Businesses in Saudi Arabia will not have much time to be compliant for the hike in VAT from July. Image Credit: Gulf News Archive

Saudi Arabia’s announcement of a VAT increase from 5 per cent to 15 will surely boost government revenues - but it could bring challenges for businesses as was seen during the initial days of the tax introduction in 2018.

At a time when some countries decided to reduce VAT rates or provide significant relief from tax payment, the Saudi announcement came as a shock. But if one think’s objectively from a country’s perspective, the intent to increase the tax rate is not farfetched.

Today, where government revenues have significantly dropped due to lower oil prices, such a step should be considered the new normal. With two different VAT rates within the GCC, businesses in the UAE may view this as an opportunity, since a lower VAT rate could potentially make UAE lucrative, especially for leisure, shopping and tourism.

Increase in VAT rates coupled with the cascading impact of excise duty may result in a further hike in retail prices. Certain business activities may become unviable in Saudi Arabia where the cost of irrecoverable input VAT may reduce margins and get more start-ups to set up a base in UAE. If played right, this could result in increased revenues for the UAE economy.

Need an immediate rethink

Organisations in the UAE having subsidiaries in the Kingdom need to start working on implementing the changes. The effective date of increase is July 1, and though one may argue it’s only a change in the VAT rate, there is a multi-fold impact on businesses including the transition, working capital management, changes in ERP, tax invoices, re-visiting contracts etc.

Transition phase

Transition from 5 per cent to 15 will involve a closer look at transactions spanning two VAT rate periods. Situations where advances have been received but services or goods supplied after July 1 will have to be dealt separately to a situation where goods or services were supplied before July 1, but invoices issued later.

Working capital

VAT has always brought about working capital issues for businesses, most typical being the delay in receipt of VAT on payments from customers and the impact on blockage of input VAT.

VAT-exempt companies in financial services such as banks or life insurance companies may experience a sudden increase in costs on account of inadmissibility of input VAT resulting in reduced margins.

The increased VAT rate will also result in a direct increase in cash outflow of 10 per cent on the value of imports until the VAT return is filed. Businesses with low margins will have to bring in such efficiencies or arrange for additional working capital.

Free supplies of gifts and promotions will have a larger cash and expense outgo on account of increased VAT on such deemed supplies.

Passing on

Other changes would include a reassessment of prices and deciding whether the cost of VAT needs to be absorbed or passed on to consumers. The strategy around discounts and other form of supports given to customers may be relooked for prompt payment.

ERPs will have to be re-configured to manage both legacy and the newly proposed VAT rates, depending on the date of supply. Upgradation to new rates from the cut-off date, introducing new tax codes, and incorporating the changes in invoices as well as credit notes are additional changes.

An immediate step will be to look at tax clauses in existing contracts to ensure the change is captured. Contracts inclusive of VAT could now see a significant impact on margins and should be renegotiated.

All new contracts should have relevant tax clauses, and going by how the rate has been increased, businesses should think of putting generic tax clauses without mention of a specific VAT rate.

There could be a possibility of retaining a 5 per cent VAT rate for certain essential supplies. While further guidance is awaited, it is important that companies should immediately start assessing the impact as time is limited.

- Nimish Goel is Partner and Akshaya Khandooja a Principal at WTS Dhruva Consultants.