By Jeremy Cape
Comment: The Decree Law answers some, but not all, of the outstanding questions, writes Jeremy Cape, Partner, Tax Strategy & Benefits, Squire Patton Boggs
The UAE has finally published its VAT Decree Law, a little over four months before VAT is due to be introduced.
While it is something of a relief to see actual law, most of which is consistent with expectations, much of the detail will be revealed in a still-to-be-published Executive Regulation. This is unfortunate, particularly if the reason for the delay is that the UAE has not fully concluded its position on some aspects of the final design of the law.
There are broadly three types of supplies – standard rated, exempt and zero-rated.
Standard-rated supplies are subject to five percent VAT, and the supplier can recover VAT from its suppliers.
Exempt supplies are not subject to VAT, but the supplier is not able to recover VAT. Zero-rated supplies are subject to VAT at zero percent, and the supplier is able to recover its VAT.
The “best” supplies for suppliers and customers are zero-rated supplies, as this means there is no VAT cost on the entire supply chain. Exempt supplies only “exempt” the final supply from VAT. So while the supply does not appear to attract VAT, revenues are still raised from the supply chain.
The UAE, which is required to implement VAT in line with the GCC VAT Framework Agreement applies the VAT exemption to broadly four supplies: financial services; bare land; residential buildings and local transportation.
These are typically exempt in a VAT system due to the conceptual difficulties in determining what is being supplied, and how it should be valued. The UAE has not issued details of what financial services will be exempted.
This makes it hard for institutions to plan, with less than four months to go. Sharia-compliant financing will apparently fall within the VAT exemption, but it remains to be seen how this will be achieved without creating uncertainty and loopholes, as has occurred in other countries that have made provision for Sharia financings.
Significantly, this does not appear to be exempt from VAT. It generally is in VAT systems, although the GCC Framework Agreement did not provide for exemption.
The UAE had indicated that it intended to exempt life assurance premiums, although this was not permitted under the Framework, and it is possible that the UAE will provide that life assurance falls within the financial services exemption.
No foods will be zero rated, which is surprising from a policy point of view, and the GCC Framework Agreement would have allowed the UAE to do so. Typically, countries introducing VAT, which is a regressive tax, seek to limit the impact on lower-income individuals and families by zero-rating certain basic items, such as non-luxury food and drink, children’s clothing and sanitary items.
Zero rating some food items does create complexity (the best-known UK VAT case concerns whether “Jaffa cakes” were zero-rated cakes or standard-rated biscuits – they were determined to be cakes).
If the supplier passes on the full cost of VAT to its customers, then those customers will see an immediate one-off five percent price hike for their weekly groceries, disproportionately squeezing the least-well off demographic. The extent to which the UAE has modelled the wider impact of this policy is unclear.
This will be zero rated, in line with the GCC Framework Agreement, although there’s no technical or policy reason why it should be. Aviation is already taxed in parts of the UAE: in 2016 a AED35 fee was introduced for Dubai International passengers.
On the other hand, the hotel sector is also already taxed, and there’s no indication that this will change when VAT is introduced, effectively giving rise to double taxation on the hospitality sector.
These are zero rated for investment purposes, but we await more detail – again in the Executive Regulation –to see which precious metals are covered, and which fall outside the zero rating. The GCC Framework Agreement envisaged only gold, silver and platinum.
Retail jewellery, unsurprisingly, will be subject to VAT. Whether there will be a tourist refund scheme will be seen when – you’ve guessed it – the Executive Regulation is published, again causing concern in this sector.
Educational and healthcare The decision to zero rate certain supplies of these two sectors is on its face a little unusual, as typically these would be exempt as a policy matter. Note, however, that the exemption is limited to “the supply of educational services and related Goods and Services for nurseries, preschool, elementary education, and higher educational institutions owned or funded by Federal or local Government”. This means that supplies made by private schools will be standard rated.
Similarly, the zero rating for healthcare is only for “preventative and basic healthcare” services (and related goods and services), with more detail to follow in the Executive Regulation. A narrow zero-rating for education and healthcare, rather than a broader exemption, may not have a significantly adverse effect on revenues, be less regressive and may create few distortions than would arise with a broader exemption.
My suspicion is that the big problems on January 1, 2018 will relate to this area. The Decree Law provides that where an existing contract is silent in relation to VAT, it shall be treated as being inclusive of VAT.
In other words, if a 2016 contract, with a duration of five years, provides for a monthly price of 100 on a supply which becomes subject to VAT on 1 January 2018, the post-VAT amount retained will decrease to 95.28, with 4.72 being VAT. If the recipient is able to recover the VAT in full, that recipient has in effect been granted a price cut of 4.72 percent.
The Decree Law provides that the Executive Regulation may make further provision in relation to transition. If businesses are not currently asking their lawyers to review their key contracts, they should do so urgently.