VAT 101: The value added tax simplified
BY Rakesh Pardasani
News that the UAE and its Arab gulf counterparts will introduce a value added tax (VAT) by the year 2018 has generated heightened discussions on the topic. While some were skeptic that the move will ever see light, many companies across the Arab Gulf region have already started preparing themselves for this new fiscal measure.
It is apparent that the hydrocarbon-rich Gulf Cooperation Council countries (GCC) are working on diversifying their source of revenue away from oil, as the latter’s prices have more than halved over the past two years.
And as far as levies go, VAT seems to be a simple tax that could generate significant revenue for these countries in the coming years. But what would a VAT mean for businesses?
How does VAT work?
The VAT is a consumption tax. That means it is to be borne by the ultimate consumers of products or services.
Quite simply, if the VAT percentage to be imposed is 5 percent for example, and you were buying a piece of furniture earlier at AED100, it will now cost you AED105 and the additional AED5 is VAT which will be collected by the store.
Similarly, when the store buys this piece of furniture from the manufacturer at AED63 which includes VAT of AED 3 (5 percent of AED 60), this AED3 can be claimed as VAT credit.
So the store will eventually pay AED5 collected, minus AED3 paid, equals AED2 as VAT.
What do we know already?
The VAT is expected to be introduced in the UAE and most GCC states by 2018.
The rate is likely to be 5 percent across most products. Certain basic food items will be exempt from the VAT.
Other sectors such as healthcare and education may also be exempt from VAT, but that is not certain yet.
The revenue threshold for registration in the UAE may be AED3.75 million ($1 million) during Phase 1. Subsequently, companies with over AED1.87 million ($0.5 million) and less than AED3.75 million will have to register in Phase 2.
What should businesses consider?
The days of managing businesses without any accounting records are numbered.
The introduction of VAT will put the onus on businesses to ensure that they keep proper records and are assessed as to their VAT liability based on those accounting records.
Even for businesses that claim that they are lower than the threshold for registration, they will have to keep records to prove that they are below the threshold.
Accordingly, businesses need to start regularizing their accounting function well in advance.
In fact, it may be a good idea to be registered for VAT since only then will companies be able to claim the credit of VAT already paid on their purchases, and they will be able to pass on the burden of VAT to the consumer.
Any company that enters into long term contracts for supply of goods or services should start considering whether the contracts they are entering into today will remain valid in 2018.
If yes, it is advisable for them to start adding a clause of VAT in their pricing.
Some businesses may also have to consider complete overhaul of their IT systems in order to account for VAT credits and VAT collections.
Accordingly, they need to start planning as soon as more legislation on VAT is out.
VAT is a self-assessment tax. This essentially means that businesses have to assess their own liability and pay the tax.
In such a situation, documentation becomes crucial as at a later stage, businesses should be able to clearly show the tax authorities, how the tax was calculated, on the basis of what documents tax credits were obtained and what the final tax liability was.
Accordingly, making sure that the accounting processes keep track of all such documentation in a proper manner is the key to proper compliance and avoiding litigations and penalties from VAT authorities.
So, even though detailed VAT legislation is not out yet, it would be better for businesses to consider gearing up for this major change. Keeping the accounts in order is a good start.
Rakesh Pardasani is a Partner at RSM, UAE.