Next Steps for the Introduction of VAT
The introduction of Value-added Tax (VAT) will occur in 2018 across the GCC. It is a popular misconception to see the current low crude oil prices and the implementation of VAT as an example of cause and effect. In fact, the GCC carried out extensive investigations into a regional VAT over a decade ago, before the global financial crisis in 2008/09. In a series of meetings in 2015, finance ministers, central bankers and governments decided to implement VAT across the region. Concerted action will be planned at GCC level (in the form of a Framework Agreement) and implemented at national level (each GCC nation will enact and implement its own VAT law). The Framework Agreement is close to being finalized and is expected to be published June 2016.
The purpose of any tax is to be revenue generative for the Government. Even at a low rate of 5%, the International Monetary Fund (IMF) has estimated that GCC states will be able to generate up to 2% of GDP from a VAT. People don’t like paying taxes. On that basis, any tax is a burden. But, government has an obligation to spend money, especially money raised from its citizens, wisely. The co-relative benefits often are – but should not be – overlooked. Since the middle of the 20th century, VAT has been adopted as the consumption tax of choice by over 150 countries. It is a relatively efficient tax (from which the Government benefits). It is a fiscally neutral tax for business and, thus, beneficial to that sector, although there are compliance costs. Once implemented, VAT is a relatively unobtrusive tax from the consumers’ point of view making it relatively painless. It must be acknowledged that tax administration, compliance and collection requires capabilities to be developed, both by national tax authorities and by businesses which are taxable persons. Administrative and compliance costs are involved in such capacity-building. However, there also benefits in terms of governmental efficiency and improved business systems. Society as a whole will also benefit from the wisdom with which the tax revenue is spent, e.g., on education, health and investments for the future. The stronger the connection between government and citizen, the more cohesive will be the social fabric. The adoption of a VAT will also be in-line with contemporary economic practice, to which GCC states will be able to contribute their experience and learning.
A VAT holds a particular attraction in the Gulf region. The flow of goods into and out of the GCC Customs Union has, historically, been monitored by the imposition of customs tariffs. With the accession of GCC states to WTO membership, that arrangement would need to have been revised in any event. VAT is an efficient alternative. The services sector has shown strong global growth. It is very difficult to apply customs tariffs to intangible goods and services. It is still not easy to do so with a VAT, but it can be done. By taxing services effectively, the fiscal burden can be spread more widely and, therefore, more fairly. Economic development involves producing more of what is consumed domestically, but also in exporting goods and services. VAT encourages exports, thereby supporting further economic diversification.
Although there has been agreement in principle to introduce a VAT across the GCC, much more still needs to be done. The immediate next step will be the finalization and publication of the Framework Agreement. It is imperative that it is made widely available. Each GCC nation will then need to draft and enact its own VAT law. It is understood that most, possibly all, GCC nations are well advanced with those plans. This step should, therefore, follow as soon as possible on the Framework Agreement. There should be a high degree of collaboration between GCC states to ensure the greatest measure of harmonisation. Given that each state will enact its own VAT legislation, total policy uniformity is probably unachievable. However, any significant variations between GCC states would be likely to jeopardise the single market created by the GCC Customs Union, which will only continue to thrive under a system of VAT broadly common across all GCC states.
Access to the VAT laws, as enacted, is needed so that preparation for implementation can begin right away. There will be a transition year 2018-2019 for the implementation of VAT across the Gulf, with different states moving at different speeds. It must, however, be kept in mind that the GCC Customs Union may not be able to function effectively if some, but not all, states have adopted a VAT system. The period between the enactment of national laws and the implementation date for VAT will be a busy time for all. Immediate attention will need to be paid to three important constituencies: (1) the tax authority, (2) taxable persons, and (3) consumers. Attention will also need to be paid to how tax disputes, an inherent part of the system, are to be resolved.
The national tax authority
The national tax authority will be responsible for the administration of the tax, including its collection and enforcement. The national tax authority must prioritize (1) its own training, and (2) the education of the other main constituencies identified.
As with any tax, VAT must be administered fairly and uniformly. At a national level, the UAE will need to make sure that there are no local variations between Emirates in the administration and collection of the tax. Periodic accounts may need to be taken to adjust for any differences between point of collection of tax and point of consumption of goods or services. Certainly, such accounts will need to be taken between GCC states if, for example, goods are imported into one GCC state, distributed within the GCC single market via the wholesale sector and consumed in another GCC state (or exported from the GCC). In such cases, VAT will have been (partially) collected in GCC states other than the state in which the consumption occurred (or in which the right to a tax credit on the exporting of the goods has arisen). The need for the consistent administration of VAT will extend to the practice, procedure and training of national tax authorities, both within each state, and between all GCC members. There must be mutual legal assistance and administrative cooperation between the tax authorities of all GCC member States.
VAT administration also depends on taxable persons being registered as such, and then periodic returns and payments (or receipt of repayments) being made by, or to, those taxable persons. It will be desirable if those exercises can be done online and electronically. The national tax authority must make sure that it has suitable e-portals, that they work, and that they are secure. The UAE’s eDirham system is a significant step in the right direction in this regard.
VAT is charged at every stage of the production and distribution processes. It involves every business in the chains of supply and delivery in all areas of the economy that are not exempted from VAT. There is an inevitable compliance burden which must be shouldered by taxable persons, with associated compliance costs. Taxable persons must put in place systems for:
- recording information and fulfilling formal documentary requirements (collecting receipts, book-keeping);
- calculating tax, completing and filing returns;
- making tax payments;
- dealing with tax advisers (including providing information);
- dealing with tax administration;
- tax planning (a cost particularly incurred by medium and large businesses);
- learning about tax laws.
There may be a need for capital expenditure on a new accounting package, or in-house training on how to operate existing accounting software functions that have not hitherto been used. If possible, a dialogue needs to be initiated by national tax authorities with professional organizations, trade bodies and individual taxable persons so that complexities are explained, and any problems that are experienced are understood.
Equally, businesses need to be well-prepared. There will be tax compliance benefits, as well as costs. The VAT element on the costs incurred will be deductible. There will be a difference between the time when tax is collected and when it is accounted for, creating a cash flow benefit. More stringent record-keeping made necessary by the tax may provide better managerial accounting information enabling better-informed business decisions to be taken. Businesses need to be aware that benefits as well as burdens will flow from the introduction of VAT.
The education of businesses is, therefore, an essential component. This should be undertaken by every means possible: advertising, information sheets, websites, webinars, FAQs, focus groups, seminars with chambers of commerce, business forums and trade associations, not forgetting social media. Feedback routes should be established, so that business feels it is being “listened to” as much as “spoken at”. The education should not be confined to an explanation of the tax. It is just as important to familiarize businesses with the process of compliance. Examples of commonly used documents (e.g., a VAT invoice) and forms (e.g., a blank VAT return) should be readily available to be downloaded from the web. An “explanatory pack” of information leaflets, specimen forms and contact details should be distributed to every taxable person. A dedicated telephone hotline should be set up, with sufficient available lines to avoid callers having to wait for a frustratingly long time for their call to be answered. It should be staffed by personnel who are knowledgeable, and trained in customer service. Conversations might be recorded to enable the consistency (and accuracy) of advice to be monitored.
The education of consumers is just as important. VAT is a tax on consumption, and the impact on consumers must, therefore, be fully appreciated and understood. The introduction of VAT will have a one-off effect on prices, which will increase by an amount up to the amount of the tax. Price increases are never popular, so the public must be reassured that a modern and efficient VAT is needed to fund ongoing development and sound economic growth. The tax will help to pay for things that people already take for granted (emergency services, road repairs, refuse collection etc.), and will contribute to building for the future (transport infrastructure, new business development, tourism). This message needs to be conveyed loudly and clearly. Taxation should be regarded as providing societal benefits, not just as a (necessary) evil. Again, every available instrument should be used: television (news, current affairs and discussion programs), radio (public service and popular), newspapers (opinion articles, editorials, business section articles), advertising, and social media. As with businesses, public engagement in discussion should be actively encouraged.
Public reactions to VAT will be varied and will need to be managed by a clear, well-prepared communications strategy. It is predictable that the initial public reaction may tend to the negative. That might be predictable, but is it fair? VAT is commonly viewed as a regressive tax; one that impacts the lower earners the most. That is so, but (1) a 5% tax is only mildly regressive, and (2) exceptions from VAT for food, health and education will help further to counter that regressive tendency. Moreover, as higher earners consume more economic goods and services than lower earners, overall, the higher earners will be paying more tax. It will be important for consumers to be reminded, through effective education and communication, of the collective benefits to be derived from a VAT.
Intergenerational equity is another attractive argument for a VAT. Where an economy is based in substantial part on natural resources (which are, by definition, finite), there will come a time when those resources run (uneconomically) low, or run out. By that time, it would be too late to look to diversify the economy. Steps must be taken much earlier to avoid the inevitable consequence of over-dependence on diminishing resources. Fairness between generations demands that earlier generations save (in sovereign wealth funds) and invest (in economy-broadening projects) to protect the interests and well-being of future generations.
The need for government vigilance and communication with the public will be at its greatest when the VAT system goes live. It might be expected that the imposition of a 5% tax would translate into a 5% price increase. As no market is fully efficient, that might not be the case. Some suppliers may improve their efficiency or cut their margins and, thereby, try to secure a competitive edge by not passing on the full increase. Other suppliers, in less price-sensitive markets, may attempt to maximise profits by raising their prices by more than 5%. Gulf governments should monitor inflation figures, stripping out other inflationary factors so as to identify the real inflation attributable to the imposition of VAT, and to see the true impact of the tax on inflation. They should clamp down publicly on any profiteering, and praise those sectors where, as a result of efficiency, competition or market pressure, the introduction of VAT results in only a minimal or very low increase in prices.
Dispute resolution – specialist courts, capable judges, competent advocates
Tax will create disputes and litigation. Disputes will arise between national tax authorities and businesses and other taxable persons. Differences of approach may also emerge between the national tax authorities in different GCC states. As tax will have a major impact on businesses, they will want differences of approach to be resolved speedily, and disputes to be heard and determined by capable judges and competent advocates. Attention will need to be devoted to how this is to be done. Differences of approach between national tax authorities can best be resolved by discussion and mutual cooperation. In addition, however, a suitable dispute resolution infrastructure will need to be developed, which will involve capacity-building through judicial, and specialist advocacy, training. This may also involve the establishment of specialist courts or tribunals which, in any event, is part of a discernible regional trend to meet the developing needs of an increasingly sophisticated market.
This is not an exhaustive summary of what will need to be accomplished, but it gives a flavour of what will need to be done. Conventional wisdom, borne of experience in Canada, New Zealand and other jurisdictions that have recently brought in VAT laws, suggests that it takes 18-24 months to implement a VAT system. Even if, as seems to be the case, the UAE and other GCC states are already well-advanced in planning, the timetable is ambitious. For it to be achieved, GCC governments will need to work consistently, and should encourage businesses to ready themselves for the compliance obligations that they will need to undertake.
The importance of reaching out to the public at each stage of this exercise should be emphasised. Keeping the public informed and, if possible, making sure of public support will go a long way to ensuring the ongoing success of the system. The collective benefits nationally and regionally for a GCC VAT system will be significant and will support GCC efforts to establish solid economic foundations for future generations. The challenges are immense and significant measures need to be undertaken over the next two years to prepare. VAT can be a complex operation, but through appropriate training, education and ongoing consultations, a successful outcome can be achieved.