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Are you ready for VAT?

As part of a region-wide drive to diversify income sources for public services, all six GCC states are poised to introduce VAT on goods and services as early as January 2018. Considering that the region has long held the tax-free tag, what impact would the new tax regime have on the private sector? What measures must HVACR companies undertake to prepare for compliance? And, perhaps more importantly, how soon should they start preparing?

| | Dec 28, 2016 | 9:56 am
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VAT

If everything goes according to plan, 2018 will see governments in the GCC region finally implementing an economic reform that has seemingly been loitering on the fringes of public consciousness for years. Value added tax (VAT) – and its introduction in the GCC states – has been floated for some time, with reports coming out in 2006 that the International Monetary Fund (IMF) and Dubai Customs were carrying out a joint study on how to ensure a smooth, region-wide implementation.¹

A quick search online would reveal that more news accounts on VAT were released in the ensuing years, featuring forecasts on when the consumption tax will be rolled out. None of the forecasts ever amounted to anything, however, and the idea of VAT remained on the back burner. But it may not stay there for much longer.

In June, during a meeting in Saudi Arabia, the news emerged that finance ministers from all the six GCC member countries had, in principle, approved a treaty on VAT, with a proposed rate of five per cent and an execution date of January 1, 2018.² While the countries will be drafting their own VAT laws, they will reportedly do so under the general guidance of a VAT framework agreement, which is expected to be finalised by the GCC Financial and Economic Cooperation Committee in the final quarter of this year.³

The value of VAT
Recognising that an economy reliant on oil revenues is hardly sustainable, not when prices are prone to volatility, the international finance community – led by the IMF and the World Bank – has long urged GCC countries to pursue certain economic reforms that would help them address budget deficits and open up additional income channels. Among the various reforms that have been suggested is the collection of taxes, including VAT.

Businesses not only must be ready themselves, they also have to make sure that their suppliers are compliant and can give them the proper documentation they’ll need to recover the VAT cost

Briefly, taxes are typically classified as either direct or indirect. Direct taxes are those collected by the government itself, such as income and corporate taxes, while indirect taxes are those collected for the government by third-party agents.In the case of VAT, businesses serve as the agents tasked with collecting taxes from the end-users or consumers on behalf of the government. Considering that there are various forms of taxes available, why go for VAT? While sounding the caveat that he can’t speak for the GCC ministers, Robert Dalla Costa, VAT Leader at KPMG Lower Gulf, explains that most governments choose VAT, because it is a fairly secure source of revenue. “VAT is a broad-based consumption tax,” he says, “which means that governments can tax almost all goods and services. Doing that won’t cause distortion in investment decisions. If you apply a high tax on one thing, on the other hand, people will buy less of it and look to invest on something else.”

The fact that VAT is hard to avoid is also a plus, adds Dalla Costa. He elaborates: “No matter how you get your earnings, whether by legal or illegal means, when you spend on groceries or buy a car or fill fuel, you pay VAT. You can’t avoid it, which is why governments see it as a very stable revenue source.” His observations are echoed in a paper published by Deloitte & Touche (M.E.), titled “VAT in the GCC – Old news or new chapter?” According to the paper, VAT is “a popular fiscal tool for a range of reasons. It is considered to be efficient, cheaper to operate, less open to fraud, and less likely to distort investment decisions by businesses than any form of direct tax. This latter point is significant; governments do not want to generate new revenue at the expense of investment from the private sector”.5

No getting off the hook

V. Chandrasekhar Reddy

V. Chandrasekhar Reddy

Just because consumers will be bearing the tax charge does not mean, however, that businesses don’t have their work cut out for them – a reality that they’re aware of, even though they’re still unclear on exactly what would be required of them. “There is no such thing as a five-year plan anymore,” says Chandrasekhar Reddy, CEO of Elemec Electromechanical Contracting. “As a company, we only have a one- to two-year plan, because long-term planning is impossible with current challenges, costs and risks – and we don’t know how VAT is going to impact us. Some of the projects we take may spiral into 2018.”

While he shares Reddy’s uncertainty of the impact of VAT, Fouad Ahmed, Marketing Manager of Wilo Middle East, says he is confident his company would be able to handle it, before disclosing that Wilo is already looking into compliance strategies. “Manufacturers or suppliers are most likely going to pass on the cost to the end-user, so I don’t think VAT will have a big impact on businesses,” says Ahmed. “But we know we need to start preparing, so we have our controlling department already studying the issue and determining what needs to be done.”

Decisions, decisions
Wilo is apparently not the only company that has started taking steps to prepare for VAT. As per Dalla Costa, since the announcement about the new tax regime was made in June, KPMG has been “inundated” with requests for assistance, and he’s sure the other Big Four accounting firms must be, as well. “We have people approaching us for quotes, and they are from large groups, who have a hundred entities trading in entertainment or running malls and hospitals,” he says. “They’re very large organisations, including a couple of airlines, and they’re all starting now. They want us to complete the initial phase of our assessment by the end of the year, because they need 12 months to then go and implement the necessary changes.”

When asked why it would take that long, he cites invoicing requirements as an example, saying that they need to change. He further points out that while the general idea is for businesses to pass on the tax cost to the end-user, companies need to make an informed decision on whether or not passing on the cost will be in their best interest.

“They need to consider what their competitors are going to do,” he says. “What if their competitors decide to only pass on four per cent instead of five? What if it’s a really competitive market? Perhaps they ought to consider not passing on the cost at all. But how will that impact their profits and their profitability? So it’s not a certainty that yes, you can just add five per cent and the next person will pay.”

If you’re a business that isn’t registered, then yes, you don’t charge your customers VAT, but your business inputs are going to come with VAT that you cannot recover

He clarifies, though, that the questions he raised will not apply in business-to-business transactions, since companies can recover their VAT charges from the government, or as succinctly laid out in the UAE Ministry of Finance website: “Businesses will be responsible for carefully documenting their business income and costs and associated VAT charges. Registered businesses and traders will charge VAT to all of their customers at the prevailing rate and incur VAT on goods/services that they buy from suppliers. The difference between these sums is reclaimed or paid to the government.”4

Dalla Costa notes that because businesses are able to reclaim their tax charges, VAT will be more of a cash flow concern than anything else. “If you’re a business owner, it doesn’t matter how much VAT you get charged, because you’ll be able to recover it,” he says. “But it is going to affect cash flow, since you’ll have to pay the tax charge and then wait for maybe three months or more before you can file your return and get the money back. So, it might create cash flow problems, but the rate they’re proposing – five per cent – is pretty low. That should minimise the impact. You go to Europe, and the average VAT rate is 22%.”

Businesses, Dalla Costa makes it a point to stress, have no reason to worry about VAT – that is, as long as they manage their cash flow right and put the right systems in place. “The main challenge for businesses is to get their systems ready, because if they are not ready, then VAT would be a cost to them,” he says, adding that businesses not only must be ready themselves, they also have to make sure that their suppliers are compliant and can give them the proper documentation they’ll need to recover the VAT cost.

“There’s a huge education process that needs to happen,” states Dalla Costa. “They need to communicate with all their suppliers and say: ‘Hey, are you going to register? Yes? Okay, but are you going to be ready? Are you going to be able to give us the tax invoice when you charge us VAT?’ These questions must be asked, because if their answer is ‘no’, there will be problems.”

To register or not to register
Expanding on the topic of potential problems that could arise, Dalla Costa touches on the significance of registration, saying: “We expect that companies with an annual turnover of more than USD 1 million will have to register for VAT, while those falling between USD 500,000 and USD 1 million will likely be given the option to register, which means they don’t have to. But in countries like Australia, for example, experience shows that a lot of companies will want to volunteer to register.”

Fouad Ahmed

Fouad Ahmed

He goes on to explain that businesses choose to volunteer because registered companies tend to only want to deal with other registered companies. “If you’re a business that isn’t registered, then yes, you don’t charge your customers VAT, but your business inputs are going to come with VAT that you cannot recover,” says Dalla Costa. “Your cost structure then goes up, because VAT would mean five per cent more on everything that you buy for your business. And how would you recover that? You’d have to increase your prices, but because the increase that you’d be charging your customers would not be VAT, they wouldn’t be able to recover it. So you can see that there’s pressure for registered businesses to only deal with other registered businesses.”

If one were to go by media announcements, though, it would appear that voluntary registration will only be an issue during the initial implementation stage of VAT, as GCC countries – or at least the UAE – will eventually make VAT registration mandatory for all businesses. According to a Gulf News report, Younis Al Khoury, Undersecretary at the UAE Ministry of Finance, confirmed that “companies in the UAE that record annual revenues over Dh 3.75 million will be obliged to register”, while those “whose revenues range between Dh 1.87 million and Dh 3.75 million will have an option to either register under the system or not during the first phase of rolling out the system”.The report also mentions Al Khoury confirming that registration will “become obligatory for all companies” in Phase 2 of implementation.6

An educational journey for all
In addition to registration, basic tax documentation is an issue that Dalla Costa thinks is fraught with possibilities for complications. Drawing attention to the region’s lack of experience with VAT, he notes that since governments themselves are new to VAT, it’ll take them some time to learn about the various types of “sophisticated transactions” that businesses enter into, which means that in the early stages of implementation, their focus will be trained on the basics of tax collection.

Robert Dalla Costa

Robert Dalla Costa

“In general, it usually takes a couple of years for governments to fully understand the complexities of VAT, or at least understand enough to be able to ask the right questions from businesses,” he says. “Until then, they’ll just be looking for very basic things. They’ll say, ‘Show me all your invoices for transactions on which you want to reclaim VAT,’ and just tick things off a list. That’s why businesses need to get those basics right, because if they don’t, they’ll risk not only missing recovery but also getting penalised.”

Dalla Costa says that for businesses to be prepared to provide the necessary documentation, they need to invest in, among other requirements, IT systems and human resources, explaining that the former is because companies will be expected to file their returns electronically. The latter, he adds, is necessary to make sure that the VAT infrastructure is properly utilised and that processes are correctly carried out.

“Many businesses think that they just need to have a finance manager who’s been trained and educated on VAT,” he says, “but they’re wrong, because VAT first enters company systems through accounts payable clerks, who get the invoices from suppliers and put them into the systems. The clerks should be able to tell if the invoices meet all the requirements set out in the law. So, that’s people right there. And we’re finding that a lot of training needs to happen with organisations, because there’s nothing simple about VAT.”

It’s not a case of this being a finance problem or an IT problem. It’s an HR problem

Though unwilling to go into what he calls the “intricacies” of VAT – claiming that it would be hard to do so in one sitting – Dalla Costa emphasises that there will be different VAT implications for different transactions, and cites a sample scenario that he feels would give businesses a clue as to how tricky the new tax regime could be if they don’t have the right tools in place.

“You could be supplying air conditioning units to someone in the same country, which would be taxed five per cent,” he says. “Or you could be trading units from the UAE to someone in Oman. The law will likely say that you don’t have to apply VAT, because the goods will end up in Oman, so the business that will purchase it in Oman will have to account for the VAT. Then there’s the third possibility: You could be supplying the units to someone outside of the GCC [region] or exporting to a country like the UK, for example. That usually attracts a VAT rate of zero per cent. So there you are, you’ve got a single sale of cooling units, and you could have at least three different outcomes. It is, therefore, important that your IT system and employees understand which one to pick.”

Zero per cent versus tax-exempt
Identifying another sign of the region’s inexperience with VAT, Dalla Costa spells out the difference between zero-rated and exempt goods or services, noting that people often confuse one with the other. “If it’s zero-rated, it means there is VAT but it’s at zero per cent,” he says. “If your business makes taxable supplies either at five or zero per cent, it means you get to recover all the VAT you paid for your business inputs. But if you were to make a product that the government says is exempt, it means you will not be allowed to charge VAT and, at the same time, not be allowed to recover the VAT on your business inputs for that particular product.”

VAT will bring greater stability to the region, since it will mean more funds for governments that have been feeling the consequences of their dependence on oil and gas revenues

Commenting on press announcements about products and services that would be declared exempt from VAT, Dalla Costa says that the wrong terminology seems to be frequently used, adding: “Governments sometimes say they’ll exempt basic foods, but that’s not good. What they really mean is they’re going to zero-rate them. In other words, they’ll tax them but at zero per cent. Why? Because if they’re really going to exempt food, that will mean that food suppliers will not be able to reclaim their VAT charges. So what’s going to happen? They’re going to increase food prices, which is not what governments want. And that is why it’s important to understand the difference between something that’s zero-rated and something that’s exempt.”

Tax-free no more
While governments may not want prices of basic goods to go up, there is no question that the implementation of VAT will affect people’s perception of the region as well as their cost of living, states Arvind Swarnkar, Managing Director of Sauter. “The biggest attraction of the UAE is that it’s taxfree. The country will lose that particular branding by introducing VAT,” he says. “Also, because charges are passed on to the consumers, we’ll be dealing with inflation, with an increase in the overall cost of things. And when the cost of living goes up, people will ask for a salary increase.”

Prakash Chablani

Prakash Chablani

Anticipating the same developments, Prakash Chablani, Managing Director at Unigulf Development, predicts that an increase in prices would be followed by an increase in earnings, saying: “If your cost of living is going up by five per cent due to VAT, won’t your company look at the situation and address it at some point?”

Not necessarily, says Dalla Costa, before elaborating: “There will certainly be people who will try to negotiate for a five per cent pay increase. But the fact is some things will be exempt and some companies will choose not to pass on the full VAT charge, so the cost of living will not go up by a full five per cent. Some products like bananas and milk will be zero-rated, and maybe even some medicines and medical equipment.”

Though acknowledging that VAT will have an inflationary effect, Dalla Costa contends that it will only be two to three per cent, not five, and that it will only be temporary and one-off. He says: “After the first 12 months, it will work itself out in the system. So the last thing businesses want to do is offer a five per cent pay increase across the board, when the effect is only temporary.”

Spurred on by the discussion on possible wage-increase requests from employees, Dalla Costa stresses the importance that HR will play in making sure businesses are sufficiently prepared for compliance with VAT regulations. “Companies need to think about their resources, about who will be on the team,” he says. “It’s not a case of this being a finance problem or an IT problem. It’s an HR problem, and not only because people will be asking for wage increases. VAT collection will involve employees in different ways. We’ve talked about needing to communicate with suppliers, which will affect procurement. And then there’s the issue of pricing. Marketing and sales teams will need to think about updating catalogues and all tender documents; everything will have to include VAT.”

VOICES

S.P. SaranganS.P. Sarangan, General Manager, Trosten Industries:
“Everybody will be impacted by VAT. The buyer will be impacted. As manufacturers, we have to bite the bullet. If it’s going to be five per cent, we will be forced to absorb to a certain extent.”

Brij SharmaBrij Sharma, Regional Business Development Manager, Trosten Industries:
“There are already indirect taxes, so are they going to stay after the implementation of VAT? If yes, then we might see a big impact. Or, will VAT replace the indirect taxes? We have to wait and see.”

Arvind Swarnkar, Managing Director, Sauter:
“The biggest attraction of the UAE is that it’s tax-free. The country will lose that particular branding by introducing VAT. Also, because charges are passed on to the consumers, we’ll be dealing with inflation, with an increase in the overall cost of things. And when the cost of living goes up, people will ask for a salary increase.”

Chandrasekhar Reddy, CEO, Elemec Electromechanical Contracting: “There is no such thing as a five-year plan anymore. As a company, we only have a one-to-two-year plan, because long-term planning is impossible with current challenges, costs and risks – and we don’t know how VAT is going to impact us. Some of the projects we take may spiral into 2018.”

Prakash Chablani, Managing Director, Unigulf Development:
“Any economic change of this type will, in the end, only benefit the economy. So everything will be fine. It’s just something that we have to get used to. After all, everything has been subsidised for so long. If you value the country and the services you’re getting, you have to pay for them.”

Fouad Ahmed, Marketing Manager, Wilo Middle East:
“Manufacturers or suppliers are most likely going to pass on the cost to the end-user, so I don’t think VAT will have a big impact on businesses. But we know we need to start preparing, so we have our controlling department already studying the issue and determining what needs to be done.”

Raphael Khlat

Raphael Khlat, CEO, Faisal Jassim Trading:
“We don’t really know which industry will be affected, but VAT will raise the price of construction, and it’s definitely going to put pressure on the accounts department and the transparency that needs to happen. They might have to report their figures now. We have to be ready for inspections from the government, and our billing and collection have to be different. You cannot build a lot of stocks, as well, because you might have to pay penalty.”

Azzam Messaykeh editedAzzam Messaykeh, COO, Faisal Jassim Trading:
“Passing [the VAT charge] to the consumer… it will definitely create inflation. This is part of the package to enable people from the other side to afford VAT and yet keep spending. The impact is yet to be seen, and we want to see how it will be implemented here.”

Noting that there may also be special VAT implications for sponsorship deals, Dalla Costa recommends training for marketing or whichever department handles sponsorships. He continues: “Of course, you have the finance people, who need to be able to generate the returns and maintain records. And then you have legal, who should be working right now. Nobody should be issuing a tender document or a contract without having a VAT clause. They should be doing that right now, because the way the law generally works is that any transaction that you make after the introduction will be subject to VAT. So if people were to enter into two-year contracts without the clause, and VAT was introduced halfway through, they won’t be able to recover the charges.”

Once all those are done, businesses can then start mapping out their supply chain, says Dalla Costa, who suggests that companies ask themselves the following: “Who are my suppliers? Who do I need to talk to? How do goods come in? Are they from another GCC country? Are they imported from the overseas?”

He reasons that if businesses started the mapping process early, they’ll have an easier time when the legislation comes out. “You’ve done all the work, so you’ll have enough time to think about how to put your plans into action,” he says. “Very large businesses understand the urgency involved, which is why they have started preparing. That philosophy should also trickle down to smaller-sized enterprises, because they face exactly the same issues. If anything, the cost to them to prepare for VAT is higher, because big businesses can afford to spend millions on new IT systems. But if you’re a small- or medium-sized business, that will be a significant cost to you.”

He further underscores that whatever investment businesses will be making in preparation for VAT will not be compensated by the government – a point that is made clear on the UAE Ministry of Finance website, which states: “When VAT is introduced, the government will provide information and education to businesses to help them make the transition. The government will not pay for businesses to buy new technologies or hire tax specialists and accountants. That is the responsibility of each business. We will, however, provide guidance and information to assist you and we are giving businesses time to prepare.”4

Off the back burner
Despite the costs and system changes that VAT compliance will involve, industry stakeholders are expressing confidence that the new tax regime will only bring positive developments to the region and, by extension, the private sector.

Arvind Swarnkar

Arvind Swarnkar

“Any economic change of this type will, in the end, only benefit the economy,” says Chablani. “So everything will be fine. It’s just something that we have to get used to. After all, everything has been subsidised for so long. If you value the country and the services you’re getting, you have to pay for them.”

Sharing Chablani’s optimism, Swarnkar predicts that VAT will bring greater stability to the region, since it will mean more funds for governments that have been feeling the consequences of their dependence on oil and gas revenues.

It is a prediction also made by Dalla Costa, who says: “I know that many are concerned about the loss of the “tax-free” label, but people need to look at the broader picture. Oil prices have collapsed, and governments just can’t continue to fund their infrastructure projects without trying to address their fiscal balance. When you have a government that is facing revenue problems, it paints a negative picture for businesses who want to invest in the region, because they’ll think that the economy lacks stability and sustainability. The thinking tends to discourage investments. But when you have VAT as an extra source of revenue, it should give people more business confidence and increase investment – something that will benefit all businesses in the end.”

It’s a lot to take in, admits Dalla Costa, but he says he is convinced that the time has come for VAT to be removed from the back burner – for it to transition from being an “if scenario” to a “when”. And if things go according to plan, that “when” may just be right around the corner.


References:

  1. http://www.wam.ae/en/news/emirates/1395227586570.html
  2. http://gulfnews.com/business/economy/uae-other-gcc-firms-urged-get-ready-for-vatnow-1.1848598
  3. http://www.khaleejtimes.com/business/economy/gcc-companies-urged-to-prepare-for-vatcompliance
  4. https://www.mof.gov.ae/En/budget/Pages/VATQuestions.aspx
  5. http://www2.deloitte.com/content/dam/Deloitte/xe/Documents/tax/me_tax_VA-%20in-the-GCC-Old%20news%20or%20new%20chapter.pdf
  6. http://gulfnews.com/business/economy/uae-outlines-vat-threshold-for-firms-in-phase-1-1.1847025

[The writer is the Assistant Editor of Climate Control Middle East.]


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