New Year Sunset For Companies In UAE’s Free Zones

The implementation of the United Arab Emirates Value Added Tax law from January 1, 2018, is expected to generate tax revenues of 12 billion dirhams, which would ultimately be borne by the final consumers. While the VAT law is well on its course to be implemented, it is worthwhile to note the efforts undertaken by the UAE Ministry of Finance, in creating awareness amongst the stakeholders. The following milestones have been achieved in the run-up to the 'Go-live date' in order to ensure a smooth implementation for all stakeholders:

• Release of various Frequently Asked Questions (FAQs) in relation to VAT,
• Signing of the Gulf Cooperation Council VAT Agreement between the GCC member states in 2016,
• Release of tax procedure law in public domain,
• Release of Executive Regulations on procedural law,
• Release of Federal Decree Law No. (8) of 2017 on August 27, 2017, in the public domain,
• Commencement of VAT registration from October 8, 2017,
• Release of Executive Regulations on November 27, 2017.

Impact On Global Economies

It is expected that the introduction of the VAT law would not significantly impact the UAE economy and it is expected to accelerate without any major pitfalls. Inflation, however, is expected to increase by a few percentage points which should get neutralised over a period of 6-8 months post-implementation. The tax incentives available combined with other natural advantages made UAE a warehousing and trading hub and a favoured investment destination for overseas businesses.

With the introduction of VAT, the overseas businesses would have to consider the impact of 5 percent VAT on their expenses, profits routed through entities set up in UAE as well as the administrative and manual procedures to become tax compliant.

Impact On The Indian Economy

India and UAE enjoy strong bonds of friendship founded on millennia-old cultural, religious and economic interaction between the two regions. The relationship further flourished since the creation of the UAE Federation in 1971 and trade has played a major role in strengthening the bilateral relationship. This led to large Indian conglomerates setting up operations in UAE.

Given the implementation of the UAE VAT Law, the following could be the broad level impact on Indian companies having a presence in UAE:

Marginal rise in office maintenance cost

Unless exempted or zero-rated, all kinds of supplies are chargeable to VAT at 5 percent. Given that the maintenance of an office involves rent charges, capital expenditure, water charges, electricity charges, printing and stationery charges, cleaning charges, etc. the cost of maintaining the office would increase to an extent. While the tax paid on such expenses should be recoverable, there could be a working capital impact of 1-2 months. Further, the tax would be recoverable only if the business is registered. Hence, if any business is not registered under UAE VAT law then the taxes paid on purchases would become a cost.

Dilution in the image of a benign tax regime

Various businesses prefer to operate in tax-friendly countries across the globe. UAE, while certainly not a tax haven, it is a region where policymakers have nurtured a benign tax regime, allowing citizens and residents to retain most of their income.

Given this, all the Indian companies having a business presence in UAE crossing the mandatory threshold limit would suffer to this extent and factor in the VAT while considering their future investment plans.

Phasing out of tax incentives available in the designated free zones

Many Indian companies have their presence in UAE to reap the benefits of tax and business-friendly regulations available in the free zones. There are approximately 45 free zones in UAE which give free trade incentives and benefits to the businesses registered in such zones.

The UAE VAT law has provided for the meaning of ‘designated zones’ and not ‘free zones’. Article 51 of the Executive Regulations provides an exemption from levy of VAT only in case of movement of goods between the designated zones. In case of movement of goods into and from a designated zone to a non-designated zone, VAT would be applicable. Also, with the implementation of the VAT law, it is expected that the number of free zones may reduce from 45 to 4 or 5. Given such tax impact and reduction in the number of free zones, it appears that the tax incentives would no longer be freely available. Hence, businesses would now have to factor in the applicability of VAT for undertaking any business decision in UAE or entire GCC region.

Mandatory registration in UAE for companies having negotiating and bargaining power

Article 13 of the UAE VAT law requires mandatory registration in case of businesses who are not registered for VAT and who supply goods/services in the state on which tax is liable to be paid by them. Further, Article 9 of UAE VAT Law has provided that the supply of goods and services through an agent acting in the name of and on behalf of a principal is considered to be a supply by the principal. Given such provision, any holding/principal company in India acting through its subsidiary agent company in UAE would have to take registration in UAE thereby increasing the compliance and administration cost.

Impact On Various Sectors

• Impact on pharma companies: Due to the Article 9 read with Article 13 of the UAE VAT law, the holding/principal company in India may have to take registration in UAE and comply with all the provisions of the UAE VAT law. The pharmaceuticals sector would be most affected by such provisions.
• Impact on telecommunication companies: Article 31 of the UAE VAT law provides that the place of supply of telecommunication services would be the place where the services are used and enjoyed. The Indian Goods and Services Tax law provides that the place of supply for the provision of telecommunication services would be the billing address of the recipient. Given these provisions in UAE and India, there may arise a situation wherein the provision of international roaming services would be taxed twice, once in India and twice in UAE.
• Impact on Indian diamond companies: It is proposed that 5 percent VAT would be applicable on sale of loose diamonds – both rough and polished from January 1, 2018. The VAT levy on diamonds would result in a serious toll on the Indian diamond industry and be challenging for Indian diamond importers. A tax-friendly environment has led to UAE emerging as one of the world’s largest diamond trading hubs and many Indian companies have established their offices in Dubai Multi Commodities Centre (DMCC). With the levy of 5 percent VAT on diamonds along with additional 0.25 percent levy of GST in India on imports from outside India, Indian companies may have to shell out a total of 5.25 percent tax on the value of diamonds.

Strict Penal Consequences

Unlike the Indian GST, the UAE VAT law has provided for strict and severe penalties for non-compliance with any particular provision of law or executive regulation. In order to avoid any penal consequences, Indian companies having a presence in UAE would have to take registration and ensure technical and timely compliance with the law.

Conclusion

It is anticipated that while there may be temporary hiccups in business growth in both countries, long-term economic growth would be unabated once the VAT is implemented. UAE should be able to maintain its reputation as a global trading hub, linking the Middle East with rest of Asia and the world whereas India should continue to modernising its economy, paving the way for increased prosperity in the years ahead. Both new consumption taxes i.e. VAT in UAE and GST in India are being introduced at a relatively lower level compared with other countries such as the United Kingdom where VAT is set at 20 percent. With tax revenues burgeoning, governments can play a major role in oiling the wheels of a modern, globalised economy creating a win-win for the government and society as a whole.

Jigar Doshi is an indirect tax partner, Shivendra Dwivedi is a manager, and Harshal Fifadra is a senior executive at SKP Business Consulting LLP. Views are personal.

The views expressed here are those of the authors’ and do not necessarily represent the views of BloombergQuint or its editorial team.