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Saudi Arabia is raising the stakes by hiking VAT and slashing the cost of living allowances for nationals employed in government services. Image Credit: Reuters

Dubai: Even with Saudi Arabia hiking its value-added tax (VAT) from July, businesses in the UAE and Bahrain are hopeful these governments would hold back for now. And even if they do raise it, it won't be to the levels imposed by Saudi Arabia.

“Several business sectors had submitted requests to the UAE authorities for a six-month VAT holiday until things get back to normal and consumers regain their confidence,” said the head of an industry grouping in Dubai. “The Saudi announcement comes as a complete jolt, and it will be difficult for consumers to sustain the tripling of VAT.”

The UAE and Saudi Arabia rolled out VAT on January 1, 2018, and Bahrain followed exactly a year later. The other Gulf states had delayed the transition to a VAT regime. (VAT-generated revenue for UAE in 2018 was Dh27 billion. In mid-November, Saudi Arabia said it had collected 46.7 billion riyals as VAT up to that point.)

Before the COVID-19 crisis, the International Monetary Fund (IMF) had advised Saudi Arabia to increase its VAT rate to 10 per cent.

The UAE is now holding a three-day government summit. Changes to VAT could be on the agenda - more so, with Saudi Arabia announcing its plans on Monday. The UAE has, for now, said there are no plans to hike VAT and match the Saudi move.

Why did Saudi Arabia triple its VAT rate?

The Saudi Finance Minister Mohammed al-Jadaan was fairly candid about the reason. "These measures are painful, but necessary to maintain financial and economic stability over the medium to long term. And to overcome the unprecedented coronavirus crisis with the least damage possible."

And this time, Saudi Arabia did not attempt to lessen the pain on residents through offering incentives elsewhere. The kingdom will also be withdrawing the cost-of-living allowance offered to Saudi nationals working in the government sector.

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Saudi Arabia is taking a step into the unknown by going in for a unilateral VAT hike announcement. Will other Gulf states join in as well? Image Credit: Gulf News Archive

According to Reuters, Saudi government had limited options, with revenues from selling oil dropping significantly. Extended restrictions on commercial activity through the COVID-19 lockdown period also hastened the revenue drop.

“Any short- to medium-term austerity measures will be significant and have a dramatic impact on businesses,” said Sachin Kerur, Head of Middle East Region, Reed Smith. “But it is hard to see how the Saudi fiscal position can be controlled without any shock treatment. After that, the fundamentals for Saudi should remain strong and Vision 2030, albeit refined and adjusted, can still play a key role in the beneficial diversification of the Saudi economy.

“Minister Al-Jadaan has said the government could lose half of its oil income, which contributes 70 per cent public revenues, given plummeting oil prices. So this is not a surprise and indeed many businesses in Saudi Arabia had been anticipating this for a little while now.

“Indeed, many expect more measures to come in soon. These latest measures are an obvious and necessary response to the growing Saudi fiscal deficit.”

What about UAE deciding not to raise VAT for now

Retaining VAT rates at the current 5 per cent would give this market a significant price advantage over Saudi retail prices. Wherever such price advantages open up, it creates opportunities for consumers and sellers.

“It’s unclear what the quantifiable advantages will be for cross-border transactions,” said Sameer Lakhani,managing director at Global Capital Partners. “But on the surface, it does appear that certain 'arbitrage' opportunities might open up if there are differences in VAT rates.”

Kerur agrees there are gains. "But the reality is that every regional government will implement its own fiscal measures to combat budgetary pressures and these are likely to be tough across the whole region," he added.

What does it mean for the consumer

Saudi Arabia and the UAE are the two leading gold consuming markets in the Gulf. But there are differences in the demand pattern. In Saudi Arabia, the interest is principally for 21K gold and mostly from national and Arab shoppers.

But in the UAE, 22K rules.

“The Saudi VAT hike to 15 per cent will have a significant impact on domestic demand there,” said Abdulsalam K.P., executive director at Malabar Gold & Diamonds and a member of Dubai Gold & Jewellery Group. “In Saudi Arabia, there are two gold base rates – one for 21K (and which includes making charges) and another for 22K.

“The 22K prices are comparable to Dubai, but 21K is already much higher. With 15 per cent VAT, the price gap will widen further.”

Malabar operates 14 stores in the kingdom, and confirmed it will be shutting down two of those keeping in mind market circumstances.

“In the gold jewellery trade, there is a vast unorganised retail sector, and with 15 per cent VAT hike, there are concerns there could be higher incidence of under-reporting of sales,” said Salam.

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Saudi Arabia's gold jewellery retail sector will be an immediate casualty from the latest VAT hike. Image Credit: Reuters

What it might mean for prices at local level

For Saudi consumers, a VAT increase will have a domino effect on what they will eventually pay at the checkout counter in stores.

Cost of import and delivery will all ratchet up in proportion, and these will add to the cost of merchandise at the store.

“Even if the duty amount is tolerable, the VAT, which is a direct tax, will have an enormous effect on the price of landed goods,” said Thomas Gregory, executive director at Fusion Specialized Shipping & Logistics. “Along with duties, the landed cost is going to be costlier by 20 per cent.

“The direct impact of VAT on exports will not be a significant impact as most services are exempted.”

On the cost of delivery, “Local moves will be impacted big time as the VAT component has increased by 300 per cent. For example, if a local move costs 500 Saudi riyals, with the new VAT rules, it could cost 575 riyals. “With companies working at a 10-12 per cent margin, this could be seen as a step that will increase product prices.

“Customers may refrain from buying non-essentials and luxury goods, but essential commodities must move.

“Logistics is a derived demand, hence there will not be a significant impact on the industry. It is a matter of time to get accustomed to the new realities of life.”

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File picture of trucks at the Saudi border in Al Ghuwaifat. Delivery and logistics could become a time consuming process if some of the other Gulf states do not raise their VAT. Image Credit: Gulf News Archives
Shadow of inflation
Will the Saudi VAT hike lead to inflationary pressures? Or will the current subdued demand at the consumer level keep price gains in check?

“The burden of VAT is generally borne by the consumer and so it is expected that Saudi Arabia will experience price inflation,” said Joanne Clarke, Tax Director for Pinsent Masons. There will be a “reduction of spending on luxury items as consumers’ disposable income becomes less valuable in the region.

“Businesses undertaking exempt activities in Saudi Arabia and unregistered businesses will also feel the impact of the VAT rate increase on their profits.”
What is a value-added tax?
It is essentially a tax on consumption, and happens at nearly every level of transaction. The actual VAT percentage can vary between countries, with Saudi Arabia now opting to go for 15 per cent while the UAE sticks to 5 per cent.

The VAT component someone pays is judged on the cost of the product, but minus the cost of materials used in making it and which have already been taxed.

On January 1, 2018, the UAE and Saudi Arabia became part of the network of countries to have introduced VAT. Currently, some form of VAT is in place at more than 160 countries.