Experts from Deloitte Middle East share critical insights on the way moving forward…
What is VAT?
VAT (Value Added Tax) is a tax on goods and services which is applied to each and every transaction within a supply chain – it is due to be introduced at a rate of five per cent in the UAE and across the GCC on January 1, 2018. The legal framework of the VAT system will be an overarching VAT Treaty agreed between the GCC states, followed by domestic VAT legislation in each individual state interpreting the principles of the Treaty and setting out the manner of its application in the country.
Globally, all VAT systems are based on a common set of principles.
VAT is charged to customers by businesses, which then collect the VAT paid by the customer and pay that VAT over to the Tax Authority. Businesses within VAT jurisdictions are often referred to as ‘unpaid tax collectors’ as a result.
Businesses will also be charged VAT by their suppliers. In the majority of cases, VAT-registered businesses will be entitled to recover the VAT they have paid to suppliers by offsetting it against the VAT they themselves are due to hand over to the Tax authority. However, individuals and businesses which are not able to register for VAT (which could include many SMEs) will not have an ability to recover the VAT they pay to suppliers. It is these final consumers and non-registered businesses which bear the cost of VAT. It is therefore crucial that SMEs establish whether –
a) They have a requirement (or an ability) to register for VAT,
b) They are likely to be able to recover the VAT on their purchases, and
c) They are able to pass the increased cost on to their customers.
The impact of VAT on SMEs
It is not known what the VAT registration threshold in the UAE will be definitively, albeit comments made in the press by Ministry of Finance, officials suggest it could quite high along with a voluntary registration threshold set at half the compulsory limit. The higher the threshold, the larger the population of SMEs which fall outside the VAT net. This SME population will therefore be required to assess the benefits of voluntary VAT registration versus the cost of absorbing the VAT on their purchases. Given that the GCC Treaty and domestic VAT law is yet to be released, it is unclear whether these registration thresholds will stand or whether there will be a policy change to move the threshold either up or down.
In the event that the registration threshold remains as announced, the smallest businesses (i.e. those below the threshold) will not be required to undertake VAT compliance responsibilities (filing returns, issuing invoices, maintaining records etc.). Whether this is a good thing will depend upon a variety of factors such as the business’ typical customer profile (business or private individual), the industry in which the business operates, the capacity of the market to absorb price inflation, the typical categories of purchases made by the business (subject to VAT or not) and so on. However, the lack of VAT compliance obligations does not mean that VAT is not going to have a large impact on small businesses. Those that cannot register for VAT are unlikely to be able to recover VAT on their purchases, meaning that VAT charged by their suppliers will lead to a direct increase in the cost of sales. Companies that are likely to fall below the thresholds should start reviewing the impact irrecoverable VAT could have on their business.
Those businesses that have the option to register for VAT need to weigh up the implementation costs of registering versus the additional VAT cost they are likely to suffer on their purchases.
For those that exceed the VAT registration threshold and therefore will be required to register for VAT, the changes which need to be managed across the business will be significant. Implementation is likely to require significant system overhauls, renegotiated contracts, renewed pricing strategies and a widespread staff training programme as a minimum. Even though the intended VAT rate of five per cent is relatively low and we expect the majority of VAT-registered SMEs to be able to recover most, if not all, VAT incurred on purchases, the cost involved in preparing for VAT implementation and ensuring VAT compliance obligations can be met will be significant.
Large businesses may appear to be better equipped to deal with these changes in the coming 12 months, but only if they begin taking steps as soon as possible. The accounting software used by larger businesses tends to be more comprehensive, there is likely to be more resources within the business, and they generally have the financial ability to bring in specialist VAT consultants to advise on the VAT implementation process. SMEs, in contrast, may be constrained by a lower budget, fewer internal resources and limited accounting software. They are also likely to be more resource-constrained in terms of both staff availability and the financial ability to engage specialist consultants. It is therefore important that SMEs take a functional approach to VAT implementation – they should focus on what they need to get right and put measures into place to achieve that in the most cost effective and time efficient manner.
What to expect in 2017?
2017 will be the year of preparation and dissemination of information about the introduction of VAT. In October 2016, the law creating the Federal Tax Authority was announced by the UAE Government. 2017 will see the Government prepare for the administration of VAT by recruiting staff into the Federal Tax Authority and by setting up the infrastructure to allow businesses to submit VAT returns and make VAT payments.
We also expect that 2017 will see the publication first of the GCC VAT Treaty (which will give the broad rules of the VAT system applicable across the GCC) followed by the UAE VAT Law. Whilst these publications will give businesses certainty over the VAT rules to apply within the UAE, businesses should take caution and not expect that the law will answer every question they have about VAT and their business. Equally, businesses do not have the time to sit back and relax whilst they wait for the law to be published – the vast majority of VAT rules can be predicted based on the operation of VAT and GST systems across the world. Businesses should begin their preparations for VAT now, taking a ‘best guess’ approach to some of the finer detail for the time being which can then be revisited and confirmed once the domestic VAT laws have been published.
How can SMEs prepare for VAT implementation?
Early preparation and training is key for all businesses, regardless of size. To maximise preparedness, SMEs should start considering the impact VAT may have on their business now. Attending seminars, keeping up to date with VAT announcements in the news and on government websites is a good start for understanding how the VAT system is likely to work. SMEs then need to apply their new understanding to the circumstances of their own business to work out how they will be impacted.
Broadly, the impacts which need to be considered can be categorised across three key levels:
- Organisational/strategic level – what are the overall business impacts? Headline impacts at a Board level – on company structure, market positioning and negotiation with customers and suppliers.
- Operational level – how does VAT affect day to day operations? A wide range of business processes across all market-facing and business support functions will require review and potential modification to become VAT-ready.
- Financial level – what is the economic impact of VAT on the business? Impacts including: overall costs and cash flow caused by inclusion of VAT, availability and cost of appropriate resourcing, cost and business impact of major technology and process changes, impact of VAT on overall finance/tax governance and strategy.
Ideally, all businesses should contact VAT specialists to assist them to undertake a VAT impact assessment so they can fully understand the implications of VAT on their business and the essential steps that need to be taken to have any chance of being ready for the go-live date on January 1, 2018.
Regardless of whether you seek advice from a VAT specialist or not however, the key takeaway we would like to reiterate is that VAT is not simply a finance ‘problem’ – it affects the business across the board and pro-active steps need to be taken in order to achieve compliance from Day One. SMEs should start now to assess their readiness for VAT implementation before time runs out.