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Mitul Patel is a VAT expert based in Muscat, Oman
2018 will bring a significant change in the taxation landscape within the Gulf Cooperation Council with the introduction of Value Added Tax (“VAT”). How will this change affect your business?
The Gulf Cooperation Council (“GCC”) states are the latest group of countries to join the growing trend of introducing a broad base VAT system (with China and India other recent high-profile examples). This falls within the backdrop of a fast evolving indirect tax landscape globally with governments now seeing VAT as a more effective method of raising taxes as compared to other forms of sales taxes or direct taxes. Whilst current global VAT rates are remaining the same or modestly increasing we are now seeing a trend amongst governments to remove VAT exemptions as well as restricting the number of items which are subject to a zero or reduced rate. There is no proposed reduced rate for the GCC and the zero rate is likely to be defined much narrower than that seen in the United Kingdom.
The proposed VAT rate in the GCC (5 percent) is low compared with other VAT regimes globally. Recent examples demonstrate that where VAT is introduced as a new tax, governments are unlikely to initially propose the high rates typical of the European model in order to minimize the disruption on businesses and prevent discontent amongst the general public. However in the GCC, given the introductory rate is low, it is a possibility that after the initial adjustment period that the 5 percent rate will be reviewed and adjusted as demonstrated in the Egyptian example where VAT came into force in 2016 and is expected to rise from 13 percent to 14 percent in 2017.
The recent public VAT announcements by The Kingdom of Saudi Arabia (“KSA”) and The Kingdom of Bahrain (“Bahrain”) have generated alot of activity within the GCC business community as companies prepare to begin charging VAT from as early as January 1, 2018. Prudent businesses are now beginning to implement VAT to be ready by January 1, 2018 whilst others are still waiting for the remaining countries to make their public announcements before taking action. The United Arab Emirates (“UAE”) Ministry of Finance has already communicated to taxpayers that the online VAT registration process will be opened three months before the introduction of VAT.
The GCC Member States are very unlikely to all be ready to implement VAT by January 1, 2018 due to differences in their domestic legislative processes. Each states domestic VAT legislation will require the incorporation of the key principles set out in the GCC Unified VAT Framework Agreement. Included within the recent VAT announcements by KSA and Bahrain was a strong indication that there will be a set list of VAT exemptions covering certain categories of services including (but not limited to) healthcare, government, education and certain finance products as well as a 0 percent rate covering items such a basic food stuffs and exports. The Unified Agreement is likely to allow Member States the flexibility to choose, in certain circumstances, on which category of supplies they wish to implement the VAT exemption and the zero rate.
The GCC States face the challenge of not only incorporating VAT into their domestic legislation but also communicating the nuances of VAT to the general public. In terms of taxpayers there will be significant challenges in achieving VAT compliance especially given that businesses may only have 10 months to be ready. During the recent implementation in Malaysia taxpayers identified that updating technology was the issue which took the longest time and most resources to resolve. The business community in Malaysia also communicated that their biggest concern following the introduction of VAT was their reliance on manual accounting processes due to insufficient automation of their system during the preparation period for VAT. Businesses in the GCC should, therefore, prioritize undertaking an assessment of the capabilities of existing IT systems and also determine how best to customize, replace or enhance their systems.
VAT implementation will not only affect businesses from the perspective of procedures and systems. Each function within a business will need to evaluate how VAT will affect them. For example, businesses should review their current contracts and commercial arrangements to determine the impact of VAT and amend these documents where they are not applicable for VAT. This will come into sharp focus where businesses have contracts where their customer is partially or fully VAT-exempt; for example, a governmental department, hospital or school. In these instances it may prove difficult to amend existing fixed price contracts as the customer will have to bare the additional VAT charged to them as an ultimate unrecoverable VAT cost.
The procurement and sales function are also critical in achieving effective VAT compliance. From a sales perspective we may see some companies operating in highly price competitive markets using the introduction of VAT as an opportunity to gain market share. This may happen in instances where instead of increasing the price by 5 percent VAT, businesses instead will keep their prices fixed and absorb the 5 percent VAT into their margin in order to appear more price competitive than their competitors in the short term and attract new business. Businesses, especially where they operate in a price sensitive industry, will need to carry out an economic analysis on the impact of VAT on their demand.
From a procurement perspective it is critical that the procurement professional develops a good understanding of how VAT will be applied. In terms of their vendors, they will need to gather their counterparties VAT information and ensure it is kept up to date. This process is often overlooked even in mature VAT jurisdictions where a vendor may open a new factory in a different country and not inform the customer such that the customers systems are not updated and they end up accounting for the VAT incorrectly.
The finance departments, aside from preparing VAT returns, will need to keep a close eye on the impact of VAT on the business' cash flow. VAT cash flow is likely to be a big challenge in the post-VAT environment with many vendors currently having to offer long credit terms to attract business. Businesses will need to evaluate the VAT cash flow cost of not receiving payment from their customer for a particular transaction despite having created a tax point for the sale and as such being required to account for the VAT on that sale. Where businesses cannot adjust their payment terms they may need to consider how they will find the funding for their VAT payments.
The challenges are not limited to IT, Sales, Procurement and Finance. The impact of VAT is deep and wide within an organization and businesses would be wise to increase tax awareness generally amongst employees especially given until now businesses had operated in a low tax environment.
The current tax challenges for businesses are not limited to VAT as VAT is just one of many tax changes being introduced to the region with many of the GCC states having implemented or planning to implement wide changes to their Income Tax Law. For example, in Oman there has been an increase to the Corporate Income Tax rate from 12 percent to 15 percent with a number of additional categories added to the list of items subject to withholding tax including interest, dividends and payments for services.
VAT is not the only indirect tax being considered and in 2017 we are likely to see the introduction of Excise Tax which is expected to be levied on items considered damaging to the general public's health. The excise levies could be as high as 50 percent on soft drinks and a 100 percent tax on cigarettes, energy drinks and alcohol.
VAT implementation and adjusting to the new GCC tax environment is likely to be a significant and complicated challenge for most businesses in the GCC. It is essential that business act now to understand the scope of the changes required to maximize the time so that they reach a stage where they have implemented the new tax changes into their business and are confident they can operate in a tax compliant manner once all the new taxes are introduced.
Mitul Patel is a VAT expert based in Muscat, Oman. He may be contacted on LinkedIn.
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