Recently, the UAE government announced the introduction of a nine percent corporate tax that will come into effect in June 2023. Whilst businesses typically react negatively to any new tax announcement, it might actually be the companies themselves that will benefit the most from such a tax.
So, which impact will the corporate tax have on the local business community as well as new investors? Companies essentially have three major options. Firstly, they can increase prices to achieve the same “after tax” profit.
Secondly, they can increase their investments and costs in order to lower the tax burden. Or, thirdly, they can accept that their net profits will decrease by nine percent. Expecting that most companies would be reluctant to accept the third and final option, let’s focus on the first two options.
Profits and taxes
Increasing prices might seem very tempting, but there is a risk of customer complaints. Hence, it does not apply to every industry. Only companies with so-called “high pricing power” might be able to get away with it. But what does having a “high pricing power” mean? It means that companies are able to raise prices without having to be afraid of a drop in demand and ultimately sales.
But who are those companies? Often, these are industries characterised by high market entry barriers, such as pharmaceuticals and biotechnology. It is rather cumbersome for their customers to switch to a competitor, for example software.
A lot of the time, these companies have a strong brand equity (e.g. luxury brands), with control over distribution (e.g. Apple) and limited numbers of competitors (e.g. telecoms). They also invest heavily in innovation and product development (e.g. patents), and so, they have a competitive edge that makes it difficult for competitors to copy their products and services.
Specifically in this region, it was quite tempting for many businesses to focus on a maximum dividend payout to their owners and shareholders as those payouts were tax-free. The word “cash cow” might have been indeed an accurate definition of how many companies were seen by their owners. In fact, our latest study shows that the percentage of net profits invested in R&D in GCC is amongst one of the lowest in the world.
Now, a nine percent corporate tax will now suddenly incentivize further reinvestment – such as funding R&D activities. The decision whether companies should invest in expensive innovations, or rather postpone the decision and allow the shareholders to enjoy a bigger dividend instead, will now be shifted in favor of longer-term investments towards product and service quality.
This will secure the companies’ competitiveness. And ultimately, the business valuation will increase, attracting more investors and making the entire UAE strengthen its position as the innovation hub for the region.
Lovrenc Kessler, is Managing Partner of Simon-Kucher & Partners Middle East.
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