VAT and income tax in UAE: What, how much and when…
After the recent fuel price deregulation reforms, Younis Haji Al Khouri, undersecretary at the UAE Ministry of Finance, revealed earlier this week that the GCC states have agreed on key issues for implementing VAT in the region.
The International Monetary Fund (IMF), among other international bodies, has been advising the UAE and the rest of the GCC countries to introduce taxation among several options for the government to strengthen their revenue base in order to minimise dependence on the fluctuating global oil price.
The 'low' rate of VAT as advised by the IMF is being generally seen as at or around 5 per cent.
Even as the IMF maintains that the UAE economy is resilient to low oil prices and sluggish global growth thanks to its fiscal buffers and safe haven status, the agency is suggesting the government to undertake additional reforms to boost its finances.
Primary among those suggestions are imposing a value-added tax, imposing an excise duty on the sale of automobiles, as well as a decrease in the corporate income tax levels but applying it to a much broader base.
Read: 5% VAT, 15% tax on cars: IMF advice to UAE
With agreements having been reached by members of the GCC on certain aspects of the VAT systems, the big question now is ‘when’ and not ‘if’ VAT will be implemented, and, importantly, by which country (or countries) first.
“The timeframe for implementation has still not been confirmed – however governments in the region are facing deficit budgets over the short- to medium-term due to the low oil price environment. Policymakers will be prompted to introduce the VAT regime sooner rather than later,” Finbarr Sexton - Mena Indirect Tax Leader at EY, told this website.
Is personal income tax 'on the table' too?
According to Stuart Halstead, Indirect Tax Leader at Deloitte Middle East, it isn’t just VAT that’s on the table right now but also personal income tax even as he maintains that introducing personal income tax would be the most challenging.
“Personal taxes offer a real challenge to the ‘tax free’ branding of the UAE and much of the GCC. For that reason alone, we would suggest that a near-term introduction of such taxes is very unlikely. Again though, it is difficult to predict how budgets will be funded in the long term and so such measures would, we feel, always be ‘on the table’ for discussion,” he told Emirates 24|7 in e-mailed comments.
And while Deloitte’s Halstead sees personal income tax as unlikely but not impossible, EY’s Sexton says introduction of taxation in the form of VAT should keep personal income tax concerns at bay – at least for the moment.
“Personal tax is not on the tax agenda of the UAE at present and is unlikely to be on the horizon in the near future. Introduction of indirect taxes in the guise of VAT is a tax on consumers and ultimately individuals will bear the cost of VAT as opposed to most businesses that will be in a position to recover input VAT against VAT on sales and services charged to consumers,” he says.
What is VAT, how much may be imposed, and when
The IMF maintains that VAT, which is a kind of consumption tax that the end-customer pays while purchasing a product, “would serve well as a low rate-broad base tax.”
“The VAT rate is likely to be a low rate of 5 per cent, which is consistent with the recommendation of the IMF,” says EY’s Sexton.
“It is important that there is an adequate lead time to allow companies to prepare their systems, train staff and staff up for the introduction of the VAT regime. Finance ministries will similarly need to staff up and implement sophisticated IT systems to deal with VAT collection and taxpayer monitoring and audits. A typical VAT implementation period would be 18 to 24 months – so the timeline for implementation may be 2018 or latest 2019,” Sexton maintains.
“VAT is generally viewed as the most stable revenue source, which has the least detrimental effects on investments,” states the IMF.
“In such a macro-fiscal environment as in the UAE, a low rate, for example 5 per cent, VAT could be considered,” it notes.
“Our understanding of the broader economic drivers in the region and our experience of recent implementations of the tax globally would suggest a low rate with very few exceptions (i.e., it would have a broad base). Many commentators (including the IMF) have suggested rates in the region of 3-5 per cent initially, which appear sensible,” says Deloitte’s Halstead.
“A broad-based consumption tax such as VAT would raise revenue proceeds at a low efficiency cost. At the same time, its equity implications would be relatively insignificant in such a macro-fiscal environment as in the UAE, where taxes are minimal and government expenditures are financed by oil revenue,” the IMF notes.
However, while the initial VAT rate may be ‘low,’ experts maintain that a gradual increase over time or even a higher introductory tax rate cannot be completely ruled out.
“Whilst the debt, cash and other fiscal performance measures that we often examine when attempting to establish an estimate would not necessarily demand a higher rate at this time, it shouldn’t be ruled out completely. Indeed, following implementation the rate may well increase over time to help governments balance growing budget requirements although we would expect any rate changes to be signalled well in advance,” added Deloitte’s Halstead.
Nevertheless, VAT will give a “significant and positive boost” to the tax administration, the IMF says.
VAT: What will be exempted
The multilateral agreements among GCC states appear to be those which are designed, primarily, to ensure that certain social-economic distortions often associated with VAT are minimised, says Deloitte. In particular, removing VAT from food products (94 items have been identified), healthcare and education would appear to reflect a broad desire to ensure that these vital household expenditure items are not directly impacted by a VAT in the GCC, the consultancy states.
“The indications from recent reports are that there is an intention amongst GCC members to implement the tax across the region within 3 years of formal agreement being reached on certain key principles (only a few of which remain to be settled). The UAE MoF has repeatedly said that it would give businesses between 18-24 months to prepare for implementation once a decision to implement has been reached. On that basis it may well be that the UAE implements the tax as part of a first wave of countries,” says Halstead.
Businesse or consumers - who will shoulder the burden of tax?
The impact of the new tax/es on corporates and end users will not be huge, believe experts, and VAT’s impact on business should only be compliance-related, they say.
“The introduction of VAT is likely to result in increased administrative and compliance burdens as well as additional costs. Accounting and other IT systems will also be required to be able to deal with the additional demands created by new VAT laws and regulations. Companies entering into medium to long term contracts will need to look carefully at their commercial terms and conditions to ensure that the introduction of a VAT regime is provided for,” says EY’s Sexton.
“Businesses play a vital role in the success of a VAT system; in essence they play the role of tax collector, charging, collecting and then remitting the sums collected to the tax authority at the appropriate time. In many cases businesses do not suffer an additional tax cost associated with VAT – in theory, the tax is one on consumption, not on businesses,” adds Deloitte’s Halstead.
“That being said, there is an administrative burden that businesses will have to bear and to that end proper preparation is key. For example, we have a simple checklist for businesses that highlights over  questions that need to be answered positively in order for a business to be ready. Businesses may also have to take the cash-flow impact of VAT into their day to day activities – an issue of particular importance for those involved in major projects with tight margins,” he notes.
“For individuals there will be cost inflation on products and services purchased,” EY’s Sexton says.
“Individuals are the ones that generally bear the cost (partially or wholly) of a VAT. At a low rate, the impact on consumers is likely to be relatively benign and of course businesses may themselves mitigate the impact further by absorbing some of the VAT charge into existing profit margins,” adds Deloitte’s Halstead.
“Importantly, there are clear signals from the GCC that they are attempting to tackle some of the potentially regressive aspects of the tax by removing the VAT charge from certain food items, healthcare and educational services. These is good news for those spending heavily on those items,” he notes.
Corporate income tax plus VAT?
In addition, analysts maintain that even as the IMF has suggested a broadening of corporate tax base in the UAE to include local firms (currently, a corporate income tax of 20 per cent is levied only on foreign banks in Dubai), logistics of implementation would suggest that this may not happen simultaneously with the introduction of VAT.
“It is unlikely that VAT and corporate tax would be introduced simultaneously in the UAE – introduction of both these tax regimes represents a major challenge for any country, and with the UAE having no pre-existing taxpayer database, there is much to achieve in coming years and many challenges to be overcome,” says Sexton.
Deloitte’s Halstead agrees that it is unlikely, but is quick to add that such a move should not be completely ruled out.
“Although the corporate tax regime in the UAE is relatively limited at this time we can foresee certain structural challenges associated with any extensive broadening of the existing corporate tax base or any rate increases. Nevertheless, that is not to say that such a measure should be necessarily ruled out absolutely,” he says.
“Indeed, many corporates generating profits in the UAE may well be paying tax on those earnings back ‘home’ wherever that may be; capturing a portion of that tax here in the UAE might not actually increase their overall global tax burden at all and there is of course international pressure to extend corporate tax bases in countries with traditional low tax regimes,” he adds.
“One other aspect worth highlighting is that simultaneous introduction of two taxes requires the alignment and delivery of two programmes of related but different implementation paths, whereas separation might reduce the overall risk,” Halstead claims.
“Looking beyond the UAE there have been examples of the expansion of corporate taxes although in most cases that is against the background of an already extensive corporate tax regime that has been in place for many years,” he explains.
Current tax structure in UAE
As of now, the UAE’s tax structure as stated by the IMF report is as follows:
* A corporate income tax of 20 per cent is levied on foreign banks in Dubai;
* A local municipal property tax of 5 per cent of the rental value;
* A 10 per cent local hotel tax on hotel services;
* The GCC’s common external tariff (a general rate of 5 per cent, 50 per cent on alcohol, and 100 per cent on tobacco) applied locally;
* Select fees on government services (applied by the federal and Dubai governments).
Excise duty on passenger vehicles
In addition, the IMF noted earlier this year in August that taxing passenger cars may also be under consideration to boost UAE government revenues. “Excises on passenger vehicles could also be considered for raising non-oil revenue,” it maintains.
“Automobiles impose a number of costs on society. These costs include direct costs such as the cost of maintaining and expanding a network of roads, and indirect costs such as productivity losses due to traffic jams and health costs because of increased pollution,” it explains.
“Imposing an excise tax on automobiles would shift costs associated with the usage of automobiles to the owners. Ad valorem tax of 15 per cent would yield 0.6 per cent of non-hydrocarbon GDP,” the IMF states, adding that “gains from excises on tobacco and alcohol would be insignificant”.
Broader base for corporate income tax
According to the agency, a corporate income tax with broader coverage but lower rates would raise additional revenue and would be seen as more equitable by foreign investors.
It suggests halving the corporate income tax rate from the current 20 per cent but applying it to all non-free zone entities.
“The tax rate could be lowered to 10 per cent from the current 20 per cent and the coverage could be broadened by including all companies (foreign, domestic, GCC) except for those located in free economic zones. In addition, a broadened corporate income tax, if applied to unincorporated companies, could provide some progressivity in taxation and would lessen the need to introduce a general income tax on individuals,” it notes.
“This measure is estimated to yield 4.1 per cent of non-hydrocarbon GDP,” the IMF reckons.
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