Gulf Cooperation Council: Introduction of VAT

Trust Bloomberg Tax for the international news and analysis to navigate the complex tax treaty networks and global business regulations.

Mitul Patel

Mitul Patel is a VAT expert based in Muscat, Oman

The Gulf Cooperation Council is expected to introduce a value added tax (“VAT”) in 2018: this measure is intended to support the establishment of a diversified regional economy with reduced reliance on oil revenues. This article explores the background and potential effect on businesses.

I. Introduction

In 2018 it is expected that a VAT will be introduced by the Gulf Cooperation Council (“GCC”) at five percent, as one of the measures aimed at supporting the establishment of a diversified regional economy with a reduced reliance on oil. This represents a change in approach to tax within a region which has historically been associated with low tax.

II. Background to the GCC VAT Introduction

In 2008 the possibility of introducing VAT to the GCC was explored; however, at the time the oil price exceeded $100 a barrel, resulting in strong government revenues which reduced the need for an additional and potentially unpopular tax. The case for the introduction of VAT was further dampened in 2010 in light of the Arab Spring.

Arguably, 2008 would have been a good time for the introduction of VAT in order to optimize tax income on the back of a better performing economy. Today's economic reality is quite different. Oil is trading closer to $50 a barrel, and as a result government revenues have been reduced. It is now generally considered that an economy based largely on oil revenue alone is both unpredictable and unsustainable, to the extent that action must be taken now to safeguard the region's future prosperity.

Governments in the region have been proactive in initiating and promoting economic reforms for diversification. For example, Oman has recently announced the “ Tanfeedh” plan, which commits to developing the manufacturing, tourism, transport, logistics, mining and fisheries industries; in another example, the Kingdom of Saudi Arabia has announced its Vision 2030, which is a roadmap to diversify away from oil, with a strong emphasis on developing non-oil exporting industries.

The expense of these structural changes, along with spending on social programs, has resulted in governments encountering larger budget deficits. A robust, fair and efficient tax system will help to establish a strong and continuous revenue stream which is likely to be looked upon favorably when investors seek to provide resources to governments as working capital in order to implement these reforms successfully. The expectation is that the introduction of VAT, in itself, could fund approximately five percent of the annual budget deficits.

There will also be an expansion of the existing Corporate Income Tax (“CIT”). In terms of creating tax fairness we have already seen a positive move from Kuwait who currently levy CIT only on foreign companies, but are now seeking to levy CIT on wholly-owned Kuwaiti companies as well.

These economic changes are supported not only by tax reforms, but also by a move away from the traditional paradigm of large public spending, with new cost-cutting initiatives being adopted to generate efficiencies and with an increasing involvement of the private sector.

III. Latest Developments for the Introduction of VAT

In December 2015, following a meeting of GCC Finance Ministry officials, it was announced that the GCC VAT Framework Agreement had broadly been agreed upon. By February 2016 it was confirmed that VAT will be implemented at five percent with a target go-live date of January 1, 2018.

With the next announcement due imminently from the GCC, there is a distinct possibility that GCC officials have now reached a final agreement such that the VAT Framework Agreement could be ratified before the end of the year. This Framework will define the broad parameters from which each state may introduce VAT into their domestic legislation. It is expected that the rates (five percent, zero percent and exempt) will be common across the states as will the categorization of transactions.

It is also anticipated that the legislation will include provisions for cross-border services as well as imports and exports. The VAT requirements for these are likely to take influence from the EU model, as well as the recent VAT implementation in Egypt.

A potential challenge facing businesses is that states may not be required to implement VAT simultaneously: this could create some transitional challenges, especially in relation to how VAT should be accounted for on cross-border supplies where one party belongs in a state which has implemented VAT and the other in a state which has not.

IV. What Does this Mean for Businesses in the GCC?

The introduction of VAT in the GCC will be one of the most important challenges that business owners and CFOs in the region may have to face in the coming years. Businesses should begin preparing for the introduction of VAT by making an assessment of the potential impact that VAT could have on their operations. The typical areas of review are finance and administration, VAT compliance, procurement, business risks, human resources, operational efficiency, pricing, cash flow, logistics and information technology (“IT”).

One of the most difficult challenges businesses will face is establishing how to VAT-enable their IT systems. In the region many IT systems, in terms of tax, will have been configured to account for CIT and may not have the prerequisite functionality to capture and analyze VAT data. Businesses will need to think carefully about what IT package best suits their needs, whether that be an extension of their existing accounting system, or a tax engine or even a move to an Enterprise Resource Planning system.

V. What have we Learnt from Recent Implementations in Egypt and Malaysia?

Once implemented, VAT is likely to make a considerable difference to the GCC economy. Businesses and governments should keep in mind that a functioning VAT system is a proven method of raising tax efficiently in order to facilitate social programs and other governmental investment. With a five percent rate, GCC states are expecting that VAT will represent approximately 1.5 percent of GDP.

On the other hand, as we move closer towards the GCC VAT Framework announcement, businesses should be wary of lessons learned in countries that have recently implemented similar regimes, such as Egypt in 2016 and Malaysia in 2015. The strongest of these lessons from Malaysia is that businesses should start as soon as possible in making their assessment of how VAT will impact them. This is reinforced in the Egyptian example, whereby businesses were only given three months from the announcement of VAT to become VAT compliant.

The Egyptian Government is targeting VAT income of approximately 32 billion Egyptian pounds a year, and some of the money raised is expected to be spent on subsidized food commodities as well as on financing the government's social expenditure. Malaysia introduced goods and services tax (“GST”) in April 2015 at six percent, replacing the previous regime of sales and services taxes: despite being labelled as GST the new tax appears more like VAT in the way it is levied. The Royal Malaysian Customs Department has so far collected $13 billion as GST Revenue in 2016.

VI. The Road Ahead

The end goal is not just a diversified economy based on exports, but also a diversified way of doing business. These tax reforms show an indication of a willingness to adapt to the reality of today's economic environment.

We must keep in mind that VAT is being introduced in the GCC for the betterment of the economy as a whole: it could represent a real game changer in the progress and growth of the GCC.

Businesses should begin as soon as possible to mitigate the risk that they may not be VAT-ready by January 1, 2018, by measuring the impact VAT will have across their business processes. They should keep up to date with VAT policy developments, especially now, as there are expected to be a number of key announcements before the end of 2016.

Mitul Patel is a VAT expert based in Muscat, Oman. He assists businesses to navigate the complexities of the introduction of VAT to the region. Prior to this he was based in London, where he spent over five years advising large corporations across Europe on indirect tax matters. He may be contacted on LinkedIn.

Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.

Request International Tax