The Implementation of Value Added Tax (VAT) in the UAE

United Arab Emirates (UAE) has been known as the tax haven for small businesses and salaried people. This situation has been present for more than two decades. The UAE has zero income tax. Prior to 2018, there were no significant indirect taxes either. Also, there are several free economic zones in the UAE area. If businesses are registered in these areas, then they don’t have to pay any taxes either! These investor-friendly policies are what has led the transformation of UAE from a desert to a thriving economic center.

However, it seems like UAE’s tax holiday is about to end. From 1st of January 2018, businesses all over the UAE will be subject to a 5% value-added tax. Implementation of a new tax is never easy and is likely to have several implications. In this article, we will analyze some of after effects that the introduction of this tax is likely to produce.

Reduction of Fiscal Deficit

Firstly, it needs to be understood that the Gulf States are under pressure. The heydays of Oil Producing and Exploring Nations seem to be over. The prices of oil in the international market have crashed. Oil sells for close to $57 per barrel, down from $120 per barrel barely two years ago. This steep fall in price can be attributed to a process called “fracking” which allows the extraction of oil from shale oil reserves. Since shale oil reserves are abundant, the world is no longer dependent on OPEC for their energy needs. This has led to a spectacular fall in prices.

Since the price of oil has halved, the revenue that nations like UAE used to generate from oil has also been halved. However, the expenditures have not gone down. As a result, oil-dependent nations like UAE are accruing debt at a staggering pace. If measures are not taken to immediately balance the budget, the oil-rich nations are likely to face an economic catastrophe. This is the reason why UAE is implementing a new tax system to beef up its revenues. UAE is not the only country to be doing this. Saudi Arabia has also introduced a similar tax to protect itself against such revenue shortfalls.

The revenues from VAT are supposed to be significant. If the projection targets are met, the VAT implementation will lead to additional revenues of $3.3 billion in 2018 and $5.4 billion in 2019. This is more than 25% of the annual budget of the United Arab Emirates. This increased revenue along with a reduction in oil subsidies will enable UAE to balance its books and prevent it from falling into a debt trap.

Moderate Inflation

The Value Added Tax is paid by every business on the amount of value that they have added. This means that they can charge 5% VAT on the goods that they sell. At the same time, they can claim the 5% that they paid to their suppliers as credit. Hence, the net effect is that they pay 5% on the value that they have added to the product. Hence the term used is value added tax.

From the nature of this tax, it is clear that this tax is paid by the consumers. As a result, it is likely to cause some amount of inflation. However, the UAE government insists that the price inflation will be minimal. The reasons for low levels of inflation are as follows.

  • Key goods that are used by the majority of the people have been kept zero-rated. This means that the government still levies no tax on such goods. Hence, the food and medical budgets of households is not going to be impacted thanks to the introduction of the VAT

  • Also, the government will closely monitor the prices during the transition period. They will check the tendency of the profiteers to raise prices in the name of new taxes.

  • Lastly, the UAE government believes that competition between the sellers will force them to absorb the price hikes with consumers facing minimal impact. This does not seem to be true. No business would want to reduce their profits and it is unlikely that they will pass on the benefits to the consumers.

Regulatory Costs

The UAE government has made it mandatory for all businesses to register for the Value Added Tax. This is regardless of whether VAT is applicable to them or not. Everybody needs to file a tax return. This is likely to create several regulatory costs. Some of these costs will eat up the incremental revenue that the government hopes to generate.

The costs will have to borne by both sides. The government will have to create systems to ensure that the tax is paid on time. Businesses will also need specialists to file these tax returns. The tax professionals in UAE are in short supply and they are charging a premium for their services. All businesses will have to hire these people to ensure that their papers are in order. These additional costs will also be passed on to the consumers.

Competitiveness of Retail

The competitiveness of retail in the UAE will also face a setback thanks to this new tax. People from all over the world used to flock to UAE to buy gold and electronics in large numbers. However, with the increase in tax, some of this price advantage will be nullified and UAE will witness declining retail sales during this period.

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