What does VAT have in store for Gulf wallets?

The introduction of VAT is one of the steps the GCC (Gulf Cooperation Council) countries have taken to fight the consequences of low oil prices. The International Monetary Fund (IMF) estimates the new tax will raise about 1.5 percent of GDP in the GCC region.

The rate of VAT has been confirmed at 5 percent, however it does not necessarily mean that each national VAT law will be identical, nor that those national laws will all become effective on exactly the same date.

Some goods and services - basic food items, essential medicines and exports of goods and international services - are expected to be zero-rated supplies, and other provisions such as healthcare, education, sale or lease of residential property and finance and insurance are also expected to be exempt from VAT.

In the UAE, it was announced that some sectors such as renewable energy, water, space, transport and technology might get special treatment as well.

Although the implementation date is 1 January 2018, there is a long-stop option which requires full implementation by 1 January 2019.

Not just a tax issue

In government communications on VAT, the company is presented as the collector of tax on behalf of the government and the end buyer is the one who bears the cost of it. Can we expect businesses to rethink their pricing too, or will prices go up 5 percent across the board?

Dr. Cedwyn Fernandes, the Director of Middlesex University in Dubai, explains that the extent to which the incidence of the tax is shared between the buyers and sellers will depend on the elasticity of demand for the product.

"With products and services which are inelastic, implying that the percentage decrease in demand will be less than the percentage increase in price, a substantial part of the tax will be pushed onto the consumer," he says.

Can we expect businesses to rethink their pricing too, or will prices go up 5 percent across the board?

The question of how much VAT is passed on to the consumer will depend on what stance competitors take. Will they collude and decide collectively not reduce their price?

"In an oligopoly market with few sellers, there is more chance of collusion and passing the tax burden onto the consumer than in a market where there are many sellers. For example, many of the products are imported via agencies which then distribute it to the retail outlets. I expect that the agency which in effect does not face competition will not be willing to take on the tax incidence," points out Dr. Fernandes.

Kate Bacon, Manager at Indirect Tax, Deloitte & Touche Middle East, agrees that businesses will have some interesting commercial decisions to make.

"In general, whenever we have seen the introduction of a VAT or GST tax, or its increase, the overall inflation within the market is seldom the full value of the rate introduction or increase," she says.

"As a result, it is unlikely that we will see prices rise by 5 percent across the board. The extent of inflation within the market will be affected by many factors – the degree of zero-rated or exempt products within the market (and within the GCC this is not expected to be very many), and the extent to which suppliers within the market choose to bear some or all of the VAT cost themselves. 

"It is this latter factor which is most difficult to predict as it depends on the price elasticity of the product in the market at the time."

Bacon further explains that demand is rarely completely inelastic and therefore businesses may need to undertake detailed price modelling to understand what effect the introduction of VAT could have on demand for their product.

Businesses may need to undertake detailed price modelling to understand what effect the introduction of VAT could have on demand for their product

Pierre Arman, Market Development Lead - Tax & Accounting and Global Trade Management at Thomson Reuters, adds that although businesses don't have to shoulder the tax, they will face the costs on the administration side as VAT is a process intensive tax.

"This is exponentially true in the GCC where the tax landscape has been kept to a minimum and the concept of indirect tax is a new concept for many. Companies need to engage tax advisers to assess how VAT will impact them and invest in the necessary technology, processes and potentially new resources so they can be compliant by the beginning of 2018."

How will VAT affect purchasing power?

So what does the new tax mean for general public; and can we expect any change in customer behaviour and spending habits? Dr Fernandes doesn't think so.

"I don't expect a major change in consumer spending habits as a VAT of 5 percent is not a prohibitive increase. And most non-essential items like perfumes, luxury fashion, big ticket electronics are not that price-sensitive given the purchasing power of the customer in this market segment," he says.

Pierre Arman acknowledges that as end consumers carry the burden of the tax, all of us will be affected.

The rate of 5 percent is low compared to the world average of 19 percent

Nevertheless, he points out, the rate of 5 percent is low compared to the world average of 19 percent (27 percent in Hungary), and in addition, VAT is a consumption tax so by definition the more you consume (especially high value or luxury items), the more you pay, so the low income citizens who are less likely to consume luxury items often, will not be so affected.

Also, the GCC governments are going to issue a list of items, mainly basic commodities (such as food), on which VAT will apply at 0 percent, so these prices are unlikely to increase, and the most vulnerable citizens should be protected.

"I wouldn't expect any major customer behaviour shift apart from a temporary increase of luxury item consumption in the fourth quarter of 2017, and a temporary consumption slowdown of these items in the first part of 2018," Aman says.

Kate Bacon also expects that we will see a change in consumer behaviour spanning the introduction of VAT, at least in the short term.

"This is likely to look like a 'boom' in activity prior to the introduction of VAT, as consumers 'accelerate' purchases in order to save the 5 percent VAT. This is particularly likely to be the case where high value household items are concerned, e.g. furniture, new cars etc. It's also possible that businesses might seek to encourage this behaviour through pre-VAT promotions, in order to boost sales and generate extra profits in the period prior to implementation."

The extra profits generated from pre-implementation spending could therefore help to carry businesses through the quieter period that will inevitably follow

She goes on to say that this could be an important tactic for retailers in particular, as a slump in consumer spending in the period immediately following implementation can be expected.

The extra profits generated from pre-implementation spending could therefore help to carry businesses through the quieter period that will inevitably follow.

Adjusting the fundamental social contract?

In the end, it's not just about the money. After being a part of patriarchal rentier states for so long, how will people cope with the concept of paying tax? Just a couple of years ago many prominent people and media criticised the very idea of taxation as un-Islamic.

Even the IMF in its paper, "Learning to live with cheaper oil", acknowledges that "implementing further large fiscal adjustment is no easy task. It will require difficult choices and adjustments in the implicit social contract between governments and citizens".  

'Introducing VAT sends a strong signal externally on the willingness to build stable and sustainable economies in the region' - Pierre Arman, Thomson Reuters

Thomson Reuters' Pierre Arman suggests that citizens in the GCC have actually been used to the concept of tax in some respect - the UAE has a tax on foreign banks, foreign companies in Qatar are subject to 10 percent corporate tax and local companies based in Saudi Arabia are subject to Zakat at 2.5 percent on their profits, which is both a religious obligation and a tax under Islam.

"That being said, indirect tax is a new concept and a paradigm shift for the GCC economies, most of which are commodity based economic models where revenue is mostly generated out of natural resources.

"But with the recent fall of oil prices, governments have introduced bold initiatives to diversify their revenues so they can sustain their strong social economic model. Part of these reforms is the introduction of VAT as a new consistent source of revenue. Citizens and companies will need time to adapt to this new norm, but introducing VAT sends a strong signal externally on the willingness to build stable and sustainable economies in the region."

Dr. Cedwyn Fernandes, too, is convinced that people understand the need for new taxation, even if they don't like it much.

"GCC governments still provide substantial social services to its citizens and provide outstanding infrastructure, safety and security to all residents. Oil is a non-renewable resource and also prices are declining and people understand that government cannot be expected to provide world class services forever without alternate forms of revenue.

"People living in the GCC countries are global citizens and know of the amount of taxes that are paid world over. In comparison a 5 percent VAT on non-essential commodities is not considered a burden, especially given the services that the government will provide," he concludes.


Stasa Salacanin is a freelance journalist who has written extensively on Middle Eastern affairs, trade and political relations, Syria and Yemen, terrorism and defence.

Opinions expressed in this article remain those of the author and do not necessarily represent those of The New Arab, its editorial board or staff.