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The Introduction of VAT in UAE Research Paper

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Updated: Jul 15th, 2021

Introduction

Value Added Tax (VAT) is a form of tax imposed on the usage or consumption of goods, as well as services at each point of sale. As an indirect levy, VAT has been applied in more than 180 countries where end-consumers endure the cost. On behalf of the government, businesses gather and account for the tax. Unlike other countries, the UAE introduced VAT recently, specifically on January 1, 2018.

It started levying a 5% tax on goods and services purchased by consumers as a way of implementing the Gulf Cooperation Council (GCC) initiative. The decision to introduce VAT in the UAE is primarily based on the need for collecting more revenue from diversified sources to facilitate the provision of high-standard public services. The UAE government aimed at minimizing its overdependence on the revenue gathered from oil and other hydrocarbons.

Money collected would develop the economy through diverse sources of revenue. Nonetheless, as revealed in this paper, the introduction of the 5% VAT affects the spending patterns of consumers in the UAE since it indicates the potential rise in prices of goods and services among other implications. This paper finds it crucial to review the available literature on the VAT issue and its implications for consumer spending before discussing the findings in the context of the UAE and providing appropriate recommendations.

Literature Review

The Effect of VAT on Consumer Spending in the UAE

Many scholars have explored the topic of VAT and its implications for consumer spending and businesses in general. Governments regard this indirect tax as an effective source of revenue. In the context of the UAE, VAT is a new taxation policy that has the potential of affecting the population’s spending habits. According to the UAE Government (2018), VAT establishment will target a majority of transactions involving goods and services while granting consumers a few exemptions. Hence, the introduction of the 5% VAT on some goods and services provided by businesses in the UAE will influence the spending habits of consumers in various dimensions.

According to Saderuddin and Barghathi (2018), the addition of VAT on transactions that include consumer goods and services in the UAE will raise the cost of living considerably, regardless of exemptions made for particular items. This rise in living standards is already being felt in the UAE, despite VAT having been introduced a few months ago. Nonetheless, the cost of living is likely to affect high-income earners compared to those in the low-income category in the country since VAT is mostly applied to expensive particulars.

In the article by Sadaqat (2018), following the implementation of VAT in the UAE, consumers have become more cautious when it comes to planning for their household items. Specifically, individuals have cut budget categories such as luxury items since they attract the 5% VAT, thus allocating more money on basic items, for instance, foodstuffs. The middle-class category of tax-payers has been hit by the introduction of the indirect levy on consumer goods and services since servicing vehicles and purchasing electronics and jewelry has become expensive.

VAT has also changed the way the people in the UAE shop for foodstuffs among other essential products. According to Sadaqat (2018), the prices of groceries have escalated to the extent of influencing customers to spend more time comparing prices in hypermarkets. In a bid to encourage customers to acquire groceries, which are mostly perishable, retailers have adopted strategies such as VAT promotions and price fixes to meet customers’ needs and expectations (Saderuddin & Barghathi, 2018).

As a result, VAT has changed consumers’ spending in the UAE since its inception in 2018. Individuals are trying their best to stay within the limits of their budget (Sadaqat, 2018). For instance, more customers have adopted the habit of evaluating prices for various items such as groceries to ensure that they observe their personal or household budgets.

Moreover, as Nagraj (2018) uncovers, the adoption of VAT has affected many of the UAE-based consumers because they now find it difficult to acquire basic commodities, including clothes and food items, which have been accompanied by an inflation of close to 5%. For parents with young children, it has become quite a hurdle to shop for their babies since the prices of milk formula, baby food, diapers, and clothes have gone up due to the VAT policy. As denoted by the 4.8% consumer price inflation, the effects of VAT on the population’s spending patterns in the UAE implies that the cost of living has raised (Sadaqat, 2018).

Therefore, most UAE households currently need to live within their budgets by avoiding the purchase of unnecessary goods and services. This strategy has helped them to keep up with the changing economic trends. However, Nagraj (2018) argues that the effects of VAT in the UAE will not have a significant impact on consumers’ spending levels since this indirect tax will only pose short-term adverse effects.

The Implications of the VAT Policy

The introduction of various forms of taxes in any given country poses various implications for both individuals and businesses. The UAE Government (2018) expects VAT to imply a slight rise in the cost of living in the endeavor to diversify its sources of revenue. According to Saderuddin and Barghathi (2018), the introduction of VAT in a new country usually affects individuals as evidenced by their efforts to adjust to the new taxation policies that result in a rise in the cost of living.

Nonetheless, the adoption of new taxation requirements such as VAT may have varying implications for consumers due to their income levels, spending behavior, and lifestyle. It is crucial to note that the significance of VAT on particular commodities is dependent on the UAE’s individual characteristics. Hence, they may not be uniform in the entire population.

For the people in the lower and middle-class, income earned usually prompts the need for budgetary adjustments for them to cope with new taxation policies such as the introduction of VAT. As a result, it is common to find low-income earners refraining from the purchase of expensive items such as smartphones, laptops, and gaming equipment due to the tax introduction at the point of sale (Saderuddin & Barghathi, 2018).

Similarly, individuals in the middle-class may change their spending behaviors on luxury items, for instance, servicing cars and purchasing jewelry, due to the rise in the consumer price inflation (CPI) level. In most scenarios, the high cost of living brought about by VAT triggers individuals to adjust their budgets to ensure that they live within their means.

However, regardless of an individual’s social class, the significance of VAT may be determined by their lifestyle choices. According to Saderuddin and Barghathi (2018), an individual may be in the high-income category where they refrain from extravagance on products and services such as jewelry and entertainment. In such cases, changes in the VAT policy may affect them negligibly due to their lifestyle and spending patterns. On the other hand, the impact of VAT on individuals in the low-income category may also result in a lifestyle of simplicity.

Businesses in the UAE will also face the implications associated with VAT. For instance, they are now required to correctly document their income, costs, as well as the appropriate VAT charges (UAE Government, 2018). Particularly, registered firms and traders have to charge VAT to their entire customer base at the current rate. These clients also incur VAT costs on goods or services they purchase from various suppliers. Differences between the collected and incurred sums will either be reclaimed by the firms and traders or repaid to the government (UAE Government, 2018). As a result, VAT charges on goods and services in the UAE imply that businesses and traders have to adopt new taxation processes that facilitate the collection of revenue on behalf of the government.

Expectations Following the Introduction of VAT in the UAE

The newly adopted 5% VAT on consumer goods and services such as food and electronics is anticipated to affect the UAE’s economy in an array of ways as witnessed in other countries. The major expectation from the UAE government after implementing VAT is to collect additional revenues that would foster the provision of quality services to its people (Saderuddin & Barghathi, 2018). This move is also expected to enhance the sustainability of investment infrastructure.

The percentage revenue of GDP is expected to rise following the taxation reforms in the UAE. Chakraborty and Dash (2013) reveal that since the adoption of the VAT system in India in 2005, the government witnessed a considerable increase in the percentage returns of GDP collected because it rose from 19% to 21% between the 2005/2006 and 2007/2008 fiscal years as shown in Appendix 1. The UAE is expected to record a higher rate of domestic revenue generation in relation to GDP following the implementation of VAT.

In addition to the positive expectations in terms of domestic revenue generation, the implementation of VAT in UAE is anticipated to be accompanied by rising inflation rates, as well as the cost of living. According to Nagraj (2018), taxation reforms introduced in the UAE in the form of VAT is expected to result in short-term negative effects on the economy. This situation was witnessed in Saudi Arabia where VAT was also adopted in early 2018.

Saderuddin and Barghathi (2018) argue that the rise in inflation rates on consumer goods and services is one of the notable results of introducing VAT. In agreement with this revelation, Nagraj (2018) reveals that Saudi Arabia has recorded a 3% year-on-year inflation rise since the adoption of VAT. Thus, it is reasonable for the UAE to report a 4.8% year-on-year increase in inflation. Therefore, a rise in inflation rates should be one of the expected results of implementing VAT in a country that has no previous history of such indirect taxes. The cost of living is also likely to rise slightly in the short-term because it is related to inflation increase in a country that has adopted a VAT taxation policy.

The UAE government should expect the emergence of VAT compliance challenges for businesses and traders in the country. According to Faridy, Copp, Freudenberg, and Sarker (2014), following the introduction of VAT in Bangladesh in July 1991, the issue of compliance made it difficult for the government to register businesses and traders operating in this developing country. Nonetheless, the conformity issue fades with time through the implementation of mechanisms that encourage businesses to comply with VAT requirements. As a result, the Federal Tax Authority (FTA) has waived penalties for late VAT registrations.

According to Saadi (2018), it has also extended the closing dates for companies to file their tax returns since 90,000 firms out of an estimated 350,000 companies have not yet been listed. Therefore, the UAE government should expect to face challenges in registering organizations to track their VAT compliance levels. Thus, it should establish measures that ensure that all companies register to facilitate the collection of the indirect tax on its behalf.

Businesses in the UAE should be expected to incur costs, management time, as well as risks associated with the implementation of the VAT policy. According to Bain, Walpole, Hansford, and Evans (2015), VAT and GST compliance issues in the United Kingdom and Australia not only expose businesses to internal costs but also consume in-house time. Thus, as UAE businesses charge, account, and reclaim VAT costs, they are expected to incur compliance expenses that may have an impact on business turnover rates.

Furthermore, Faridy et al. (2014) agree that the VAT compliance issue affects all aspects of business ranging from procurement to marketing. Therefore, UAE businesses need to prepare for possible increments in transactional expenses and operating costs in their endeavor to comply with the newly introduced VAT policy.

Benchmarking the UAE’s VAT System

As mentioned earlier, at least 180 countries in the world apply VAT as a tool for domestic revenue generation to supplement government expenditure on public services and development among other areas. The UK’s taxation rules and regulations provide a good benchmark to gauge the cost aspects of the UAE’s taxation system as far as the VAT issue is concerned. The UK government introduced the VAT policy in 1973 to replace the Purchase Tax. Thus, this indirect tax has affected the UK’s economy for an extensive period compared to the case of the UAE. Currently, the standard VAT rate that applies to most of the common commodities stands at 20% (Andrejovská & Mihóková, 2015). The UAE applies a 5% VAT standard rate, zero-rate, and tax-exempt.

In the UK, items such as most foodstuffs and children clothes are zero-rated (Shoaib, 2017). The decision to include such basic items in the zero-rated VAT category is advantageous to the public because it reduces possible price volatility cases in the market, thus eliminating the need for consumers to cut their budgets on essential products and services. Conversely, the standard rate VAT administered in the UAE covers basic items such as foodstuffs for adults and children, as well as children’s clothes (Nagraj, 2018). Furthermore, the 5% VAT on utilities such as electricity heightens the cost of living among the people of the UAE. As a result, taxing basic items burdens households in the UAE in their effort to cope with the rising cost of living in relation to the case of the UK.

Discussion

The UAE is expected to record higher revenue levels generated locally through the administration of VAT on consumer goods and services at the point of sale. India reported a higher percentage of returns on GDP immediately after introducing VAT in 2005 (Chakraborty & Dash, 2013). As a result, it is expected that the UAE will realize positive socio-economic growth in the long-run after pursuing the diversification of revenue sources from oil. Nevertheless, the inception of VAT in the UAE has various implications for the economy.

GCC countries are seeking to diversify their sources of revenue. The 5% standard rate VAT influences consumers’ spending patterns in the UAE. As indicated earlier, the consumer price inflation level increased by 4.8% (Sadaqat, 2018). Consequently, consumers, especially the middle-class, have shown reluctance in purchasing expensive products such as electronics and cars. Such changing consumer behaviors witnessed in the UAE since early 2018 imply that the cost of living has increased slightly. Individuals are now cutting their budget on luxury items.

Amid triggering implications such as influencing consumers’ purchasing power and their spending habits, VAT charges affect businesses in the UAE. Since traders collect revenues on behalf of the government, they need to comply with the FTA for them to operate legally. Nonetheless, VAT compliance issues have undermined the ability to realize the full registration of UAE businesses and traders within the first-year period of administering this indirect tax (Saadi, 2018). As UAE companies seek to assume new accounting rules regarding the collection of VAT on behalf of the government, issues of compliance are anticipated since a new taxation concept is being introduced to the UAE’s business spectrum.

Furthermore, the role of businesses in administering VAT, including charging, recording, reclaiming, and repaying taxes, will expose UAE firms to transaction costs. It will also increase in-house management time and business risks as witnessed in the UK and Australia (Bain et al., 2015). Consequently, VAT is not only expected to pose cost implications for individuals but also businesses operating in the UAE. Benchmarking the UAE’s system with the UK’s VAT policy uncovers various dimensions of the implications of this indirect tax for the former country’s economy. Particularly, the standard rate VAT applied in the UAE constitutes common goods and services, including food and clothing, which fall into the category of zero-rated or reduced-rate VAT administered in the UK.

Conclusions and Recommendations

The introduction of the 5% standard rate VAT in the UAE, one of the lowest rates globally, promises increased domestic revenue generation as GCC countries pursue the diversification of revenue sources. The new indirect tax adopted in the UAE influences consumers’ spending patterns, especially on essential goods and services, due to the small rise in the cost of living associated with VAT. Such an increment triggers the consumer price inflation index. As UAE companies embrace VAT rules and regulations, the implications of VAT on businesses include compliance complexities, rising transaction and operating costs, and lengthened management time.

The performance benchmarking shows that the UAE government needs to consider a few areas that require improvements. First, the FTA should remove basic goods and services such as food, children’s clothes, and home energy and water from the standard rate to zero-rated VAT to lessen the cost of living. Second, the UAE government needs to consider adopting initiatives that encourage VAT registration and compliance among businesses and traders to foster the administration of the indirect tax. Third, the adoption of digital systems for collecting, accounting, and remitting VAT is necessary because it helps to reduce the cost and time spent on administering the tax. The adoption of the mentioned recommendations will help to safeguard UAE citizens from the high costs of living.

Appendix

Revenue Receipts by Centers, State, and Combined
Revenue Receipts by Centers, State, and Combined.

References

Andrejovská, A., & Mihóková, L. (2015). Developments of VAT rates in EU countries in the context of harmonization and fiscal consolidation. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 63(2), 487-498. Web.

Bain, K., Walpole, M., Hansford, A., & Evans, C. (2015). The internal costs of VAT compliance: Evidence from Australia and the United Kingdom and suggestions for mitigation. eJournal of Tax Research, 13(1), 158-182.

Chakraborty, P., & Dash, B. B. (2013). Fiscal reforms, fiscal rule and development spending: How Indian states have performed? Public Budgeting & Finance, 37(4), 111-133. Web.

Faridy, N., Copp, R., Freudenberg, B., & Sarker, T. (2014). Complexity, compliance costs and non-compliance with VAT by small and medium enterprises in Bangladesh: Is there a relationship. Australian Tax Forum, 29, 1-48. Web.

Nagraj, A. (2018). . Gulf Business. Web.

Saadi, D. (2018). . The National. Web.

Sadaqat, R. (2018). . Khaleej Times. Web.

Saderuddin, A., & Barghathi, Y. (2018). The impacts of introduction of VAT on the audit profession and economy in the UAE: Auditors’ perspective. Journal of Accounting and Management Information Systems, 17(3), 406-439. Web.

Shoaib, A. (2017). Web.

UAE Government. (2018). . Web.

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