Out-Law Analysis | 14 May 2020 | 8:30 am | 6 min. read
The KSA introduced VAT with effect from 1 January 2018 at a standard rate of 5%, with specific limited zero-ratings and exemptions. The KSA is the first of the Gulf Cooperation Council (GCC) States to step away from the originally agreed GCC standard rate of 5%.
Since the signing of the GCC VAT Framework in 2016, the UAE and Bahrain have successfully implemented VAT at the standard rate of 5%, and have not yet implemented any rate changes. Oman, Qatar and Kuwait are yet to implement VAT and therefore, there will be a question over whether these States will implement at the originally agreed 5% or will seek to implement at a higher rate, following the KSA's actions this week.
As the increase in VAT rate takes effect in less than two months, businesses will be under significant pressure to assess the impact of this rate change on their business and ensure an ability to comply, without creating risk of error and penalties for their business. For others, the VAT rate increase will trigger increased cash flow issues where the business is in a continuous refund position in the KSA.
Of course, this short window to prepare is also a short window of opportunity for businesses with the cash availability to "bulk purchase" stock in advance of the rate increase. For taxable businesses, this will simply be a cash flow advantage of having 5% VAT flow through their VAT compliance process rather than 15% of cash being tied up. However, availing of the lower VAT inclusive pricing is especially important for businesses who undertake exempt activities or who are unregistered for VAT purposes in the KSA, as this will likely be a real cost saving of 10%.
Also, as the new VAT rate of 15% flows through the purchase and sales side of each business, businesses should be cautious that their overall net VAT position may change temporarily. For example, a business may move from a VAT refund to a VAT payment position. This should be anticipated and planned for appropriately.
VAT was introduced in the KSA as part of a much wider package of fiscal policy reforms by Gulf Cooperation Council (GCC) countries. The aim is to diversify government revenues away from heavy dependence on natural resources towards more sustainable and stable income streams. The introduction of VAT has been successful in this aim, raising around $12 billion in additional government revenue in its first year of operation in 2018.
VAT has now become a useful fiscal tool for the KSA government in balancing its budget. With the substantial fiscal impact of the Covid-19 crisis on the country, together with the budget deficit already experienced over the last few years, the increase in the standard rate of VAT from 5% to 15% is a strategic fiscal decision aimed at supporting the state with its liquidity during these turbulent times.
VAT was implemented in the KSA through a national VAT Law and implementing regulations. However, this national legislation aims to implement, and often refers back to, the 2016 Common VAT Agreement of the States of the GCC. It is therefore likely that certain legislative amendments will be required at both GCC and national level to give effect to the change.
The average standard VAT rate among OECD countries is approx. 20%. The minimum allowed standard VAT rate under EU law is 15%.
This is possible, and seems likely in the long term given that most VAT regimes around the world have a higher standard rate of VAT with multiple lower rates for specific limited goods and services. However, additional rates are unlikely to be implemented in the short term.
Businesses and private individuals will both be impacted by the VAT rate increase, although in very different ways.
Unregistered businesses, exempt and partially exempt businesses and private consumers will feel the real cost of the VAT rate increase as they will bear the burden of the additional charge.
VAT registered businesses have a very short window of less than two months to assess the impact of the VAT rate increase on their business and to implement the necessary changes in order to be compliant with effect from 1 July. However, for the most part, the VAT rate increase should have only an administrative impact on taxpayers rather than representing a real VAT cost for their business.
We can expect price inflation as a direct result of the VAT rate increase. This should generally last between 12 and 18 months.
Private consumers’ disposable income will have less buying power and therefore we can expect restricted spending on luxury items for a period of time.
Unregistered businesses and exempt and partially exempt businesses do not technically charge VAT to their customers and therefore will not be legally obliged to increase their prices by 10%. However, they will incur an additional 10% VAT on a portion of their purchases and therefore their cost base will increase. This may in turn put pressure on these businesses to increase prices in order to sustain profitability. Certain real estate and financial services businesses are likely to be particularly affected.
VAT registered businesses may face some pricing challenges when supplying to private consumers, exempt businesses and unregistered businesses. They will therefore need to analyse the impact on demand of a price increase of 10%, and make a difficult commercial decision on whether to pass on the full VAT rate increase to their customers. Often, the industry sector as a whole will drive the approach taken. The current economic climate will also need to be considered.
The change in VAT rate may be the first real test of whether a business’ original VAT implementation was ‘future proofed’. Each business will need to review its system capabilities; invoicing and credit/debit note templates; contracts with vendors and customers; pricing strategies; and internal procedures and controls.
If the business’ systems have been configured to allow for VAT rate changes, its invoicing is automated and its contracts include sufficient tax clauses, the impact of the change is likely to be minimal. Other businesses may require another ‘mini-implementation’ of the new VAT rate throughout their business.
Businesses with partially or fully exempt activities, or which are not registered for VAT purposes but incur costs liable to the standard rate of KSA VAT, will need to assess the real financial cost to the business, mitigate this cost where possible and allow for it in financial budgets.
Businesses will need to ensure that a 15% standard VAT rate tax code is created within their enterprise resource planning (ERP) system for both sales and purchases, together with appropriate procedures and controls as to when it should be used and appropriate mapping to their general ledger.
Tax invoicing or simplified invoicing will continue as normal. However, businesses may need to issue debit notes or credit notes to revise VAT treatments in certain circumstances.
Similar to when VAT was first introduced in the KSA, there will be a transitional period where contracts and transactions span 1 July 2020 and businesses will need to decide whether the transaction is liable to VAT at 5% or 15%. It is expected that the General Authority for Zakat and Tax (GAZT) will issue guidance notes in relation to the VAT rate increase shortly.
Generally, any transaction within the scope of KSA VAT which is not liable to a specific zero-rating or exemption for which the supply, invoicing and payment:
For a transitional transaction - where the supply, invoice or payment occurs before 1 July and the remainder occurs after 1 July - businesses will need to assess carefully whether to apply VAT at 5% or 15%.
In most regimes, when there is a change in VAT rate, the authority will require businesses to continue to follow the general ‘date of supply’ rules in order to determine the correct VAT rate applicable. In the KSA, the date of supply will generally be the earlier of:
However, where VAT has already been accounted for before 1 July but the actual goods or services are supplied in full or in part after 1 July, the GAZT may require the VAT treatment to be adjusted proportionately. This may happen, for example, on an advance billing invoice for the ongoing supply of services for a six-month period. These rules should be reviewed very closely by all businesses that expect to have transitional transactions, together with any GAZT guidance issued in due course, in order to avoid error and the risk of penalties.
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