Ever since the Ministry of Finance has announced the introduction of new consumption tax called Value Added Tax in UAE, the whole nation is trying its best to get in terms with the new tax rule and adjusting their personal and business operations in accordance with the law. According to an estimate, while about 300,000-350,000 companies in the UAE will be impacted, the whole population of the country will be subject to the new tax system. Who is the real beneficiary of this bold move by the state?

The Middle East is losing big on the oil economy. UAE has also felt the heat of it but by soon rolling out their new tax law termed under Value Added Tax (VAT), will they be able to turn down the wheel of fortune in their own favor? Many of the organizations and small-scale enterprises will directly fall under the new tax regime and had to contribute tax for their national development. Will their sacrifice be worthwhile or it's just an excuse for the governing authority to leverage their oil loss?

The UAE is a most diversified economy in the region as oil only contributes 25 percent to the country's gross domestic product compared to 46 percent of other GCC countries. Initially, about 350,000 companies are expected to register under the new tax regime in the UAE and will help diversify revenue sources to cut dependence on oil falling from a high of $113 per barrel in June 2014 to less than $50 today.

The International Monetary Funds, in its latest report, also indicated that inflation in the UAE eased to 1.8 percent last year from 4.1 percent in 2015 chiefly due to declining rent. It further estimated that the inflation will average 2.9 percent next year and 2.5 percent in 2019 despite VAT implementation in the country. The impact of VAT on inflation and government revenue will vary depending on the proportion of consumption in the economy and how much of the consumer base is captured by VAT.

The implementation of VAT will come with some corporate challenges, especially for businesses which have not previously been exposed to the nuances of tax compliance. Aside from having to accommodate for additional administration costs, companies will need to consider how VAT will affect their operating models, including supply chain arrangements, financial systems, transition periods, end customer pricing and other relevant areas.

The impact of VAT may also vary based on industry or organizational structure of a company. For instance, where a company has the presence in multiple GCC countries, it would want to consider how best to treat the tax implementation if the VAT is not introduced simultaneously across the GCC countries. Similarly, companies that engage in long-term contracts would need to address existing contracts that do not account for the introduction of VAT.  It will also be important for businesses to review their contracts for goods and services to consider if these contracts adequately allocate the risk of payment of VAT and whether the payment obligation will be inclusive or exclusive of VAT in the case where the contract is silent on the matter.

Accordingly, organizations should begin by analyzing contracts to review their current position on tax and amend seek to make amendments by including clauses that accommodate for VAT. In the case of existing long-term projects, companies may wish to consider price adjustments to account for the introduction of VAT mid-contract. It is also worth considering how VAT might impact contract disputes and resolution. For instance, like other taxes, VAT payment may be applicable to payments ordered as a result of a dispute resolution. However, this would likely only be required where the payment is for rendered services, not where the penalty is purely compensatory in nature and where no service has been provided.   

As far as consumers are concerned, analysts say with some key components of the consumer price inflation basket in the UAE remaining either zero-rated or exempt will mean that the percentage point rise in inflation directly from VAT will be far less than the tax rate, especially as residential housing tends to have the largest weighting in the inflation basket. Food items with a high weighting, and governments considering the only limited number of exemptions, prices are expected to surge and will be a major component of price increase linked to VAT.

Analysts and experts said the consumers are unlikely to face any major impact from 5 percent standard VAT in January as the government has already exempted around 100 basic food items, housing rent, life insurance and some healthcare services from the new levy. Education and public transport services are also expected to be zero-rated VAT to keep the inflation in control, however, the consumers will have to bear additional cost for non-essential food items, dining out, vehicles buying and its insurance, among others.

VAT is usually a transparent system and has proven to be successful in many countries, and we should expect the same in the UAE. To reiterate, VAT is an on-value addition, so it will not really have much impact on consumers.