The much awaited Value Added Tax (VAT) system will be introduced in the UAE as from 1 January 2018. Although not each and every detail is known yet (also as e.g. in the UAE the Implementing Regulations have not been published yet), it is expected that VAT will be levied in the UAE and Saudi Arabia as from 1 January 2018, while the other GCC members should follow shortly thereafter (in any event before 1 January 2019). For prior coverage please click here for the link to our VAT alert of 10 May 2016.
The GCC VAT system is materially based on the VAT system as has been in place in the European Union since 1969. Stibbe as a leading Benelux law firm has substantial experience with the EU VAT system. We regularly advise businesses and government (related entities) about their (strategic) VAT position, assess (draft) VAT legislation, conduct VAT litigation before the Courts (including e.g. the European Court of Justice) and provide in-house training. Against this background, we will below highlight a couple of items which are particularly relevant at this stage. For now we focus on the UAE VAT law (although we expect that materially the same will apply in the other GCC jurisdictions).
VAT in a nutshell
In its very essence VAT is a tax on consumption of goods and services, which is borne by the consumer and collected by enterprises (taxable persons) that provide these goods and services. In principle taxable persons therefore do not have to bear the VAT they have to pay on goods or services they have received and used to make their supplies of goods or services.
In this illustration taxable person A sells his product for 100 + 5% VAT = 105. He will have to pay the VAT that he collects from the buyer (5) to the Treasury. Because taxable person B is going to use the product to make another taxable supply, he will be entitled to a recovery of the VAT he has paid to taxable person A (5), so that the product only cost him 100. When he sells the product to the consumer for 200, then the price will be increased with 5% VAT, so that the consumer will have to pay 210. The VAT included in that amount (10) will be collected by taxable person B and will be paid to the Treasury. This illustrates how VAT is collected in every step of the supply chain, but how it is ultimately born exclusively by the end-consumer.
VAT exempted/zero rated/5% rated
The standard VAT rate will be 5%. As a rule this new tax should not lead to additional expenses in a transaction between taxable persons (business-to-business), because the essential feature of VAT is that a taxable person can recover all VAT paid on goods and services received. This so called “input VAT deduction”, however, will only be available to the extent that such goods and services are used by the taxable person to make supplies of goods or services that are subject to VAT or that are zero rated.
Since VAT is a consumption tax the effect will be primarily felt by consumers. Therefore at first sight it may seem to be more interesting if a taxable person could supply goods or services that are VAT exempt. This, however, is not true in every situation, because taxable persons who make exempt supplies do not have the right to recover input VAT they paid on goods and services received.
When preparing for the introduction of VAT some strategical decisions need to be made with regard to the above aspects in order to balance the maximization of input VAT deduction and the application of exemptions.
At present only a very limited number of exemptions is foreseen, namely for (i) financial services, (ii) supply of residential buildings (subject to conditions), (iii) supply of bare land and (iv) supply of local passenger transport.
AT implications will be different per business sector
Because the applicable VAT treatment depends on the activities carried out, the VAT status of enterprises active in different business sectors may be very different.
First of all, certain ‘activities’ may not result in a qualification as a taxable person, because not every kind of turnover necessarily leads to taxable events for VAT. For instance, the mere collecting of dividends by a passive holding company would normally not lead to a taxable person status. Furthermore, government entities will in most cases not qualify as taxable persons either, unless their activities are conducted in a non-sovereign capacity and are in competition with the private sector. In the European Union these criteria have led to numerous discussions and case law.
The activities carried out could also be subject to a different VAT regime: 5% VAT, zero rate or exemption. Companies making both rated and exempt supplies will have a mixed status, meaning that they will only be entitled to a partial recovery of input VAT paid. This will typically be the case for financial service companies or real estate companies. For businesses in this situation it will be important to start structuring their activities in such a way as to make sure that the method to limit the VAT recovery is fully optimized.
Businesses delivering primarily zero rated goods or services may have specific VAT prefinancing issues. Zero rated are amongst others export, international transport of passengers and goods, the supply of crude oil and natural gas and the supply of basic healthcare services. These business will not collect VAT from their customers, but they will have to pay VAT on supplies made to them. Even though this VAT may be recoverable by them, the delay between the payment and the recovery of this VAT may imply important financing costs. Such practical timing aspects will be further dealt with in the implementing regulations.
VAT and real estate
Just like in the European Union, the real estate sector is a typical case where different VAT regimes can be applicable. In principal the supply of real estate will be subject to VAT, but there is an exemption for the supply of bare land and the supply of residential buildings. The supply of the latter will however not be exempt, but zero rated (thus giving the real estate company the right to recover VAT) if the supply is the first supply of the residential building within three years of its completion or after its conversion from non-residential to residential.
Crossborder transactions in the GCC (compared to the EU)
Cross border transactions of goods or services between taxable persons within the GCC will follow a typical logic of zero rate in the country of the supplier and taxation upon importation in the land of the receiver. Typically the receiver will then have to pay the VAT directly to the Treasury and not to the supplier.
This system is inspired by the European regime of intracommunity transactions between the EU member states. This system has proven to be very fraud sensitive. Taxable persons who carry out this kind of activities have to be very careful to properly identify their customers. They need to ascertain amongst others that their customers are effectively taxable persons in the other GCC country, otherwise they may wrongfully zero rate their supply and risk sanctions.
The introduction of VAT will bring along many changes in the way businesses are run. Businesses should start preparing for this in a timely manner. Since 1 January 2018 is coming closer, it is the highest time to start preparing strategical decisions to optimize your VAT status and to put the necessary procedures in place to keep your business safe from high penalties and involuntary involvement in cross border fraud. We are confident that Stibbe's experience with the EU VAT system can provide you with further guidance that will help you anticipate the issues that can be expected after 1 January 2018.