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VAT

Financial sector hard hit by VAT

Financial sector hard hit by VAT

The UAE and KSA will both introduce VAT on 1 January 2018. The other GCC countries are expected to follow over the course of 2018. In KSA the laws are in place whereas in the UAE the publication of the implementing regulations is imminent.  

On the basis of the VAT laws in both countries, VAT applies on supplies of goods and services at a rate of 5%. The introduction of VAT has a profound impact on the business community in the GCC, triggering a higher cost of the products and services they offer, and a higher administrative burden to administer VAT.  

The financial and insurance sector occupy a special place in VAT legislation benefiting from deviating rules and therefore introducing even greater complexity. Applying VAT on complex products is not an easy task. The legislation often ends up zero rating or exempting financial and insurance transactions, instead of just subjecting them to VAT. The VAT exemption is not on any social or economic reason but on account of the conceptual and administrative difficulties associated with measuring the value of financial services.

The distinction between both is important, as on the face they both do not carry VAT, but the consequences in terms of the possibility to deduct input VAT are very different. Zero rating still allows input VAT deduction whereas the application of an exemption does not. This blockage of input taxes gives rise to cascading of tax and competitive distortions.

Additionally, certain income in the financial and insurance sector is out of scope of VAT, such as dividends or certain capital gains, which in turn again may impact the VAT recovery of such a business.   

KSA will tax fee based products (e.g. obtaining a credit card) and exempt margin-based products (e.g. a credit card loan). This principle will be applied throughout the financial sector. In terms of the insurance sector, life insurance will be exempt whereas other insurances subject to VAT. The UAE will only exempt certain financial services. The Director General of the FTA has recently declared that the sale and purchase of shares will be out of scope of VAT and profit margins will not be taxed. But the VAT treatment of financial services is much more extensive and complicated. The other GCC countries will likely apply a similar treatment.  

The fact that the financial and insurance sector is often largely exempt from VAT entails that they have a ‘mixed status’ for VAT purposes. It means that businesses need to get registered for VAT purposes but cannot deduct all of their input VAT, like regular businesses can. Instead, they need to apply a method to apportion the deductible input VAT. This method needs to be revised regularly.  

Contrary to regular businesses, VAT does not just flow through the financial and insurance sector. Instead it constitutes a cost. This has a number of negative consequences for purchases, outsourcing and intercompany charges, which may come at a higher cost.  

Even if the financial institution is fully VAT exempt, it will still have to pay VAT to its vendors and required to register for VAT purposes if they purchase services from outside the UAE. And even if the financial and insurance sector is largely exempt, the compliance burden is high. It has to keep the same records as a general business, i.e. a sales and purchase journal, and will have to file a VAT return like any other business.  

For example, it has to pay VAT itself on all services which businesses it receives from abroad. It requires that it keeps a purchase journal and makes a clear distinction between its foreign service supplier and its domestic suppliers.  

Opportunities lie in grouping related companies in the same country for VAT purposes, or by analysing which kinds of transactions could potentially benefit from a zero rate for VAT purposes.  

Islamic finance products further challenge the qualification of financial and insurance products for VAT purposes. Because of the riba prohibition, or prohibition to earn interest on loans, the underlying assets are often sold or given as security. This triggers a number of unsought consequences from a VAT perspective.  

The commercial opportunity for banks lies in a higher need for businesses of working capital and higher lending pending the introduction of VAT. The myriad of providers in the financial sector each have their specific position and VAT impact. Funds are impacted in a very different way than insurers or payment providers.   

Likewise credit card services, asset management services, insurance, investment in marketable securities all will be treated differently for VAT purposes. The common aspect for all financial services businesses is that all of them will be confronted with VAT and most of them simply have to get registered for VAT purposes.
    
Taking into account the date set for the implementation the UAE, (1 January 2018), it is about time that the FTA determines their comprehensive regulations for the implementation of VAT in financial sector. The uncertainty may deter investors in the UAE and lead it to shift to other jurisdictions where VAT is not implemented yet or is implemented in a more favorable way. Businesses in the financial sector need to make an impact assessment and determine their strategy for the implementation.