UAE must allow itself flexibility on tax regime
Image Credit: Gulf News

In 2018, the UAE’s Gross Domestic Product (GDP) was estimated at $414 billion. It was in the same year that a value-added tax (VAT) of 5 per cent was introduced for the first time, with a targeted revenue of Dh12 billion.

The federal share of the revenues was set at 30 per cent, and the seven emirates claiming the remainder 70 per cent. According to the CIA Factbook’s 2017 estimates, UAE’s household consumption alone represented 34.9 per cent of GDP, which when multiplied by $414 billion and then by 5 per cent produces a projected VAT revenues’ figure of Dh26.5 billion.

Dh27b

was collected as VAT in 2018 surpassing the estimates of Dh26.5b

That said, VAT revenues collected in 2018 surpassed the announced target, with Dh27 billion. Of the Dh27 billion, Dh8.1 billion went to the federal government and Dh18.9 billion to the seven emirates in proportion to the share of VAT-related transactions that took place in each emirate.

As a result, Dubai claimed the highest share among the seven, receiving more than 40 per cent of the Dh27 billion collected in VAT revenues. Given that more than one year elapsed since VAT’s introduction, it is time to discuss its impact and what can be improved moving forward.

VAT is a tax on consumption. It being value-added however means that it applies and is payable throughout the value chain. This is where the VAT differs from a Goods and Services Tax (GST), in which the tax percentage is applied to the final price of the product or service being sold.

In VAT’s case, every step in the value chain is taxed by the same amount, which means that the total VAT amount paid on the final product or service is the combination of all those smaller VATs paid all along the value chain.

They can crimp consumption habits

Unlike VAT, GST offers the option to avail tax credit for inputs, meaning that the total payable tax amount on the final product or service is passed on to the consumer. Both taxes though are consumption-based taxes that can, if rates are set high enough, curb household and other types of consumption in an economy.

40%

of VAT revenue went to Dubai which reflects its diversified economy

They can also discourage tourism and tourists’ spending if refunds are not allowed. While the effects on consumption and tourist spending is straightforward, the same cannot be said about inflation and the net effect on the country’s economy.

Notably, VAT’s introduction in the UAE did not have a significant impact on inflation. This could be attributed to what is termed in economics as a “Deadweight Loss” (DWL), an offsetting effect that results from tax introduction.

For VAT, DWL would deter consumption in the economy because of taxes paid along the value chain and higher prices for products and services. Therefore, DWL in effect acts as a deterrent for inflation despite the fact that VAT in the UAE affects products that are included in the measure of inflation.

The relationship between VAT and inflation is not a linear one, however and. It is more complex than that, as consumption is also influenced by price elasticity for products and services upon which VAT is imposed.

Also, since interest rates are relatively low, a 1 per cent increase in inflation between 2017 and 2018 is nothing short of remarkable. Besides the above, here are three main observations from VAT’s first year.

First, the allotted VAT share of revenues to each emirate signifies the extent of economic diversification in them and the wider range in economic activities. Those activities resulted in higher VAT collected in those emirates, thus higher shares from the 70 per cent to fund their budgets.

Secondly, it is now time to go over the list of exemptions and study the possibility to include products that have been previously overlooked when deciding on the list of VAT-exempted products and services. For instance, food necessities as well as baby and children related products, including food and beverages, could be considered here.

Giving tourists a VAT break

Thirdly, the decision to refund VAT to tourists was in fact a wise one, even if it was only implemented towards the end of 2018. The current arrangement allows a refund to tourists of 85 per cent of VAT, with 15 per cent going to the operator of the tax refund system.

In a recent announcement, the Federal Tax Authority (FTA) has lowered the amount retrieved by each tourist from Dh10,000 to Dh7,000 per day. This serves as a push towards cashless refund transactions with no limit set on credit card refunds.

Given how important tourism and tourism-related industries are to current and future economic diversification, the focus should be shifted now to simplifying procedures and expanding availability and visibility of the refund operator in major retail locations. This is crucial not just because of the UAE’s standing as a touristic hub, but also because the country is in the final stages to host Expo 2020.

In conclusion, VAT is helpful in diversifying public revenues, especially one that aims for further economic diversification away from an oil extraction-based and highly subsidised economy. VAT is not a fix-it-all remedy nevertheless, and its introduction should be a first step to an overhaul of the UAE’s economy and its revenue sources.

In a similar vein, estimated targets must be carefully calculated and announced, ensuring that all direct and indirect factors that could affect VAT revenues are appropriately accounted for. Not only that, but VAT and other future taxes should be treated as work in progress.

This means the consistent review and amendment of policies whenever needed based on annual assessments of taxation impact on various levers of the UAE’s economy.

The last thought that I want to leave you with: What is the relationship between population breakdown and VAT revenues?

Abdulnasser Alshaali is a UAE based economist.