the VAT rate of five per cent from January 1, 2018. On June 15, 2016, the Undersecretary of the UAE Ministry of Finance, Younis Al Khoury, announced that companies in the UAE that report annual revenues over Dh 3.75 million will be obliged to be registered under the GCC VAT system. Al Khoury also confirmed that companies whose revenues fall between Dh 1.87 million and Dh 3.75 million will have the option to register for VAT during the first phase of the VAT implementation.

The requirement to be registered will arise in early 2018 during the first phase of the GCC VAT implementation. Once registered, companies will be required to account for VAT on an ongoing basis to the Ministry of Finance.

The minister said it would eventually become obligatory for all companies to be registered under the system when it is rolled out in the second phase, regardless of the reported revenues. The roll-out date of the second phase of the implementation is still to be decided.

Some exceptions may apply mainly driven by socio economic policy considerations. For example, some items may be subject to VAT at 0%, such as basic food – where no VAT applies but the related VAT incurred on purchases can be deducted. Other areas such as healthcare and education may be exempt from VAT – where VAT will not apply and the related VAT incurred on purchases cannot be deducted.

Based on general VAT principles, VAT will apply to goods imported into the GCC and this will be payable at the time and place of import. Exports (of goods to countries outside the GCC territory) will not be subject to VAT (generally zero-rated).

Now let me explain the VAT in detail for the common understanding.

Value Added Tax (VAT) as it is an indirect tax on consumption and it applies to all goods and services unless specifically stated and exempted by the government. VAT is levied on business transactions, i.e. on goods and services supplied in the course of business until it reaches the end consumer. Although VAT applies to most goods and services, in countries where VAT operates there are normally some exceptions provided by the local government.

VAT is levied at each stage in the chain of production and distribution and is collected by businesses on behalf of the VAT authorities. There is a wide spread misconception that the VAT is paid by the producer, wholesaler and the retailer but the real truth is that the VAT is ultimately paid by the end consumer and all other’s involved in the chain of production to distribution only have the responsibility to collect the same and deposit to the concerned authorities.

I will try to explain the same through an example as how this mechanism generally works and then will touch upon its impact on the business and the actions to be taken by the business.

* VAT rate applied here is 5%.

**Amount in AED

Now I believe that the above table well explained the method of VAT calculation. The  entire activity in this chain of production to distribution generated a VAT of AED 2 .The tax authority received a total of AED 2 and this entire amount of AED 2 was collected from the end consumer .The producer paid a VAT of AED 0.5 to the authority which he received from the Wholesaler and the wholesaler paid AED 1 to the authority which he received from the Retailer and the retailer paid AED 0.5 to the authority  from the AED 2 he received from the consumer after keeping the AED 1.5 which he already paid to the wholesaler.

So basically the VAT paid on the purchases or expenses is credited against the VAT paid on sales. The below diagram with a simple example of two companies will further explain this working more clearly.

The company A will have to pay AED 4,000 to the authority and company B can request a refund of AED 2,000.

Now that you have a fair idea about what is VAT and how would it generally work, let us understand how the introduction of VAT impact your business and what are the practical measures to be taken and implemented at this juncture when we are just 18 months away from the beginning of the VAT era.

While VAT is charged and collected by businesses on behalf of the Government and as such should not be considered as a cost, there will be an additional work in terms of administration and compliance with the new legislation.

Businesses will need to amend the systems, processes and procedures and will need to ensure that they comply with the new requirements without any error. The business should have a competitive and qualified accountant and Auditor or else should seek professional help from external consultants.

The business need not have to have the fear that the VAT is going to substantially increase the cost to the business. Yes, this can bring in few additional cost in the regular maintenance of accounts but a host of other advantages like financial discipline, better control on your finance, availability of better credit information and weeding out of fake companies.

If you are engaged in the supply of goods or services that are subject to VAT (including at the zero rate) you will be entitled to reclaim the VAT you incurred on costs and this will not additionally increase your expenses as you reclaim them from the consumer.

However, if you are engaged in activities that are exempt from VAT and you cannot reclaim VAT incurred on costs, VAT will be a cost to your business indirectly (as suppliers will charge VAT that you cannot reclaim). Example could be an educational institution which will attract VAT at many instances of it purchasing materials but will not be able to reclaim the same from students. In such cases we may see the fees being increased to adjust the increase in cost if permitted by the governments to do so.

The VAT will definitely lead to the end consumer being charged more and the way this affects the prices and margins are a function of the price adjustment which may have to be made by the sellers as per the market demand.

VAT is a tax on consumption and is levied on the price charged to the customer. Therefore, it is expected that prices will increase by the amount of VAT. However, it is ultimately a matter for suppliers to determine the price of their goods / services. The price will need to take account of VAT, i.e. whether you charge AED 10 or AED 10.5 the amount will be deemed to include VAT. For example, if a supplier charges AED 10.5 now and AED 10.5 after the introduction of VAT (at say 5%) then the supplier will only retain 10 after the introduction as 0.5 would be due as VAT to the tax Authority. If the supplier wants to retain the 10.5 then the price needs to be increased by the amount of VAT (say 5%) to 11.025. If the supplier does not increase the selling price when VAT is introduced, then this will affect margins as VAT will be due on the amount received.

One could fairly estimate that this decision will be taken by the seller based on the demand from the consumers at the higher price. If the seller feels that the demand for his item at that price will not be taken by the market, he may have to absorb the VAT under his price. This will be based on the product and the demand and supply dynamics and needs a thorough market research to establish this new dynamic that may work out in each sectors.

The business in UAE has to respond to this new and inevitable change as early as possible to create a robust and smooth system within the company, as it is said the time stands with the ones who are ready to adapt.

The time is ripe and there is a relatively short time to analyse the implications of the introduction of VAT and to make the necessary changes in your business model. The amount of work required will depend on the size and complexity of your business, efficiency of the current accounting systems and people and it is also essential that you consider the impact now and design the best strategy to deal with it. At this stage, until we get more clarity on the UAE VAT legislation, we recommend you to gain a basic understanding of VAT and how a 5% increment in price will affect the consumption behaviour of the end consumers of your product. In case you lack a very professional in-house team to deal with the issue we suggest you take the help of an external consultant to design and implement a strategy and timeline for the systems implementation and subsequent supervision of accounts and finance function.

A final word of advice is that there is no need to panic and a maximum of 5% VAT will not damage your business if you manage and imbibe the change to adopt newer strategies for a changing era in the Middle east.