The Gulf Cooperation Council (GCC), which comprises the United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar, and Kuwait, has decided that its member countries will implement a value-added tax (VAT) system by 2018.
This decision was adopted in the context of a dramatic drop in recent years in the oil revenues that finance most of these countries' public expenditures.
The news of the forthcoming introduction of a five percent VAT in the Gulf region has plunged the VAT world into turmoil.
The GCC has enacted the Unified GCC VAT Framework Agreement (GCC VAT framework) that lays the groundwork for its members to implement VAT in their respective jurisdictions.
At press time, only two GCC members, the Kingdom of Saudi Arabia (KSA) and the United Arab Emirates (UAE), passed legislation to implement the GCC VAT system in their respective countries. The other four member states will more likely than not postpone the introduction of the VAT system until mid-2018 or later.
The main purpose of a VAT system is to impose a broad-based tax on final consumption by households to avoid burdening businesses.
It is noteworthy that VAT will be imposed not only on most domestic supplies of goods and services across each GCC country but also on purchases made from unestablished suppliers, which currently are untaxed. These purchases will now be taxable through the so-called reverse-charge mechanism.
The VAT is collected in stages. Each business in the supply chain collects the tax and remits a portion of it based on its margin, which is the difference between the VATs on inputs and outputs.
Businesses have a relief mechanism to offset the VAT, the invoice credit method, whereby each business credits the input tax against the output VAT charged on its supplies, and the business either sends the balance to the tax authorities or receives a refund when it has excess credits.
The right to deduct the input VAT in each phase of the process, except in the final stage of selling to the end consumer, guarantees the neutrality of this tax and prevents the cascading effects of other indirect taxes.
EU VAT Vs. GCC VAT
Some describe the GCC's VAT as a simplified version of the European Union's VAT system and, to a certain extent, they are right.
That doesn't mean the two systems are twins. There are fundamental differences between the EU VAT directive and the GCC VAT framework with regard to, for example, the taxable base, place-of-supply rules, and rates. These distinctions should draw the attention of any company considering adapting its ERP systems and processes to apply GCC VAT.
With regard to the taxable base, the EU VAT has embraced the "subjective value" for VAT purposes. The basis for assessing VAT, as expressed in several judgments by the Court of Justice of the European Union (ECJ), "is the consideration actually received and not a value estimated according to objective criteria."
Corporate tax experts might find it shocking that VAT upholds the "subjective value" rather than the arm's-length principle espoused in the world of transfer pricing. However, as an exception, the open market value should be applied in the case of supplies between related parties where the subjective value could be manipulated to grant unfair advantages.
In contrast, the GCC VAT framework has opted for the arm's-length principle even in unrelated transactions, as follows: "The fair market value is an amount for which the goods and services can be traded in an open market between two independent parties under competitive conditions prescribed by each Member State" (Article 26).
The introduction of "objective value" as the basis to determine the taxable base raises questions about the freedom to set prices between parties (related or not) and introduces a high degree of legal uncertainty regarding the consideration agreed to by the parties and in the price range(s) used by tax authorities. If the scope of the rule is not sufficiently narrowed by member countries, the potential risks linked to abandoning the subjective valuation would be innumerable.
Nevertheless, some may argue that the main hurdle does not lie in the freedom to set prices but in having to include another field, one that includes the market value, in each invoice, to calculate the VAT on a higher (or lower) amount than the contract price. When trading on the commodity market, where prices fluctuate daily, traders might have an agreement on delivery of goods against a set price for a longer period, in which case there will be a discrepancy between the amount effectively charged and the base used to calculate the VAT.
To be safe, should traders always overcharge VAT (better more than less), or would doing so create risk on the deduction side? This issue poses questions about legal certainty and even the proper functioning of the system.
So far, fortunately, KSA's regulations have limited the wide limits of the fair market value to when the consideration agreed between related parties is lower than arm's length and benefits the acquirer with limited right to reclaim the VAT. Whether other member states will follow KSA's steps is for now unknown.
What also seems unusual in the GCC VAT framework is that all prices must be VAT-inclusive (Article 25(2)), without clarifying whether this applies to both B2B and B2C or only to B2C supplies. If GCC member countries take the view that even in B2B transactions the pricing should be VAT-inclusive, that may create difficulties in the event of rate changes when suppliers are not entitled to adjust pricing accordingly to pass on VAT rate increases (or decreases) to business customers. In anticipation, companies should refresh the tax clauses of...