For years the UAE has been touted as a tax free haven. This month we break down the necessity and impact of VAT in Dubai.
Value added tax has long been the bane of the consumer, ever since it was first introduced in France in the mid 1950s. It has slowly crept up on developing societies, and now is about to hit the GCC. This is a worry for residents, especially in Dubai given the rocketing cost of living that has plagued the emirate in recent years. Nevertheless, it is time to face the reality that a tax must be introduced, with VAT hitting the UAE within the coming two to three years.
The implementation of VAT is not necessarily a blame game, because a tax of some sort is a natural evolution for the UAE. But, if you want to point the finger of blame at someone, blame the IMF. In their 2005 Staff Report on the UAE, the IMF recommended "broadening the tax base and introducing the VAT system" But don't be too harsh in your judgment - their recommendations come with good logic.
There are three reasons why the tax is necessary: one, the federal government currently has no revenue streams that fall under its own control and rely primarily on payments from Abu Dhabi and Dubai; two, with free trade agreements in discussion stages with the US, EU, Australia and China, customs duty will have to be removed leaving minimal revenue from the remaining countries; and three, there is essentially limited monetary policy control with the Dirham being pegged to the US Dollar.
But let us clear one thing up - taxes do already exist. Profits of the international banks and the energy firms are taxed at the federal level. Visit any hotel in Dubai, even for a meal and slap another 10 per cent on to the bill. Alcohol? - Well, that is taxed at50% on entry to the country. Maintenance fees at the free-zone developments are considered tax equivalent also. And if you didn't know, there is also a council tax that is secretly picked up through utility bills.
But what exactly is VAT? VAT is an indirect tax levied on the sale of goods and services. It is classed as an indirect tax, because it is a tax that is collected from someone other than the person who actually bears the cost of the tax. VAT is therefore likely to be an administrative hassle for firms, since they will essentially collect the tax for the government. Look at it this way - VAT is a saving grace for the consumer - if there was an intention to take the direct approach and tax income, there would be all sorts of ramifications. Psychologically, VAT is easier to stomach than income tax. In any case, the UAE currently does not have an accurate enough financial system to be able to implement an income tax. What the VAT will do is start to force companies to fill in a tax return and finally create some semblance of accurate financials and visibility.
Some opponents say, why tax now? Oil is at an all time high. The UAE is in budget surplus - everything looks more or less rosy. That is exactly the point. While oil is expected to remain at a relatively high level in the short to medium term, historically, it is highly volatile. Less than 8 years ago, we were looking at $10 a barrel. And while hedging against future oil losses might be an option, bringing in a tax to stabilise the federal budget and looking beyond the current oil boom, coupled with a discretionary fiscal spending policy should further impress long term investors that the UAE is serious about planning for the future.
What rate would VAT come in at? Most likely, the starting rate would be between five and seven per cent in order to cover the lost income from implementing the free trade agreements. And so, in theory, it should not have much effect on the consumer, if there is a straight swap, since many goods are currently imported. However, keeping an eye on inflation would be sensible as well as policing companies preventing them from passing down more charges that are actually necessary. It would also be prudent to phase in the VAT, firstly on inelastic type goods, such as tobacco as well as on electrical and luxury items such as cars, with a second phase on other products. And to protect the effect on the lower middle classes, there would need to be exemptions on basic goods and services such as bread and medical care, for example. Furthermore, it would also have to be exempted from the free-zones, or this would lead to companies citing promises broken, breaking down investor confidence.
How will tax affect competition? Not much. A five per cent VAT implementation will not change the perception of the UAE as a low tax destination or hurt economic activity. Indeed, as there will be no personal tax, the label of "high quality, low cost environment" will still remain. VAT would be positive with regard to fiscal reform and would most likely not hurt the competitiveness of the UAE. Bear in mind, firstly, that the GCC as a region would most likely follow suit in the same direction as the UAE as it moves forward to a common market in 2007 and monetary union in 2010, by economic convergence. This would mean that, assuming free trade agreements are signed in 2006, that VAT would be implemented before these agreements were fully implemented, i.e. within two years of signing the agreements.
What's next on the tax agenda? Are you worried that income will get slashed? There's no need to at the moment. The IMF's next recommendations are a property tax and a corporate tax across all sectors. No comment on that just yet, but it is all a matter of time. The oil in Abu Dhabi won't last forever.
The main issue is in the implementation of VAT. Lessons will be learned from the recent realization of VAT in India. If the tax is to succeed, it will need to be meticulously planned and conceived. No doubt the IMF and Dubai Customs are doing that as we speak. The UAE has undergone a major transformation which needs a fresh approach for a changed economic reality. The time to change for the future is now.