Value Added Tax in the GCC Insights by industry | Volume 1 · such that it is the final consumer of goods and services, generally in their private capacity, that should bear the total

Value Added Tax in the GCCInsights by industry | Volume 1

Ninety years in the Middle East

Deloitte Value added Tax in the GCC | Insights by industry

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Deloitte | Value Added Tax in the GCC | Contents

Contents

04Chapter 1 Introduction

10Chapter 2 Preparing for changeVAT – It’s coming, so how dowe go about preparing for it?

16Chapter 3 Retail industryRetailers, VAT and the pricingconundrum

20Chapter 4Automotive industryGearing up for change, theview ahead for dealers andbuyers

26Chapter 5 Meetings, Incentives,Conferences, and Events industryLead times on the VAT challenge

32Chapter 6Financial Services & InsuranceindustryWhy VAT, Financial Services andInsurance are a difficultcombination

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Deloitte | Value Added Tax in the GCC | Introduction

Introduction

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VAT, but why now?On June 16 2016, ministers representingeach of the Gulf Cooperation Council(GCC) Member States met in Jeddah, SaudiArabia, to discuss the introduction of valueadded tax (VAT) in each of their nations. Itwas confirmed that during the meeting amulti-lateral agreement has been reachedto implement the tax, but that theremaining details of the plan, or morespecifically the GCC VAT Treaty, would befinalized at a meeting to be held inOctober this year. These developmentsmark the start of some of the mostexciting, dramatic and far-reachingsocioeconomic changes in the regionsince the discovery of oil reserves incommercial quantities during the 1960’s.

This news on VAT is not new, however.Rumors have been circulating for manyyears, occasionally coming to a head butsubsiding shortly thereafter, aboutmultilateral and unilateral efforts toimplement the tax. But whilst the demandfor VAT was previously driven by anoverarching fiscal reform agenda withinwhich VAT would be introduced as a “niceto have,” the volatile hydrocarbon marketscoupled with larger and relatively fixedpublic spending commitments have,arguably, turned domestic revenue raiserslike VAT into a “need to have” for many.

Around the GCC, the dependence on oil asthe principal contributor to GDP (and thepublic purse) differs quite substantially.The UAE, having pursued fiscaldiversification policies for many years,generates around a third of its GDP via theoil economy. Kuwait on the other handturns this ratio on its head; almost 65% ofits national output is derived from thehydrocarbon industry. Whilst that is notthe only measure of exposure to achallenging international oil market andthe consequences for a domesticeconomy, the fact that hydrocarbonsaccount for around 50% of GCC output onaverage provides the backdrop againstwhich policy makers are now striving tomake meaningful long-term changes.

The new-normal for oil producingcountries looks increasingly like US$40-60per barrel, and as a result most countriesin the GCC are now running deficits.Although these can be sustained, even inthe long term in many cases (cashreserves in the GCC are estimated toexceed US$754 billion), policy- makers arefaced with two options; cut spending, orraise new revenue on a sustainable basis.

Cutting spending to any significant degreeis unrealistic; the region is in growth modeand a range of important but costly

programs of lasting significance areunderway. In the alternative, imposingtaxes – even if only at a very low rate – in a region that has historically remained a“tax free” outlier appears to offer the mostpalatable long term solution.

And so to VATVAT is a tax on consumption, not profits,and for many policy-makers it provides thepreferred means of raising public revenuewithout sacrificing much private sectoractivity in the process. Essentially,introducing VAT is not a cost-less exerciseeconomically speaking, but rather it is lesscostly than introducing a corporate orpersonal income tax. Across the OECD,VAT represents around 6.5% of GDP andapproximately 34% of total taxes raised.Recent estimates have indicated that inthe GCC a VAT at 5% would representaround 1.4% of GDP, a figure whichreflects on the relatively large share ofpublic participation in the 6 economiesand the low rate being considered. Indeed,a rate of 5% is around a quarter ofaverage rates in the OECD (19%).

To some extent, however, the ratediscussion is somewhat irrelevant. The tax plans being deployed by GCC policy-makers are designed to enable long termfiscal sustainability and stability; this is notan exercise in short-termism. Creating aneffective tax framework, creating newadministrative capacity and deployingbest-in-breed administration systems is,even at a low VAT rate, a vitally importantstep along the road to a taxingenvironment that serves the needs of afully developed non-oil economy, in timemore effectively.

But why VAT?VAT can be found in more than 160countries today. Recent introductions ofthe tax into major economies have takenplace in Malaysia (2015) and China (2014),whilst all of the EU Member States, NewZealand and Australia have beenoperating the tax or its equivalent, Goods

GCC non-oil GDP share 2015/16

76

24

44

56

37

63

49

51

66

34

57

43

0

10

20

30

40

50

60

70

80

90

100

Saudi Arabia

Oil Non-oil

J

United ArabEmirates

Qatar Kuwait Oman Bahrain


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and Services Tax (GST), for decades. It isrelatively simple to administer due to itsdesign around self-assessment principles,and the fairly straight-forward nature ofthe underlying tax code compared toother tax types. A broad-based, low-ratedesign also limits the extent to whichinvestment and spending decisions aredistorted.

On a more basic level, the preferred“credit-invoice” version of VAT works byhaving all VAT registered suppliers chargeVAT on most if not all of their transactions,whilst allowing registered purchasers tocredit for VAT that they have paid usinginvoices issued by suppliers as evidencefor that claim (i.e. VAT should be neutralbetween VAT registered businesses).

The VAT charged by suppliers is paid overto the tax authority, whilst VAT credits forVAT paid out by those suppliers is claimedby them, effectively being netted offagainst the VAT collected, at all stages ofproduction. Indeed, the design of VAT issuch that it is the final consumer of goodsand services, generally in their private

capacity, that should bear the total cost ofVAT accruing along the supply chain; VATcharged by the final supplier in that chainis paid over to the authority but cannot berecovered by the person to whom it wascharged.

Details, details, details!Although the basic theory behind theoperation of VAT is conceptually simple, in practice the rules can often be quitecomplex. In some cases this complexity is required in order to limit or preventinstances of avoidance or evasion with the intent of the tax. In other cases it isassociated with the existence ofexceptions from the normal operation of the tax, those exceptions beingdeliberately designed to achieve certainsocial or economic ends. These exceptionsare often aimed at neutralizing thepotential regressive nature of the tax, andensuring that the primary focus is onconsumers’ discretionary spend, ratherthan the essentials for life.

Importantly, however, self-assessmentrequires that businesses “get it right” in

Bahrain

Jan 15

120

100

80

60

40

20

0

FTI cruide oil price (US$ barrel) 2015-16

Jan 16

Source: IMF, OPEC

Fiscal break-even 2015/16 (US$ barrel)

Kuwait Oman Qatar SaudiArabia

UAE

107.

5

96

73.1

94.8

66.7

69.1

71.8

52.1

49.2

2015 2016

95.1

51.8

52.4

VAT is a tax onconsumption, not profits,and for many policymakers it provides thepreferred means ofraising public revenuewithout sacrificing muchprivate sector activity inthe process. Essentially,introducing VAT is not a cost-less exerciseeconomically speaking,but rather it is less costlythan introducing acorporate or personalincome tax.

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order to avoid penalties; getting it rightcan be more difficult for some thanothers.

Business impactsAnd so with many predicting theprogressive implementation of VATthroughout the GCC from January 1 2018,the time does appear to be upon us all tostart looking in detail at the potentialimpacts it will have on businesses,whether from an organizational,operational, commercial or financialperspective. VAT is often described asbeing cost-less for businesses. While as a general statement this may have anelement of truth, in many (though not all) cases it is not cost-less from theperspective of a business preparing forchange and managing their newobligations.

To help businesses in the GCC understandthe potential impacts of theimplementation of, and operation under,VAT, Deloitte Middle East is issuing anumber of short papers under a numberof volumes designed to provide a greaterunderstanding of the impacts of the taxon specific industry types. We try, where

possible, to outline the scenarios whichare most likely and possible responses tothem in order to give a fuller flavor of thechanges to be expected.

This first volume provides an overview ofhow businesses should go about shiftingfrom thinking to implementing, andputting themselves in a position to submitaccurate, on-time VAT returns. In additionit looks at the retail, automotive, Meetings,Incentives, Conferences and Events (MICE)and financial services and insuranceindustries.

ContactsShould you have any questions aboutthese papers or just want to speak to us, please feel free to contact JustinWhitehouse, Middle East Indirect TaxLeader on the details listed below. If youwant us to consider your particularindustry as part of our series, we would be pleased to take your suggestion.


Justin WhitehouseIndirect Tax LeaderTel +971 (0) 4 [email protected]

VAT – It’s coming,so how do we goabout preparingfor it?

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Deloitte | Value Added Tax in the GCC | Preparing for change

Chapter 2 – Preparing for change

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The introduction of VAT marks a majorshift in fiscal thinking in a region where, for many businesses, tax is a relativeunknown.

Even for those operating in Saudi Arabia,Qatar, Oman and Kuwait paying corporateincome tax or ZAKAT, it has to beremembered that VAT requires a verydifferent perspective. Being a transactionaltax - rather than one which is simply leviedon profits - its impact across businessoperations can be significant. Indeed, suchis the range of its potential impact that it ishard, if not impossible, to contemplatethem all in one sitting.

To some extent it is possible to break theimpacts of VAT implementation down intothe following categories: • Those which have a bearing on thedesign of the organization;

• Those which have operational impactsrelating to areas such as businessprocesses, the underlying technologythat supports them and the peopleentrusted to carry them out;

• Those which have a financial impact interms of absolute tax cost, workingcapital implications, and which requireclose examination of purchase andselling pricing; and

• Those that affect operational decisions,commercial arrangements and businessrelationships.

There are many other ways to categorizethem but these headers are helpful interms of framing a response to therequirement to prepare for VAT and, asthe case may be, moving through theprocess from identifying the impact to theway in which transactions should beaccounted for to making meaningfulefforts to prepare the business for thechange.

Getting to grips with change“Tax” tends to suffer from being a low-priority issue for many businesses. Tomany it is an unfortunate but necessaryreality, and handled accordingly. In thisregard, it is important to understand thatat its foundation, VAT is often referred toas a “self-assessed” tax, meaning that theonus is on the taxpayer to get things right.Further, the tax is generally framed in sucha manner that the supplier of the goodsor services is responsible for the collectionand payment of the tax.

As such, the tax is effectively assessed onan inclusive basis, meaning that a portionof the revenue generated by a businesswill be handed to government by way ofthe VAT collected, unless pricing revisionsare made to protect revenues, orcommercial arrangements take account ofthe need to on-charge the VAT. Likewise,purchases made by the business are likelyto be subjected to VAT and, whilst that VATmay be recoverable, unless the cash-flowimpact of that short-term cost has beenmeasured and catered for, a workingcapital squeeze will be inevitable.

The typical design of a VAT regime alsoincorporates some fairly hefty penaltiesfor getting things wrong. Sometimes thesecan be levied on a personal basis on theofficers of the business, but perhaps moreimportantly, the powers granted to taxauthorities that administer VAT can extendto allowing businesses to be closed downand assets liquidated in cases ofpersistent non-compliance. Finally, somecountries will even extend to the threat ofimprisonment for non-compliance, albeitthis is likely to be applied only in the worstcases. Bearing this in mind, mostbusinesses need to move quickly to makethe necessary changes to their short termplanning “get things right”.

The tax is effectivelyassessed on an inclusivebasis, meaning that aportion of the revenuegenerated by a businesswill be handed togovernment by way ofthe VAT collected, unlesspricing revisions aremade to protectrevenues, or commercialarrangements takeaccount of the need toon-charge the VAT


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Instituting changeSo how do we identify what needs to bedone to take a business from its currentstate, to the post-VAT implementationstate?

The first thing that needs to beunderstood is that, in the case of VAT, thisis a complex ‘whole of business’ process.Sometimes it is difficult to see VAT asanything other than a finance process andso it is tempting to ‘hand it over to finance’,but this rarely works. The reasons for thisare simple – as a transactional tax, VATimpacts every part of the business. Thelegal department needs to understand it so they get contracts right (pricing), themarketing department needs tounderstand it because the tax authoritiesrarely like some of the more inventivemarketing schemes that may be used, for reasons explained in Chapter 3, theprocurement function needs to thinkabout VAT before the VAT implementationdate and the list goes on.

So VAT change as a process needs to beapproached in a structured way so that atcompletion of the process, the businessowners have comfort that everything thatneeds to be done has been identified, andthere are no major areas that have beenmissed out completely. It is highly likelythat there will be issues identified post-implementation, but if the approach toimplementing VAT is well planned,considered, and undertaken methodically,any such issues should be relatively minorand have no significant long termconsequences. In this regard, it is as much a risk management exercise as an implementation process.

What are the structures that wewould suggest?The best way of proceeding is therefore toidentify the Project Owner or sponsor inthe entity. That person should be the

one that will ultimately report back to the Board - often through a ProjectGovernance Board comprising membersof the Board of Directors. It is the Project Owner that should chair theimplementation Steering Committee.

Typically the Project Governance Boardwill include Board members and seniormanagement that will not be directlyinvolved in the Implementation Process,but will have an interest from theperspective that their area ofresponsibilities will be affected. They willtherefore require that they be updated on the progress of the project, and maywish to retain the underlying decisionresponsibilities for when the project canmove from one phase to the next. This isessential to ensure that all aspects of thecompleted phase have in fact been signed off.

This may, of course, not always bepossible without holding up the progressof the overall project, so the ProjectGovernance Board will typically need to beconvinced that adequate alternative stepsare in place to address any unresolvedissues that may be preventing thecompletion of the phase which is to besigned off.

The Implementation Steering Committee(as distinct from the Project GovernanceBoard) should include representativesfrom all of the significant functions withinthe business: finance, procurement, salesand marketing, HR, legal, logistics, ERP and AP/AR at a very minimum as they will need to report to the Project Owner.Being a member of the SteeringCommittee is not a prestigiousappointment with no substance – it is an important function.

It requires that members have a deepunderstanding of the areas of thebusiness which they represent. They will also have responsibility for ensuringthat the discussions on processes andtransactions undertaken by their area ofoperations are dealt with by the peoplethat have the deepest knowledge of the practicalities of all transactionsundertaken by their area of responsibilityand are in a position to identify all thevariations so that they can be addressedin determining the treatment under the VAT.

VAT change as a process needs to beapproached in a structured way sothat at completion of the process, thebusiness owners have comfort thateverything that needs to be done hasbeen identified, and there are nomajor areas that have been missed outcompletely


Having established the internalreporting structures, what is theprocess thereafter?The initial stages of the process will alwaysneed to start with establishing a basicunderstanding of VAT amongst those thatwill be involved, either in the SteeringCommittee, or in interacting or reportingdirectly with members of the SteeringCommittee, during the implementationprocess. These staff members will allrequire a basic level of training so thatthey can respond to questions onstructure and process around transactionsand systems with an understanding of thecontext and importance of the questionand the method of response. This willform an integral part of what is generallyreferred to as the Impact Assessment.

The Impact Assessment process is aimedat establishing where the business ispositioned in relation to its ability torespond to the changes that will berequired for the implementation of VAT. It is intended to highlight the currentposition so that Deloitte’s staff can thenassist the business in undertaking the next stage – that is planning the processrequired to achieve the implementation of VAT within the business.

Deloitte typically utilizes a computer basedinteractive questionnaire as a basis forensuring that there is coverage over allaspects of the business, and in order tominimize the risk of non-standardtransactions not being addressed. Theresponses received, when interrogated by experienced VAT consultants shouldensure that the risk profile and areas ofconcern, or the areas requiring furtherfocus, will be identified readily so that theycan be addressed during the planning ofthe implementation project.

Once the Impact Assessment process iscomplete, this should form the

foundations of the project plan that isintended to drive the business through toimplementation of VAT. Without theImpact Assessment a business mayunderstand where it needs to be byImplementation date, but it will not havean ability to determine, or understand,what needs to be achieved in the periodup to Implementation date. As such, theImpact Assessment is crucial to thisprocess.

After the Impact Assessment process has been completed, the role andresponsibility of the Steering Committeechanges subtly, as it now becomes one ofchoosing the various staff members thatneed to take responsibility for variousfunctions within the Implementation plan,and monitor them on that journey.

It will also need to become activelyinvolved in ensuring that timelines areadhered to, and any issues or concernsare brought to the attention of the ProjectOwner so that decisions can be made as

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In undertaking the Implementationprocess, it should always be rememberedthat there are defined sectors orfunctions within the business that driveits progress. These efforts need to beenabled through a range of businessprocesses, technologies and a range ofpersonnel trained to ensure a relativelysmooth procure-pay-sell experience forsuppliers and customers alike.


to what alternative actions are available tothe business. This may require amendingthe manner in which a transaction takesplace, altering or updating contracts,engaging with others within the supplychain that may be impacted, or applyingfor clarification from the relevantauthorities as to the basis upon which thetransaction needs to be treated for VATpurposes.

Once the implementation process hasbeen completed, and the ERP systems and documentation required to complywith the requirements of VAT have beenamended, it is then essential that thebusiness undertakes some form of testingin order to ensure that nothing has beenmissed and, when the time comes, theresults will ultimately allow the business to account for VAT in the required return.Inevitably, at this stage, there will be a fewloose ends identified, so it is essential thatthe business gives itself sufficient time tomake and test any amendments that mayhave been required. If there is notsufficient time for the necessary ‘fixes’ tobe implemented and tested, at least itgives the business time to ensure thatthere is a ‘work-around’ put in place sothat it can account for VAT correctly.

VAT and the legacy process andsystem challengeIn undertaking the Implementationprocess, it should always be rememberedthat there are defined sectors or functionswithin the business that drive its progress.These efforts need to be enabled througha range of business processes,technologies and a range of personneltrained to ensure a relatively smoothprocure-pay-sell experience for suppliersand customers alike.

Modern ERP solutions drive thisexperience from the centre, allowing forrelatively swift (albeit sometimes costly)changes to be effected in order to comply

with new VAT invoicing and accountingobligations.

In many instances, however, theexperience is not quite as seamless.

Email-based procurement, stand-alonePoint of Sale machinery and a vast array of spreadsheets recording general ledgerdata for upload into a central accountingsystem are commonplace in anysophisticated industry. These solutions will have served businesses well in thepast, but could well make complying withthe new VAT rules more difficult to achieveconsistently. Moreover, costly changesmay well have to be made to multiplesystem types whilst internal service teamsare re-trained on a business sector (eg AP,AR, marketing, procurement etc), ratherthan corporate level.

In short, legacy approaches to ordering,selling and accounting for transactions arelikely to come under significant pressurefrom VAT. Looking carefully at options nowand establishing an approach to thesefundamentals which balances the needsof the business with the cost of changewill be vital.

Once the Implementation process hasbeen undertaken – What next?Finally, and often at the same time as thetesting regime is in process as indicatedabove, it would be a advisable for thebusiness to undertake training for all the other staff that may need to makedecisions on a day to day basis, where VATcould have an impact. This goes beyondthe requirement to deal with the ERPsystem, and will stretch from staff engagedin negotiating contracts, through to staffsubmitting expense claims that they wishto have reimbursed by the business.Once all that is done, life will slowly returnto normal, with the focus reverting toFinance, who will likely have responsibilityfor preparing the first, and subsequent

VAT returns. These obviously need to bechecked far more closely on the first fewoccasions in order to ensure that the VAT has been properly accounted for.Thereafter, accounting for VAT trulybecomes a part of the life of the business.One last comment – businesses thatembrace this process, and see it as areason to review and improve theirinternal processes, are the ones thatsucceed most with the implementation ofVAT. Being dragged into the process at thelast possible moment is a recipe fordisaster, and it is always useful toremember – If you fail to plan – you areplanning to fail. With the implementationof VAT, there is no escaping this outcome.

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Retailers, VAT and the pricingconundrumQuite apart from the actualimplementation process identified inChapter 2, the introduction of VAT in theGCC poses a serious question for allretailers – should they pass the additionalVAT charge on to their customers?

Indeed, some would say it would beparadoxical not to: why introduce aconsumption tax only for businesses toabsorb it all? But it is never quite as simpleas that.

Who bears the VAT cost?One of the key principles of a VAT systemis that it should be borne by the endconsumer, whether an individual, or anunregistered business. Neither would, as ageneral rule, be in a position to register forVAT and therefore recover VAT incurred ontheir purchases. As a result, VAT willrepresent an additional cost of living ordoing business for those affected.

Retailers that are required to registerbecause they exceed the VAT registrationthreshold (and those that register on avoluntary basis) are required to accountfor VAT on their sales. That is, they areresponsible for collecting the VAT andpaying the net amount of VAT that theycollect to the Taxation Authorities. Thereason we refer to them being required topay the ‘net amount of VAT’ is that they aregenerally entitled to deduct the VAT that

they have paid to other businesses forpurposes relating to their conducting thebusiness of making taxable supplies.

The concept of being required to ‘accountfor VAT’ on their supplies is slightlydifferent from being required to chargeVAT on their sale. This is because one ofthe core concepts of VAT is that it is thesupplier of the goods or services that isresponsible for accounting for the VAT onthe goods or services that it supplies – notthe purchaser. Whether the supplier isable to recover the VAT from thepurchaser on the supplies that it makes(so that it does not reduce its profitmargin) will be up to it to decide, and adecision that the supplier makes based onthe market place that it is in.

It is common practice for retail goods,particularly those that will be sold to finalconsumers, to be priced on a VAT-inclusivebasis, which means that the priceadvertised to the customer includes theVAT element within it (“the price you see, isthe price you pay”). While this is not idealduring the changeover period (fromJanuary 1, 2018), in that customers will seean immediate increase in the price, longerterm it may be better in that it avoids theprice shock that comes with someonebuying goods for, say, Dh100, only to findthat they have to pay Dh105 when theyget to the checkout.

Chapter 3 – Retail industry

Deloitte | Value Added Tax in the GCC | Retail industry

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Based on overseas experience, inbusiness to consumer (B2C) transactionswe expect the majority of retailers to seekto increase the price of their goods to takeinto account the additional VAT chargethat they wish to pass on to the consumer.However, retailers should considerwhether this is the best thing to do, andthis is not a ‘one size fits all’ decision.There will be numerous factors that eachbusiness will wish to take into account, notleast of which will be the marketing impactof any such decision.

Retailers’ margins immediately after theintroduction of VAT could be squeezed, inthe event that there is any irrecoverableVAT in the supply chain impacting on theprice of their own purchases. Therefore, itwill be very tempting for retailers to passthis increased cost and the additional VATcharge on to their customers, unless thereare good commercial reasons not to.

At the same time, it has been observed inother countries that have implementedVAT/GST systems, that astute marketersmay increase their prices in the monthsrunning up to the implementation of VAT,for two reasons.

Firstly, they take advantage of the pre-implementation sales rush to obtain extraprofits, and secondly, it allows them someleeway to ‘reduce’ prices after theimplementation in order to accommodatethe VAT that is to be charged. This allowsthem to maintain their long runningaverage margins, while being able to takethe moral high ground by claiming, post-VAT, that they will cover the additional VATcost to the benefit of the consumer- “Youpay the pre-VAT price, and we will pay yourVAT!”

These sorts of schemes are typicallyfrowned upon by the authorities, but inpractice, generate a lot of goodwill

amongst consumers as long as they arenot aware of the pre-implementation pricehike.

Price elasticityGenerally speaking, all other things beingequal, price increases should lead to a fallin demand. Some retailers may actually be better off only passing a smallerproportion (say 50 percent) of theincreased cost on to their customers and suffering 50 percent of the increasethemselves in an effort to retain marketshare. Alternatively, many may, as an initialmarketing ploy, offer to cover the fullamount of the VAT in order to keepvolume of sales at a reasonable levelduring the settling-in period. Clearly thesewill all be commercial decisions that needto be considered.

Much will depend on the price elasticity of the product in the market at that time.When demand is perfectly inelastic (i.e. anincrease in price has no effect on demand)retailers should be able to pass on the fullburden of VAT to the customer. This is,however, seldom, if ever, permanently thecase as there may be a number of otherfactors that could have an impact, albeitfor a short period only. If this is the case,however, retailers should considerundertaking a detailed price modelinganalysis (at least on their large volume, orhigh value stock items) to understandwhat effect the introduction of VAT couldhave on demand for their product. Thiswill help them decide how much, if any, ofthe VAT cost they may be able to pass onto the customer.

Such an analysis could also give theretailer the tools to be able to establishhow much it could limit any priceincreases to, in order to ‘buy’ market sharewithout necessarily engaging in thepractices described above.

Retailers should considerundertaking a detailedprice modeling analysis(at least on their largevolume, or high valuestock items) tounderstand what effectthe introduction of VATcould have on demandfor their product. This willhelp them decide howmuch, if any, of the VATcost they may be able topass on to the customer.


Not all bad news?A business issue that retailers need toponder is what will happen on the night ofDecember 31 2017? The answer to this isthat any self-respecting budget consciousshopper will consider perhapsaccelerating a purchase, in order toattempt to avoid the VAT cost.

There are some VAT technical points here – will tax point rules mean that,notwithstanding a purchase beingexecuted before January 1 2018, VAT willbe due? And the answer is perhaps incases where actual delivery of the goods is planned to take place on the January 12018 then there may well be special rulesto address this (something an onlineretailer will perhaps be more conscious of, but also those that deliver large itemse.g. furniture etc). However, forstraightforward purchases executedbefore and taken home by the shopper (in a retail environment) the chances areVAT will not be due.

The fact that VAT may be briefly avoidedlike this could make shoppers tempted toaccelerate shopping trips – particularly ifthey are needing to purchase higher valuegoods. In all, probably some businessesmay well encourage this temptation inorder to boost sales and accelerateincome, and each business will have toreview marketing plans to respond to thisactivity. Businesses may also want toconsider product stocking levels(particularly for high value householditems where there is likely to be moredemand), as well as logistics includingsuch things as how many staff will beneeded in the weeks leading up to January 1 2018 and whether to open late on the night of the December 31 2017!

Finally, after the potential boom in the runup, things are inevitably going to be

quieter, and so businesses may also needto consider the financial and operationalissues associated with lower income andlower activity.

Other issues for retailers to consider In many VAT jurisdictions, retailers havespecial rules applicable to the way inwhich they may transact, and these maybe different to those applicable to otherbusinesses. Similar rules may beapplicable for retailers in the GCC, andcould potentially include:

• Different methods of accounting for VAT (special retail VAT schemes);

• Alternative invoicing requirements forgoods under a certain value i.e. asimplified VAT invoice;

• Potentially complex rules for discounts,promotion schemes, loyalty programsand vouchers;

• Special rules for paying a ‘securitydeposit’ for purposes of ensuring that a transaction will be completed;

• Tourist refund scheme criteria andindeed whether such a scheme willapply;

• Treatment of linked products, forexample where one product is zero-

rated, and the other is standard rated;and

• Additional VAT recovery considerationsfor goods sold on finance.

The above list is by no means exhaustive,but is useful to highlight just a few of theadditional considerations that retailersneed to bear in mind when consideringthe impact that VAT implementation willhave on their business.

Retailers should start considering theimpact it may have on their business assoon as possible, so that they can fullyunderstand the implications, and plan andimplement the steps required to be readyahead of the implementation.

One final issue that retailers shouldconsider is the possibility that there couldbe some ‘anti-profiteering’ regulations putin place prior to the introduction of theVAT. This could have an impact on itsability to raise prices for a period followingthe introduction of VAT.

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Businesses may want to considerproduct stocking levels (particularly for high value household items wherethere is likely to be more demand), aswell as logistics including such thingsas how many staff will be needed inthe weeks leading up to January 1 2018


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Deloitte | Value Added Tax in the GCC | Automotive industry

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Gearing up forchange, the viewahead for dealersand buyers


Chapter 4 – Automotive industry

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It is almost inevitable that sales of motorvehicles will become subject to VAT in theGCC upon implementation of VAT. Eventhough the anticipated VAT rate of 5% islow by comparison to rates of VAT appliedin other countries (the average VAT ratearound the OECD is 19%), for a region witha penchant for purchasing expensivemotor vehicles, the imposition of VAT islikely to increase the nominal purchaseprice of the region’s favorite luxury brandssignificantly, if for no other reason thanthat the cost of such vehicles is alreadysubstantial.

Of course, the automotive sector in theGCC does not only cover the sale of newcars, and to restrict it in this way would beto significantly underestimate its size andimportance to the economies of theMember States. Some of the regions’largest players in this market are highlydiversified corporates with operationsextending beyond the sale of new andsecond-hand vehicles sales into theprovision of finance, insurance, propertydevelopment and sales to name but a fewexamples. The scale and scope of thesebusinesses can be enormous.

The supply chain feeding the automotiveretail business is also significant andincludes vehicle manufacturers, the localimporters, and then the distributorsthemselves of course. The dealer andproprietary after-sales market in parts,accessories and services comprise a vitalcomponent of the industry overall, as toois the vibrant second-hand vehicle salesmarket and the associated financeproviders. In addition, business andpersonal classified listings make up a largeportion of total vehicle transactions in theregion, so this, together with the normaladvertising, whether radio, TV ornewspaper, spend by the main dealerscould be significant.

In time, the full spectrum of the impactassociated with VAT being applied

throughout this highly evolved and diversesector will come to light. We focus,however, on the impacts likely to be felt bythose in the business of selling vehicles,and those buying them.

Pre-implementation demand pullOne operational issue, in common withthe retail industry as referred to inChapter 3, will be how dealers respond toa likely spike in demand in the run-up tothe introduction of VAT. It has been wellobserved that new introductions or rateincreases typically advance the buyingdecisions of consumers in order to “beat”the inevitable increase in the price of a car purchased from a dealer. Indeed,businesses often make a point of running‘pre-implementation’ specials in order tocapitalize on this demand and bring-onsubstantial stocks to fill showrooms andstorage facilities so as not to disappointeager buyers.

Manufacturers and other up-streamsuppliers to the industry are also likely to be faced with a surge in demand asdealers book relatively large pre-orders.The flip side of this is that there is likely to be a glut of second-hand cars comingonto the market as consumers ‘flip’ themin order to take on their new vehicles.

To some extent the large pre-orders ofnew vehicles will be welcome for thoselooking for an outlet for production during

a period of global economic uncertainty,but they will have to ensure appropriatestock is available, and that lead times andlogistics arrangements are in place toensure stock can be in the right place atthe right time. Manufacturers must alsoassess whether there will be an impact onthe lead times for new/bespoke vehicles,and how this may impact the customerpurchasing decision.

Dealers will need to make sure thatcustomers are not disappointed whentrying to make a more immediatepurchasing decision than normal. Stockingthe right vehicles at the right specificationwill be key – vehicles ordered prior to, butdelivered after, implementation are at riskof being subject to a VAT surcharge.Dealers need to be satisfied thatappropriate resources will be available interms of staffing the sales floor, whilstcoping with (albeit temporary) increasedvehicle storage and preparation needs.This could be a challenge for many,particularly in that at the same time theymay well need to deal with a substantialnumber of second hand vehicles that willneed to be accommodated within themarket.

In many cases car sales depend on theready supply of credit, whether that beworking capital in the case of the dealer,or finance deals in the case of consumers.Dealers will need to consider the likelyimplications of this demand spike withtheir own banking institutions and otherfinance businesses so as to prevent anychoking-off of demand arising simply dueto the lack of availability of finance (asopposed to the lack of credit-worthinessof the borrower). If there are anydealership floor plans in place to financethe stock on hand, these may need to bereconsidered.

And finally, advertising agencies,production houses and media outletsshould expect to see a flood of advertising

It has been well observedthat new introductions orrate increases typicallyadvance the buyingdecisions of consumersin order to “beat” theinevitable increase in theprice of a car purchasedfrom a dealer


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placements from dealers hoping to takeadvantage of the desire to supply vehiclesprior to anticipated price increases.Dealers will need to have thought wellahead about how they want to go tomarket in connection with VAT, however,the messaging may not be all that simpleand will need to be carefully targeted.

All in all, the impact of pre-implementationdemand is likely to put a fair amount ofstrain on dealers and their supply chain.This is not necessarily bad news of course– the opportunity to push sales and see amajor revenue uptick from car sales,bonuses/rebates, accessory andintermediary fees could perhaps offer asilver lining for Q4 2017, although they willneed to be careful with the pricing on anytrade in vehicles.

Stock planning for 2017 is likely to be infull force at this time of year – every dealerand associated businesses should bethinking about the pre-implementationdemand pull, now. Failure to capitalize onthe opportunity could result in a majorrevenue shock in H1 2018 as consumerstake stock of pricing changes and eitherdefer purchasing decisions, or havingbrought forward their purchasingrequirements, are well set for some timein the future.

Adjusting to new cash and pricingrealitiesMost if not all new vehicles are importedinto the GCC having been manufactured inthird countries. As with most VAT regimes,it is likely that the importation of a car willbe subject to import VAT at the time thevehicle is removed from customs controland entered into so-called “freecirculation”. The same goes for otherpurchases made by dealers; VAT will haveto be paid on purchases and theadditional amount will need to be pre-financed until a credit for it can beobtained from the tax authority.The lag between payment and credit can

be substantial, (certainly during the initialphase of operations under the VAT), withthe result that working capital headroommay have to be increased in order to allowfor it. Of course, VAT accounting typicallyallows for the offsetting of VAT on costsincurred against VAT on sales on the samereturn and so finding a better timingbalance between these two elements ofthe value chain is vital. Much can be donein this regard with adequate preparation.

As with any retail supplies, dealers willneed to look closely at the pricing ofvehicles given the likely impact thatpassing on the full cost of VAT may haveon sale volumes. In embarking on thisanalysis, it should be done with the viewthat it is unlikely that dealers will be ableto pass on the full charge of the new VATto private consumers or unregisteredbusinesses in the short-term. This will beexacerbated if the legislation seeks toblock input tax on motor vehicles asoccurs in a number of other countries, as

The impact of pre-implementationdemand is likely to put a fair amount ofstrain on dealers and their supply chain.This is not necessarily bad news ofcourse – the opportunity to push salesand see a major revenue uptick fromcar sales, bonuses/rebates, accessoryand intermediary fees could perhapsoffer a silver lining for Q4 2017,although they will need to be carefulwith the pricing on any trade in vehicles.


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the same issue would then affect allvehicle purchasers.

To the extent that the products arethemselves price elastic, small pricingchanges, and the period over which theyare granted could significantly impactpurchasing decisions. Understanding thelink between pricing changes and thepotential impact on demand can be doneat a variety of different levels of detailbearing in mind that dealer margins arenot necessarily generated wholly orindeed partly at the front-end (i.e. theticket price), but may also be impacted atthe back-end instead (i.e. the bonuses and rebates granted to dealers bymanufacturers for meeting targets) and so vary quite significantly by vehicle andmanufacturer.

The weirder and more wonderfulelements of the motor tradeMotor trade VAT accounting is notoriouslycomplex. So far we have looked at theobvious impacts of VAT, but some of themore challenging aspects of VAT for theautomotive trade can be found in thefollowing paragraphs:

The second-hand/margin schemeGenerally applicable in some form tosecond-hand cars supplies where initialVAT recovery has been disallowed for thepurchaser (bought-in/part-exchangevehicles) as the supplier (very often anindividual consumer) is unregistered anddoes not charge VAT, but has previouslyincurred VAT when the vehicle waspurchased.

To ensure that there is no ‘tax-on-tax’cascading, VAT is chargeable on the profitmargin achieved on sale by the registereddealer, for ‘margin scheme’ cars. Whilstconceptually simple, dealer systems mustbe ready to capture these sales, andcalculate VAT on profit. Sales staff must

also be trained to understand thecommercial impact of their actions.

Indeed, calculations can be complicatedby certain dealer practices, particularlywhere trade-in values are inflated by thedealer, to allow the purchaser to meet theminimum deposit for finance – a practiceknown as ‘bumping’. Ultimately, it will befor the GCC to decide whether a ‘margin-scheme’ will be implemented, or whetherVAT at 5% will also apply to the sale ofsecond-hand cars. The latter may bepreferable for simplicity, but the extra costwould be substantial and, inevitably, woulderode margins, with cars taxed multipletimes as they change hands.

Financial Intermediary Services In the EU, where a dealer introduces acustomer to a provider of financialservices, such as lending, and receives acommission for doing so, this commissionmay be VAT-exempt. Whilst no VAT ischargeable on the supply of theintroductory service to the financeprovider, dealers suffer a restriction onthe recovery of input tax incurred inmaking such supplies, resulting inpotentially complex ‘partial exemption’calculations, to determine overall VATrecovery – a concept thoroughly examinedin VAT ‘automotive’ case law.

It is, however, unclear whether the GCCwill implement an exemption for financialintermediary services, and the impact istherefore likely only to be assessable, oncethe particulars of the applicable legislationare announced. In Australia, the supply ofsuch services by what are referred to as‘Financial Service facilitators’ would betaxable in similar circumstances. Thiswould mean that VAT would be due on theintermediary fee – but that VAT is thenunlikely to be recoverable by the financehouse – leading to further erosion ofmargin.

Stock-in-trade and demonstrator carsRecovery of input tax on demonstratorvehicles has often been restricted on thebasis that those vehicles are madeavailable for non-business/personal use,such as by sales staff. Where VAT recoveryis restricted, some tax authoritiesassumed that the eventual sale of thevehicle would become subject to thesecond-hand margin scheme. It will beinteresting to see whether the GCCapplies the exemption for the sale of items on which initial VAT recovery wasrestricted, or treats these as taxablesupplies. It is important to remember that,as an exempt sale, like financial services,there is a corresponding input taxrestriction.

Reliefs for adapted vehicles for thedisabledCars adapted for use by disabled personsmay qualify for VAT relief, such as theapplication of the ‘zero-rate’ of VAT.However, in territories where similar reliefshave been applied - such as in the UK -abuse of such schemes has occurred,mostly perpetrated by criminal gangs and fronted by individuals who meet thecriteria for relief. Tax authorities havepreviously penalized dealers for failing toensure that the purchaser is genuinelydisabled, and the vehicle is for their ownpersonal use. Again, it remains to be seenwhether the GCC states will apply a reliefto such vehicles. However, with a potentialVAT advantage of 5%, the incentive toperpetrate such dishonesty is likely to below.

It is no secret that motorvehicles have historicallybeen treated unfavorablyby tax authorities


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And what about purchasers?It is no secret that motor vehicles havehistorically been treated unfavorably bytax authorities. The restrictive nature ofrecovering VAT on motor cars is largelyrelated to the fact that the system has,historically, been open to abuse, withsome individuals and companies havingsought to recover the input tax charged infull as a business expense, despitesignificant ‘non-business’/private use. Thepotential for abuse was particularly

apparent in the UK court case ofFagomatic, where the owner of a cigarettevending machine business sought torecover the VAT in full on the purchase ofa Lamborghini, purportedly used only forbusiness purposes.

Whilst the situation in Fagomatic is aparticularly unique (and perhaps extreme)case, the basic rule for a business seekingto recover VAT on the purchase of a motorcar has been, quite simply ‘don’t’, unlessthe ability to evidence sole business use isstrictly unequivocal. Again, with referenceto the region’s love of expensive cars,Fagomatic may once again rear its head,albeit in another guise, and is therefore an important lesson.

With the introduction of VAT in the GCC,on the expectation that the region willfollow the European model, and OECDbest practice, it is likely that businesses will experience a largely restrictiveenvironment in which to recover VATcharged on the purchase of company

motor cars, which would result in anincreased cost to the P&L.

Preparing for changeEven a demand driven second half of2017 sales bonanza for new vehicles mayonly offer a modest amount of comfort tothose charged with preparing anautomotive business for its new VATobligations in 2018, and this could well beoffset by a glut of second hand vehicles onthe market.

Concerns over whether their systems,processes and people will be able to copewith VAT on January 1 2018 are likely to bea major focus for program managers upuntil that time. Unless they do, accuratelyaccounting for VAT on sales on or afterthat date will become a major headacheand at worse, stop sales in their tracks.

Early preparation is key, not only for VATpurposes, but for stocking and aftersalespurposes. The trade will shortly besubmitting its 2017 sales plans. Ensuringthat the impact that VAT is likely to have on customer purchasing decisions bothbefore and after its implementation hasbeen factored into factory orders, will behugely important to businessesattempting to smooth revenues during the changeover period.

Early preparation is key, not only forVAT purposes, but for stocking andaftersales purposes


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Deloitte | Value Added Tax in the GCC | MICE industry

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Lead times on the VAT challenge

Chapter 5 – Meetings, Incentives, Conferences, and Events (MICE) industry


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For those that have not previouslyencountered this term, MICE is adescriptor of a sector of the ‘tourism’industry in which large groups, usuallyplanned well in advance, are broughttogether for a particular purpose.Accordingly, it is sometimes referred to as either the 'meetings industry' or the‘events industry’.

Most components of MICE (Meetings,Incentives, Conferences and Events) arewell understood, perhaps with the mainexception being the incentives sector.Incentive tourism is usually undertaken asa type of employee reward by a companyor institution for targets met or exceeded,or a job well done. Unlike the other typesof MICE tourism, incentive tourism is oftenconducted purely for entertainment,rather than professional or educationpurposes, and as such may have differentconsequences for VAT purposes.

MICE events, other than incentive tourismare usually centered on a theme or topic,whether industry focused or otherwise(the Ramadan night markets in the DubaiWorld Trade Centre would be a classicexample), and are aimed at a professional,academic or trade organizations or otherspecial interest group. Larger MICE eventsmay take the form of Industry orProfessional conferences, or Trade Showsand similar exhibitions, or could be evenmore extensive as, for example Expo2020.

From the perspective of theimplementation of VAT this is an unusualcommercial sector, as there are so manyaspects to it. In a place like the UAE, therewill be a number of businesses andactivities that are likely to be impacted bythe manner in which this sector will betreated for VAT purposes.

Impact on different sectors operatingin the MICE spaceAt the outset it is useful to identify andconsider some of the macro-industriesthat fall within the supply chain that allowsthe MICE sector to operate.

In short, the supply chain will typicallyinclude the transport, tourism,accommodation and venue hirecommercial sectors with lesser input from, or implications for, the suppliers of ancillary services such as caterers,sound system providers, lightingtechnicians and the like. Accordingly, tohave a full understanding of the impact of the introduction of VAT on the MICEindustry, one really needs to understandthe various component parts and howthey are to be treated for VAT.

As a general rule, however, it can beassumed that most of the sectorsidentified, where the participants areeither required to be registered, or areable to, and do, register voluntarily, will besubject to VAT at standard rate (probably5%). They will then be entitled to claimback VAT incurred on costs as an input taxcredit (ie they will be able to set off thisVAT incurred against the VAT that theycollect).

The difficulty for the industry will be whenone gets to the smaller sub-contractors(including, for example, lightingtechnicians, sound systems techniciansand the like) in the supply chain as theywill either not register for VAT, or not beentitled to do so. What this will mean isthat they will incur VAT on their costs, andassuming that they wish to retain theirprofit margins, this VAT will then be built inwith the charges that they make. As theywill not be able to charge VAT that thelarger organizations would be able to


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recover as an input tax credit, this couldlead to the potential for the additionalcosts flowing through the system, or asignificant push to bring such smallerindependent contractors into largerorganizations, or for some, bringing workthat is currently outsourced, in house.

Dealing with lead timesAnother significant issue for the industry,particularly where conferences andexhibitions are being arranged, is thatthere may be longish lead times betweenthe initial contract date and the actualdate of the event – as an extremeexample, consider how long it takesbetween when a city bids for theOlympics, through to when they actuallyoccur.

Further, due to the costs that are generallyinvolved in preparing a conference(arranging a venue for the event,accommodation, various facilities such aslighting, sound, subsidiary events etc, aswell as project management, advertisingand management of potential attendees)any contract for the conference will ofteninclude periodic milestone paymentsduring the period up to thecommencement of the event.

These factors can lead to two issues thatshould be addressed.

Firstly, if any ongoing, or longer termarrangements are currently being put inplace for multiple annual events (ie theundertaking of an annual event over thenext 3-5 years), then the contracts shouldbe reviewed in order to establish the VATconsequences, if any, of any arrangementsand whether they deal with the billingsthat will occur after the implementation ofVAT. This will be particularly important, as afailure to address this issue could end up

in the VAT becoming an additional costthat will come straight out of ‘bottom line’profits.

Secondly, the tax point, at which VAT will become payable to the revenueauthorities, will typically be the earlier of the date of an invoice, or the date onwhich a payment (any payment – notnecessarily payment of the full amount) is made. This being the case, if there areperiodic milestone payments made sometime before the event and, particularly,where these are not specifically linked toan activity, then unless properly structuredthere is a risk that VAT would need to beaccounted for on the full contract value by the event manager well before it ispossible to get the recipient to makepayment. What this will mean, in effect isthat the business will be paying out VAT on amounts that it may not yet even beentitled to charge to their client, for thesimple reason that most of the contractcharge is not yet due or payable. Thiscould end up being a significant cashflowdrain, particularly taking into account the

fact that often the first payment is merelyin the nature of a mobilization fee, and theVAT alone on the full contract value mayeven exceed that mobilization fee, whichcould have disastrous consequences forthe funding structures adopted by thebusiness.

The reality is that none of this isdisastrous. All it needs is close attention to detail, a review of transactionarrangements, and making an effort torevisit contractual arrangements. Add tothis the need to set up contract files toreflect the manner in which charges havebeen raised, and having the ability toaccount for the VAT correctly due andpayable out of the charges will be crucial.

Contract issuesA further concern that should beaddressed in any review undertaken bythe organizers of MICE events would bewhether the existing contracts that applyto the full process for the arrangement ofthe event allow the organizer (and thevarious subcontractors) to charge VAT onthose of the supplies that are consideredto be made after VAT is operational.

In this regard, it is important tounderstand that the manner in which VAT legislation is typically structured isthat, as a self-assessment tax system, theresponsibility for accounting for the VATon the correct amounts, and at the correcttime, rests solely on the supplier of theservices in question. Should they notensure that the contracts under whichtheir services are supplied allow them to on-charge that VAT, then they will beconsidered to have included the VATcharge in their fees, and they will need to account for that VAT amount whetheror not it is able to recover it from therecipient in any way.

From the perspective ofthe implementation ofVAT this is an unusualcommercial sector, asthere are so manyaspects to it. In a placelike the UAE, there will bea number of businessesand activities that arelikely to be impacted bythe manner in which thissector will be treated forVAT purposes.


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In addition, as far as the recipient of theservices may be concerned, if the recipientis not required to pay an additionalamount to cover the VAT impost that willnot be the end of it. They will still beentitled to request that the supplierprovide them with the requireddocumentation that will allow them toclaim the VAT input tax. Essentially, thishas the potential to result that for everyAED100 they are required to pay, thesupplier will receive AED95.25, and theVAT of AED4.75 will be payable by thesupplier, and refundable to the recipientof the services that were supplied.

While many businesses that are affectedwill consider themselves to becontractually protected on the basis that they have a ‘tax clause’ in theiragreements, this is seldom the case.

Firstly, the GCC members, for the mostpart, do not have significant corporate taximposts, so it is unlikely that adequate taxclauses will be found in many contracts.Secondly, standard ‘tax clauses’ that maybe found in some contracts will seldom be adequate when viewed in light of therequirements of the VAT. This is becausethe manner in which VAT is to beadministered, and the minimumrequirements for an adequate VAT Clauseare vastly different from the manner inwhich corporate taxes would beaddressed.

It therefore becomes imperative thatbusinesses protect themselves as amatter of urgency – it may be too late todo so once an agreement has beenconcluded.

It is important to understand that themanner in which VAT legislation istypically structured is that, as a self-assessment tax system, theresponsibility for accounting for the VAT on the correct amounts, and at thecorrect time, rests solely on the supplierof the services in question


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Why VAT, financialservices andinsurance are adifficult combination

Chapter 6 – Financial services and insurance industry

Deloitte | Value Added Tax in the GCC | FSI industry

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Not much has been said publicly by thegovernments of the GCC as to how theyexpect VAT to apply to the financialservices and insurance sectors, at leastnot in its totality. However, the problem forpolicy makers is that unfortunately tryingto successfully1 apply normal VAT rules (i.e.to tax instead of exempting them) to agood number of insurance and financialservices transactions is exceptionallydifficult to achieve. Theoretically it ispossible to tax all such services, butsufficient practical challenges remain as tomake achieving that objective a somewhatdistant prospect, despite almost fourdecades of governmental effort in thisspace.

These challenges include:

“They are too difficult to tax” The “value” for VAT purposes, particularlyin the context of margin-basedtransactions, is almost impossible todetermine accurately and consistently ona transaction-by-transaction basis.Undertaxation (leaving the treasury out ofpocket) or, worse, overtaxation (taking toomuch out of the pockets of taxpayers)could arise leaving both suppliers andconsumers in an uncertain position withrespect to their obligations and rightsrespectively.

“Taxing financial services andinsurance is to tax the wrong thing” Financial intermediation, and the assetsunderlying it, represents the means ofconsumption and not consumption itself.Moreover, by taxing potentially investableassets you could choke off economicactivity at its genesis, something that isgenerally best avoided. Bearing in mindVAT is designed to be a tax onconsumption, not savings or investment,

an obvious tension exists in this particularcontext.

“Exemption is the preferred approach.Everyone does it”As far back as 1918, banking transactionswere exempted from turnover taxes inGermany. The 29 member states of theEuropean Union have all implemented VAT exemption extensively as requiredunder the Principal VAT Directive and itspredecessors. The legacy of VATexemption is vast, therefore, and wellrehearsed. To some extent the inertia hasat least become somewhat self-fulfilling.

Yet unfortunately VAT exemption createsas many problems as it solves. It is animperfect answer to a difficult questionand, as a result, is a topic that garnersmuch attention from the industry’sprofessional advisors, governments andacademics alike, all of whom object to oneor more of the following impacts, amongstother things:

CascadingThe “locking-in” of irrecoverable VAT into asupply (i.e. it is essentially hidden within aVAT exempt cost), resulting in increasedcosts for borrowers even where theborrower might otherwise normally beable to deduct VAT.

Low-tax VAT regime bias Encouraging financial service andinsurance providers to source servicesfrom jurisdictions that apply a lower rateof VAT, or have no VAT whatsoever.

Liability boundary disputes A costly issue for most businesses lockedin discussions with tax authorities overwhat should or should not be exempted.

1. Success is of course a subjective matter to some extent. In this case we define success as being one inwhich the risk of under or over-taxation of the service has been removed, and that input tax credits canbe accurately attributed to the recipient of the service.

Theoretically it is possibleto tax all such services,but sufficient practicalchallenges remain as tomake achieving thatobjective a somewhatdistant prospect, despitealmost four decades ofgovernmental effort inthis space


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Vertical integration biasVAT costs arising on outsourced servicescreate an incentive to in-source,potentially inefficiently.

Regulatory tension The financial services and insurancesectors, so often required to restructure in part in order to meet new regulatoryobligations, finds itself at risk of bearingadditional VAT costs brought about byreorganization efforts.

Nevertheless, we are witnessing a gradualshift in the trajectory of policy thinking thatis beginning to create a new ‘normal’ forthe industry, particularly in those countriesthat have introduced VAT comparativelyrecently.

Recognizing the inherent challenge ofvaluing, and taxing, individual transactionsoften sold on aggregated interest margins,one obvious place to start is with anythingthat is not aggregated or which is at leastvalued explicitly in the normal course ofbusiness. Generally speaking, agentsarranging supplies of financial servicesand insurance do just this, charging anexplicit fee for their services to theprincipal or the customer, as the case may be. Principals themselves also chargeexplicit fees for a range of financialservices and insurance: cheque bookissuance charges, and credit cardmembership and administration fees, for example.

In the alternative, or indeed incombination with this taxation approach,is the option of simplifying VAT recoveryfor institutions making VAT-exemptsupplies of financial services andinsurance. Essentially this requires thesetting of a guaranteed VAT recovery rate

for institutions2 and the removal of asignificant portion of hithertoirrecoverable VAT costs from their financialstatements. This presumes of course thatthe benefits of VAT recovery are indeedpassed on in the form of lower costs, andthat the institutions themselves revert toinvesting ‘normally’.

More radical approaches include enablingfinancial service and insurance providersto “opt to tax”3 otherwise exempttransactions, or potentially applying azero-rate4 (the transaction is not subject toVAT but the institution is entitled torecover VAT on costs in full) on business-to-business transactions in order tomitigate the risk of hidden VAT cascadinginto borrowing costs and disincentivizinginvestment decisions.

But, no single best practice has emergedas the leading candidate for wholesalerevalidation of the VAT treatment of thesector at this time. To some extent this is

down to a desire to retain simplicity on thepart of governments. In other cases it isdue to the highly theoretical, technical andadministratively cumbersome aspects ofthe alternatives amongst other things. Inshort, the alternatives to exemption createnew challenges.

We are witnessing agradual shift in thetrajectory of policythinking that is beginningto create a new ‘normal’for the industry,particularly in thosecountries that haveintroduced VATcomparatively recently

2. Singapore has implemented a fixed rate recovery scheme for businesses that choose to opt into it3. Certain countries in the EU have implemented this measure4. Only New Zealand has implemented this approach to date

This table deals with the supply-side of the transaction, not the treatment of VAT on purchases

Principal or Agent

Principal

Agent

* Partly through Z/R B2B** Recent development

Charge type

Implicit marginExempt/Option to Tax**

E/OTT**

E/OTT**

E

T

T

T

T

T

Tax model development trajectory

Explicit fee

Explicit fee

1978EuropeanUnion

1997SingaporeSouth AfricaAustralia

1985-2014China New Zealand*


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What does this mean for financialservices and insurance?As a result of the policy challenges,traditionally financial services andinsurance businesses are amongst themost VAT complex businesses. Theyusually end up with multiple challenges all of which are practical issues.

On the sales side, businesses will usuallyend up with multiple VAT liabilities on theirsupplies and for now at least financialservices and insurance businesses willneed to consider a series of variables aswe await the final policies.

That said, inevitably, as discussed earlier,there is a high chance of some form ofexemption. That being the case, thebusiness has to carefully review itsproducts and consider the potential VATliability. Inevitably this leads to a one offexercise during the implementationprocess of categorization and review ofcontracts. However, there is an also anongoing challenge: increasingly financialservices and insurance are being bundledand personalization of the productsprovided is becoming common – what wasprovided yesterday, will change tomorrow.

Unfortunately VAT law very rarely keepspace with the speed of business changeand thus categorizing new servicesbecomes a process challenge. You couldhave hundreds of unique productsespecially if you have staff allowed adegree of latitude in what they sell tocustomers – this can require a dynamicdecision making process and/or guidancefor sales staff which may end uprestricting what they can sell. Finally it isnaïve to think that once a business hasdecided what it thinks the VAT liability is,the tax authority will agree – so it becomesa VAT technical issue with, as we

mentioned earlier, liability boundarydisputes being common and highlycomplex to deal with.

Almost always, even though there is anexemption, because financial services andinsurance businesses are usually veryimportant for foreign trade earnings,government usually allows some form ofzero-rating for exported financial servicesand insurance (exports here probablywould mean outside the GCC but thisremains to be seen). This comes with thebenefit of VAT recovery, but usually thereare conditions attached to achieving zero-rating and identifying those supplies (inorder to enhance VAT recovery) becomesan issue.

Finally VAT has an impact on thecustomers of the financial services andinsurance businesses that has a veryunique effect on them because of wherethey sit in the supply chain.

There are opportunities in this – manybusinesses will be facing cash flow andworking capital demands that neverpreviously existed and therefore demandfor short term financing becomes morecommon place. Financial services andinsurance businesses will need toconsider how they respond to this – andlikewise, what about, as referred to inChapter 4, the short term demand for newcars before January 1 2018 – who is goingto provide all that finance?

There are also challenges – by way of anexample, insurers face a double challenge.The first of these is that if VAT is due onpremiums, can they pass this cost on? And remember, insurance premium tax in Europe has long been seen as theequivalent of VAT for the insurance trade,but it is far more logical to use the VAT

But, no single bestpractice has emerged asthe leading candidate forwholesale revalidation ofthe VAT treatment of thesector at this time


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system, so one must not assume anexemption will apply, though of course this is not known right now.

The second challenge for both the insurerand insured is the cost of insurance (inessence a variation on the cascading issuereferred to earlier). On the retail insurancebusiness, yesterday if you had a caraccident and the insurer paid the bill forthe repair, there was no VAT, tomorrowthere will be. Instantly the insurable valuehas increased and the insurer will need toconsider its premium pricing. In contraston the business insurance side, insurersneed to ask themselves – do I need toinsure the VAT? Surely if the business is

fully taxable it will be able to deduct theVAT it might incur on a repair work to itscar fleet. If that is the case, the premiummay be overstated if this is not identifiedand VAT excluded from the insurablevalue.

Once you have overcome the issues inrespect of VAT on sales of services and

the impact on customers, the next issuebecomes the vexed question of VATrecovery. If there is an exemption, thebusiness will not be entitled to recover VAT that relates to those supplies. Theproblem in the world of services andfinancial services and insurance inparticular is that very rarely is itstraightforward to identify a cost and whatit directly relates to – inevitably there issome debate and a great deal of costsincurred by the business that fall into thecategory of ‘general overhead’. This thenmeans the business needs a process todecide what proportion of the VAT it incurscan be recovered – this adds a furtherburden on the AP function.

In many countries around the world thisbecomes a very complex (effectively)management accounting process oftenrequiring negotiation and agreement with the tax authorities. In a minority of countries there are fixed industrypercentages that can be applied (notablyin Singapore), this is a welcome relief forthose otherwise charged with doing the

calculations, but often such blanketrecovery rates don’t truly reflect the costbase and, whilst simple, often lead tounfairness in terms of the level of recoveryachieved.

Finally, because VAT becomes a cost on purchases, financial services andinsurance businesses inevitably start tothink about how to reduce it. Sometimesthis affects behavior in quite startlingways, and the most startling of these isvertical integration as referred to above.Essentially the benefit of verticalintegration arises from the fact that, veryspecifically, salary costs do not incur a VATcharge. It is therefore more efficient, froma VAT perspective, to employ peopledirectly than it is to outsource. Thetemptation therefore is not to outsource,and in fact to consider insourcing – orbuying the business that was providingyou with services and vertically integratingit thereby generating an overnight savingof 5% of the salary cost of the purchasedbusiness.

What all this means is that along with allthe challenges faced by any otherbusiness, financial services and insurancebusinesses inherently have their own veryspecial issues, which are perhaps amongstthe most complex in terms of VATtechnicalities and business practicalities.They are also faced with perhaps morecomplex uncertainties than many otherbusinesses whilst we await the detail ofthe law and so will be more tempted todelay implementation, whilst, somewhatperversely, having the most complex VATissues.

What all this means is that along withall the challenges faced by any otherbusiness, financial services andinsurance businesses inherently havetheir own very special issues, which areperhaps amongst the most complex interms of VAT technicalities andbusiness practicalities


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Documents

Value Added Tax in the GCC Insights by industry | Volume 1 · such that it is the final consumer of goods and services, generally in their private capacity, that should bear the total