The recent move by the UAE to reduce fuel subsidies has sparked debate on the likelihood of a Value Added Tax (VAT) implementation once again.
The fact of the matter is that global oil markets are not being kind to the region, bearing in mind the central role the commodity plays in balancing GCC government budgets.
The scale of the challenge can be seen when considering that this country needs to sell its oil at about US$70 per barrel to achieve what is known as fiscal break-even, while at Thursday lunchtime, the benchmark Brent was at $44.76 per barrel.
Currently, the GCC and the UAE Governments are using their substantial cash reserves to fund a large portion of their deficits, yet all are aware that this can only be a short-term strategy. Fiscal stability and sustainability in the long term has to be the ultimate goal, something that the IMF is also urging in its latest country report into the UAE published this month. Introducing domestic taxation is one such way to achieve greater stability and sustainability.
The UAE has made no secret of the various studies on VAT and Corporate Income Tax (CIT) already undertaken, a state of affairs confirmed by the Ministry of Finance on August 18. Although no firm decision has been made on what, if any new taxes are to be introduced, the signs seem to point towards an important announcement in the near term.
Previously, moves to implement VAT in the UAE were stalled by failure to reach a GCC multilateral agreement for a joint introduction. However, faced with different socio-economic and political environments at home, the GCC recently downplayed the need for a simultaneous implementation.
Turning to the question of what a taxed environment in the UAE might look like, much has been written about the relative merits of VAT over CIT. VAT is a popular fiscal tool for a range of reasons. It is considered to be efficient when operated at a low rate and consistently applied throughout the economy, cheaper to operate, less open to fraud and less likely to distort investment decisions by businesses than any form of direct tax.
Compared to a VAT, CIT is theoretically more likely to act as a disincentive to business investment in the region and adversely impact GDP growth as a result.
Yet many multinationals generating profits in the UAE may already be paying CIT on those earnings to other jurisdictions to some extent; therefore a low-rate broad-based domestic CIT in this country may not actually have as negative an impact on their investment sentiment as might initially be thought. Perhaps more importantly, the UAE has never been bound by regional considerations when contemplating a domestic CIT.
On the other hand, a personal income tax presents an obvious challenge to the “tax-free” branding that has served the region so well in the past and it is unlikely that this option would be pursued without first maximising revenues earned by other means.
Importantly, even if oil prices recover, regional budgets will remain to a large extent at the mercy of the vagaries of the global oil markets. That in itself is an important reason to start generating internal revenues in the UAE. The need to preserve cash reserves is another important driver; at current rates of expenditure existing reserves would be exhausted in a few short years.
A low-rate, broad-base VAT seems to tick more boxes than CIT at this stage, potentially balancing revenue generation with the protection of investors a little better. That is not to say that the country needs to decide on one over the other (it could implement both), but that VAT may well be the frontrunner. Regardless, the UAE is committed to giving business a significant amount of time to prepare for implementation – a clear message that has been delivered by the Ministry of Finance on a number of occasions.
Stuart Halstead is head of indirect tax, the Middle East at Deloitte & Touche