Dubai: Implementation of Value Added Tax (VAT) in the UAE starting from January 1, 2018 will have some adverse implications for the banking sector’s margins, irrespective of the rate at which the VAT will be charged on the financial services.

Following the introduction of VAT, it will apply to most supplies of goods and services and this may be at the standard rate of 5 per cent or at zero rate, referred to as taxable supplies. There will be a third category of supplies that will not be subject to VAT, referred to as exempt supplies.

Everything you need to know about VAT in UAE

Going by the indication in the recently introduced UAE VAT Law (Federal Decree-Law No (8) of 2017 on Value Added Tax), most financial services, except the fee-based services are going to be in the VAT exempt category. However, clarity on this will be available only when the government issues the Executive Regulation of this Decree-Law specifying tax rates and categories.

Going by the international practices, most financial service will fall in the exempt category, except fee based services. According to tax experts, many services offered by banks falling in the VAT exempt category could mean, these institutions are not able to recover the tax costs on inputs or pass it on to their customers, implying significant cost implications ultimately impacting margins.

“VAT is likely to be an irrecoverable cost, negatively affecting margins for the banking sector. It is therefore imperative that the impact of VAT on UAE banks is clearly understood,” said Umair Hameed, Partner at KPMG, in Banking sector Perspectives 2017.

VAT is a tax on transactions and impacts all areas of business from IT systems to legal, HR to marketing, and procurement to finance. The standard rate of VAT is going to be five per cent. Whether a service is supplied at either five per cent or zero per cent VAT, the taxpayer making the supplies is generally entitled to recover any VAT incurred on their costs.

Blocked VAT cost

For banks, this will include administrative and cash flow costs. However, it is likely that most financial services will be VAT exempt. “VAT exempt is not a rate of tax and so cannot be added to the price of goods or services. Supplies that are VAT exempt do not typically allow for VAT incurred on costs to be recovered, thereby creating a blocked VAT cost,” said Hameed.

Transactions involving moving money are likely to be VAT exempt. International transactions may be zero rated or outside the scope of VAT. VAT registered businesses that supply goods and services subject to VAT at a standard rate or zero-rate are usually entitled to claim a “credit” for VAT paid on their business expenses (input VAT). However, in the supply of exempt goods and services, no input tax credit will be available. Therefore the VAT cost will be borne by these businesses.

“Exemption means that no VAT will be charged on the provision of such exempt supplies and VAT incurred in relation to making these supplies cannot be reclaimed,” PwC said in a recent note.

The exempt supplies generally include the acceptance of deposits, the provision of loans or granting of credit, the operating of any current, deposit or savings accounts, the issue, transfer or disposal of securities among others. In addition, any services banks provide acting in an intermediary capacity to facilitate the making of a financial supply, are generally exempt. Many fee based services such as advisory fees, debt factoring services, managing and safekeeping of physical securities are taxable.

A bank that provides both taxable (whatever the rate) and VAT exempt services will be required to calculate how much VAT it is entitled to recover. The exact amount will depend on the local legislation would vary from fixed percentages to reasonable or special methods that may require negotiation with the tax authority.