The UAE plans to introduce a VAT (value-added tax), though the timing and rate is yet to be fixed. Initial reaction everywhere to any new tax is always greeted with scepticism, but experts say slowly all businesses will be able to factor in the increase and the consumers will get used to VAT.

CONCERNS ABOUT VAT

Like elsewhere, businesses and consumers in the UAE are concerned about VAT, which is proposed to be introduced from 2009. Although the UAE authorities have not given any timetable for introducing the new tax, it is seen to be replacing the customs duty.

The authorities have been looking at introducing VAT for some time and spent the past two years studying its feasibility. Experts say the implementation will, however, take time as the entire business cycle will need to have their processes in place before the new tax can be imposed. Experts seem doubtful that the UAE will be able to bring in indirect taxation soon even as the prices of goods and services are rising. In order to inform the stakeholders and the public, Dubai Customs held a briefing last month to explain the new tax system.

According to Ahmad Butti Ahmad, Director-General of Dubai Customs, the draft laws have already been submitted to the UAE's federal authorities, who will have to take a final decision on the matter. The VAT is expected to be levied in the UAE between a three per cent threshold. The VAT is expected to replace the five per cent customs duty.

Worldwide VAT levels varies. Although the standard rate of VAT is 17.5 per cent in the UK, the average VAT rate is approximately 20 per cent. However, certain countries such as Denmark, Norway or Sweden have a standard VAT rate of 25 per cent.

FISCAL POLICY

Explaining the rationale and timing for introduction of VAT, Howard R Hull, International Tax Services Leader for the Middle East, said the UAE (and the GCC) is negotiating free trade agreements (FTAs) with its major trading partners (the EU, the US, India, and China), and once the agreements are concluded, the customs duties will no longer be applicable. "As a replacement of the source of income, VAT is being contemplated since it an good alternative," he added.

According to him, the main reason for introducing VAT is not only to replace the source of income, but also "to have a sound fiscal policy".

As tackling inflation is an important goal for the authorities in the UAE, he said a prudent fiscal policy will help fight inflationary trends in the economy in the long-run. "At present, the authorities are deploying short-term measures like capping rents," he added.

Experts say that tax payers, tax administrators and procedures have to be ready before the new tax can be introduced. According to Hull, there are a number of aspects to the issue of readiness that will need to be put into place first. "Clearly in order to have a credible VAT, the tax payers, tax administrators and procedures have to be ready before launching the new tax. Training of people, IT processes also have to be in place and all this does not come into force fast," said Hull.

The readiness of local companies to be able to pay VAT when it comes into force will be crucial in this regard. Companies will have to be given enough time to build in-house knowledge about the systems and the processes of implementation, apart from adding reporting and filing expertise within.

According to Hull, all this countries had a tax system in place, but the UAE is starting from ground zero. Dubai Customs' Butti, however, said the agency is ready to implement the system as soon as it is approved because Dubai has already initiated a proper methodology in 2006 to implement VAT.

"VAT system is the best taxation system in the world, and by being highly transparent and accurate, this system would bring a lot of benefits to the UAE. This system would not have any negative effect on foreign investments because foreigners are used to such taxation systems and they prefer to operate under the umbrella of this system instead of being subject to unclear taxes." Butti added. He said VAT is in use in more than 150 countries and over the past years it has been proven that VAT is the most transparent taxation system.

NO FUELLING INFLATION

As the UAE is grappling with 11 per cent inflation, many people wonder whether the new tax will fuel the prices further.

Butti said the revenues from the new VAT system would match customs duties, which will be cancelled when the new system is implemented. Therefore, the new VAT system would not have any negative effect on the inflation rates in UAE, he added.

In the GCC, the UAE will be the first country to have VAT, but it will not significantly fuel inflation. "Since the intention is to replace the customs duty, it will not significantly fuel inflation," said Hull.

Giving the example of Switzerland, Hull said that when the authorities introduced VAT in 1995 to replace sales tax, companies were given between 12 and 18 months to prepare. "And that was in a country where companies were already filing returns. In the UAE, not all companies are accustomed to such an exercise. The different UAE emirates would have to be ready to introduce VAT at the same time and would have to agree with the revenue-sharing model that the federation would have to propose."

Marios Maratheftis, Regional Head of Research, MEPNA, Standard Chartered Bank, said the new VAT will generate revenue comparable to what is currently collected from customs duties. Welcoming it as a positive step, he added that VAT revenue will provide the government with a new channel of income generation to offset potential revenue lost from the end of customs duties.

Many people fear VAT will hinder the development of tourism, especially given Dubai's aspiration to receive 15 million tourists by 2015 and Abu Dhabi aiming to welcome 2.7 million visitors by 2012.

But Maratheftis believes the impact will be limited. "Like most countries which levy VAT, tourists will be able to reclaim the tax before departing the UAE. Moreover, the three per cent to five per cent VAT rate proposed remains significantly lower than the VAT rate charged in some other economies," he said.

Dr Eckart Woertz, Programme Manager Economics at Gulf Research Center, agrees with Maratheftis. He said the aim of the new tax is to generate non-oil revenues for the state and to make up for a loss in the five per cent GCC external tariff in case future free trade agreements are signed.

Woertz said theoretically a VAT introduction of five per cent would be cost neutral if the external tariff of five per cent is abolished in the wake of FTAs. "FTAs with all trading partners will take time and some of them will never be signed and there are many services that are not traded over borders

[eg. hairdresser] and they become now more expensive. In many cases, the whole seller might be tempted as well to pass on the VAT to the consumer but keep the FTA tariff saving for himself," he added

Hari Padmanabhan, Chief Strategic Adviser, 3i Infotech, said concern about any new tax in any economy is always the same – that the new tax will increase will impact costs and competitiveness. But as the economy is growing, the authorities have to find means of diversifying revenue as they have to fund developmental projects. "In the short-term, there are issues about any new tax, soon people get used to it if the system is transparent," he said, adding there will be serious impact from the rising costs.

 

What's vat?

VAT is a tax on the value added to most goods and services at each stage of their production, distribution and supply to the end customers of those goods and services. Consequently, VAT represents a tax on consumption. It is an indirect tax which is charged by VAT registered taxable persons on their supplies or acquisitions of defined goods and services within the UAE, as well as of any imported goods or services they handle. Similar VAT systems are used in more than 150 countries, although some call it "goods and services tax".

VAT in the UAE

Acting on behalf of the GCC, the IMF in collaboration with Dubai Customs, conducted an extensive study into the world's best systems of indirect taxation. This study strongly recommended implementing VAT. The GCC then assigned the UAE Government, which handed this study to the Ministry of Finance, that chose Dubai Customs, to handle the task of planning the implementation of this new form of indirect taxation.