COMMENT: VAT and the Supply Chain
By Jeremy Cape, partner, tax strategy & benefits, Squire Patton Boggs
The consequences of the arrival of Value Added Tax in all six members of the Gulf Cooperation Council, scheduled for 1 January 2018, are unlikely to be straightforward for businesses, particularly those in those countries that currently do not have significant taxes.
The Member States of the GCC signed a VAT Framework Treaty in October 2016. The VAT Framework Treaty broadly shares the characteristics of the VAT system in use across the European Union (EU) and can be expected to operate in a similar way. Although the VAT Framework Treaty will form the basis for the domestic VAT legislation in each GCC Member State, not only will there almost certainly be some differences in legislation between countries, but there will be major differences in the way that the legislation is interpreted by each country’s tax authorities and courts. At the time of writing, we await publication of the draft legislation for each country.
VAT will initially be introduced in the GCC with a (comparatively low) standard rate of 5%. Typically, countries introducing VAT do so at a relatively low rate with a view to increasing it in the medium term (as was the case with most EU countries and, more recently, Japan). It is not entirely clear whether it was the intention, or the legal effect, of the VAT Framework Treaty to allow countries to increase the rate unilaterally, or whether it must be done by all six members simultaneously. Nevertheless, it would be surprising if the rate did not increase at some stage over the next decade in at least some countries, as their governments look to move away from relying mainly on oil and gas revenues. An increased rate means, of course, an increased cost for businesses and consumers, and more significant exposure in the event that businesses make mistakes in implementing the rules.
A company which is registered for VAT will need to pay VAT (input VAT) on any taxable supply it receives, charge VAT (output (VAT) on taxable supply it makes, and account for any output VAT it has collected (net of an allowable proportion of input VAT already paid) to the relevant tax authority.
The applicable rate of VAT will be dictated by the type of supply in question. The default position is that supplies will be subject to the standard rate of VAT. Some supplies will be zero-rated, which means that they are subject to VAT, but the rate will be 0%. Zero rating is excellent both from the position of the supplier and the recipient, because the supplier does not need to account for any amount of output VAT (and will therefore not need to seek to increase the price) but will be able to recover the input VAT it incurs in respect of the supplies. Certain other supplies will be exempt from VAT. A supplier making exempt supplies will not need to account for output VAT but will not generally by permitted to recover input VAT in relation to those supplies. This means that, unlike a supplier of standard-rated or zero-rated goods and services, a supplier making exempt supplies will suffer input VAT as a cost, and may wish to pass that cost on to its customers.
In the first instance, businesses will need to determine the impact of VAT on their economics and pricing. In the absence (at the time of writing) of published legislation, there will remain an element of uncertainty, but it should be possible, on the basis of existing published legal guidance and an understanding of how VAT generally works, to determine the key positions in the relevant countries.
There will be immense challenges for businesses and tax authorities of correctly identifying and analysing both the fundamental and subtle issues which frequently arise in relation to VAT and, as soon as legislation is published, businesses will need to move quickly to ensure that they are ready for 1 January 2018.