UNDERSTANDING VAT AND ITS IMPLICATIONS ON THE WAY OF DOING BUSINESS
What is VAT?
VAT is a multi-point taxation system, where tax is collected on a product at each stage of its production, based on the value added to that product. Tax paid on purchases (input tax) is deducted with the tax that is payable on sales (output tax).
VAT is a general, broadly based consumption tax assessed on the value added to goods and services that are bought and sold for use or consumption in the country. While the VAT ultimately falls on final consumers, the fractioned payment at each stage – whereby taxable persons (businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities – ensures the self-policing strength of the VAT and implies that the actual tax burden is visible at each stage in the production and distribution chain.
VAT implementation in the UAE is likely to begin from January 1 2018. However, businesses are likely to have a 12-18 month window in which to get their VAT processes operational. The Gulf Cooperation Council (GCC) is expected to adopt a standard VAT system with a single rate of 5% applying to most goods and services. However there are likely to be some limited exceptions, such as basic food items, which will be charged a rate of 0% VAT. Other sectors, like healthcare and education, are expected to be exempt from VAT – businesses in these sectors will be unable to register for VAT, so will not charge VAT.
Non-VAT registered businesses
Compulsory VAT registration thresholds have yet to be announced, but are expected to apply to businesses with annual turnover of somewhere between half a million to one million USD. Although this threshold may be significantly higher than the turnover expected by some SMEs, this is the right time to be thinking about how VAT will impact such businesses. If a business is likely to not be VAT registered, either because of not meeting the VAT turnover threshold or because the business operates within an industry likely to be VAT exempt (e.g., healthcare and education), it is worth reviewing the input VAT that will be suffered on the purchases that the business makes. These VAT costs will not be recoverable and therefore represent a real cost to the business.
Once VAT becomes effective in the UAE and business’ suppliers become VAT registered, any purchases bought from them will include a VAT charge. If any business is not VAT registered they will not be able to reclaim that VAT. A businessman may need to consider whether there are smaller non-VAT registered suppliers he could switch to, or if that’s not possible, to consider the impact of a higher cost base on his profit margins and how it will reflect in his product pricing.
Registered & Non-registered VAT businesses
If businesses anticipate a substantial capital investment coming up, it would be worthwhile considering how much of that could be pulled forward to before VAT is implemented in the UAE, so that large capital items can be purchased without suffering the VAT charge.
If there are long-term contracts with customers that will run over into 2018, it would be worth contemplating a ‘change / amendment of law’ clause to allow for contracts to be updated to charge VAT on top of the agreed prices when the VAT laws becomes effective (assuming the business will have to register for VAT). If this step is not taken, customers who may be reluctant to bear the VAT bill might insist that the business pay the VAT due on the contract out of their margin.
VAT registered businesses
A VAT registered business need not to worry, in layman terms, they need to pay to authorities the difference between the output VAT and input VAT. So what is Output and Input VAT.
Output VAT:- VAT you apply on sales. For example, sale value of an item ‘X’ is AED 100, and VAT rate is 5%, the business will charge customers AED 105, here AED 5 is output VAT.
Input VAT:- VAT paid on purchases, for example a business purchased the same items ‘X’ at cost price of AED 80 plus AED 4 VAT @ 5% VAT, total AED 84.
Thus, the business only needs to pay the authorities AED 1 – being the difference between the output VAT of AED 5 and input VAT of AED 4.
What does this mean to most businesses? Generally, no impact on the profitability, however it can impact the overall sales due to the additional VAT component of 5% included in the sale price making the sale more expensive for end users/consumers.
On the technical side – businesses will need to register for VAT, and will need to consider if they have accounting software that can record VAT, both on purchases and sales transactions, so that they have the necessary information readily available to report to the VAT Authority. If not, they need to consider the time line within which they need to begin adapting their systems and processes to allow for this.
Cause for Concern?
Not if businesses plan in advance. The bottom line is not a point of concern, but an opportunity to relook at the business’ operating model to make it leaner and smarter to compensate for the possible VAT impact for non-VAT registered businesses. Although it has the disadvantage of affecting the final price of goods, an advantage of VAT is that it encourages investment instead of spending. Also, since VAT is based on value add not on total price, the price does not increase as a result of VAT. Being VAT registered will add more credibility to a business as most customers/ suppliers would prefer dealing with only VAT registered companies. Customers/ clients that are VAT registered can reclaim the VAT that businesses charge them – this may not necessarily be an advantage, but then again it creates a more professional image and the customer may then be more inclined to use that business again in the near future, knowing they are both VAT registered and that they can possibly reclaim their input tax.
(This article has been compiled by our Partner, Mr. Stany Pereira, and Mr. Chaitanya Kirtikar, Senior Manager, Offshore and Free Zone Services.)