VAT on UAE banking: Do the math

dubai - Customers won't feel the pinch but banks' profit margins will be hit

The proposed value-added tax (VAT) at a standard rate of five per cent is unlikely to have a major impact on general bank customers in the UAE, but it will negatively affect banking sector margins from next year onwards, said experts.

Analysts and tax experts said the banking industry, comprising 23 local and 26 foreign lenders offering various services through 931 branches across the UAE, should ready itself for a new era as the VAT and common reporting standards are likely to have a significant impact on their operations in the country.

They were of the view that the UAE banking sector remains well-capitalised, highly liquid and enjoys financial stability, but is yet to gear up for VAT due to be charged from January 1, 2018. They suggest banks, which recorded a 6.2 per cent rise in customer deposits at Dh1.56 trillion in 2016, should prepare themselves for VAT by raising awareness, assessing the impact of the new consumption tax as well as securing resources, planning and analysing projects to protect their margins.

"VAT is likely to be an irrecoverable cost, negatively affecting margins for the banking sector. VAT is a tax on transactions and impacts all areas of business from IT systems to legal, HR to marketing, and procurement to finance," Clare McColl, partner, KPMG Lower Gulf, told Khaleej Times.

Atik Munshi, partner at Crowe Horwath UAE, said the financial sector would traditionally include banking, insurance, exchange houses, brokerage, asset management, etc. Most countries with VAT have kept the range of financial services to be exempt in view of the sheer volume and the difficulty in measuring implicit financial fees.

Exempt services
"Deposits and savings accounts, granting of loans, among others, are normally exempt. However, certain services like advisory, debt buying, asset purchase [for Islamic banks], etc., may not be exempt from the proposed VAT in January next year," said Munshi.

Considering this exemption, he said the general bank customer will not bear an additional burden in a significant way though one needs to keep in mind that bank operations overall would be costlier. Eventually, banks would pass on the costs to customers in the form of hiked fees.

"In case of commercial accounts, the impact may be more as they might be using the bank services more for instruments, advisory, purchase of assets, etc., which may not be VAT exempt. The UAE government will not differ in its stance compared to the rest of the world. We need to wait till the VAT Law is published," he said.

McColl of KPMG said the standard rate of VAT is expected to be five per cent. An additional taxable rate of zero per cent may be extended by some GCC member states to cover certain financial services.

Whether a service is supplied at either five per cent or zero per cent, the taxpayer making the supplies is generally entitled to recover any VAT incurred on their costs for banks, this will include administrative and cash flow costs. However, it is likely that many financial services will be VAT exempt, she said.

"VAT exempt is not a rate of tax and so cannot be added to the price of goods or services. Supplies that are VAT exempt do not typically allow VAT incurred on costs to be recovered, thereby creating a blocked VAT cost," she said.

Recovering costs
Elaborating, she said a bank that provides both taxable and VAT exempt services would be required to calculate how much VAT it is entitled to recover.

"The exact amount will depend on the currently unreleased UAE legislation - international practice varies from fixed percentages to reasonable of social methods that may require negotiation with the tax authority," she said.

Elliot Severs, senior manager, indirect tax, at Deloitte, said banks are among the most VAT complex businesses. They will usually end up with multiple VAT liabilities on their supplies and the VAT law is rarely specific enough to prescribe the correct VAT treatment. Banks will need to take the decision themselves, support it with evidence and try to decide the amount of VAT that can be recovered.

"The likely outcome for the consumer is that fees that are charged by banks are likely to have VAT at 5 per cent applied to them. Products that are not fee-based such as interest, are likely to be exempt from VAT. Banks will not be able to recover all the VAT that they incur, so may look at ways of protecting their profit margin by increasing or charging more fees," Severs told Khaleej Times.

Latest UAE central bank data indicates that local banks are growing in terms of assets and credit by registering an increase of seven per cent and 8.1 per cent respectively last year. The national banks assets rose to Dh2.23 trillion in December 2016 while gross credit climbed to Dh1.37 trillion.

"With insurance, we're expecting VAT to be applied to most forms of insurance at 5 per cent. The likely exception is life insurance, which tends to be viewed as an investment and treated as exempt from VAT. Those just selling life insurance are also likely to see VAT as cost and may look to pass on these additional costs to consumers," Severs concluded.

- muzaffarrizvi@khaleejtimes.com