VAT diversifies UAE government revenues with minimum rise in prices

Dubai: Introduction of value added tax in the UAE has diversified the government revenues enhancing the country’s institutional capacity to respond to the oil price shock while limiting inflationary impact to the minimum, said credit rating agency Moody’s.

Of the six Gulf Cooperation Council (GCC) states, only Saudi Arabia has introduced the tax on schedule along with the UAE. While the VAT is at a uniform rate of 5 per cent, the level of tax compliance will be clear only when the revenue receipts are announced. Reports suggest that around 260,000-275,000 of an estimated 350,000 companies have registered for VAT so far.

“The implementation of VAT in the UAE also marks a positive step towards revenue diversification. With the introduction of strict penalties on tax evasion, the UAE expects to achieve high levels of compliance, and could raise up to 1.7 per cent of GDP [Dh24 billion] in additional revenue for the country annually,” said Thaddeus Best, a Moody’s Analyst.

In the early years of adoption, the rating agency expects that realised revenue may be lower because of less than total compliance.

Inflation

The inflationary impact immediately following VAT’s introduction was modest (2.7 percentage points on a month/month basis between December 2017 and January 2018). In part, this was due to the impact of exemptions and zero-rated items. In addition, the ongoing deflationary trends in the real estate market also helped to contain inflation said Moody’s.

Among the several consumer basket segments, the lowest pass-through was in housing (where residential sale and leases have been exempted), healthcare, and education (where most basic educational goods and services have been exempted or zero-rated).

“Price increases in sectors like transportation were also relatively modest in part because of exemptions, but also likely reflecting retailers absorbing the cost within their margin, at least initially, due to subdued consumer demand for vehicle purchases. This is also consistent with the Emirates NDB PMI readings for the UAE since the start of the year which have shown that input costs had increased for firms but these had largely not carried through into higher output costs,” Moody’s analysts said.

Revenue sharing

Although the UAE government has confirmed that just 30 per cent of the revenues will be retained by the federal government, the tax share of individual emirates is yet to be announced.

“The exact revenue sharing formula for the emirate-level share has yet to be announced by the government, although we expect it will most likely be a based on a combination of GDP, non-oil GDP, and population size,” said Best.

The fiscal impact of VAT on the individual emirates will depend on what revenue-sharing formula is ultimately adopted. For example, assuming full compliance, basing the VAT redistribution on GDP would generate up to 1.2 per cent of GDP for each emirate. However, using non-oil GDP for example would be more favourable for Dubai and Sharjah given the lack of significant hydrocarbons output, generating around 1.4 per cent and 1.3 per cent of GDP respectively, whereas Abu Dhabi’s share would fall to around 1 per cent of GDP, according to Moody’s estimates.

Emirates like Sharjah, where around a quarter of the population works in Dubai, would benefit most from a population-based approach, according to Moody’s.