In a surprise move on Monday, Saudi Arabia increased VAT threefold to 15 per cent and also suspended the cost of living allowance to increase revenues.
"Cost of living allowance will be suspended as of June 1, and VAT will be increased to 15 per cent from 5 per cent as of July 1," the Kingdom's state news agency said on Monday.
Mayank Sawhney, managing director at MaxGrowth Consultancy, said the Kingdom's move will prompt a discussion in the UAE and other neighbouring countries to increase the VAT rate in their respective countries.
"However, any such move could be detrimental to businesses and consumers in these countries, who have already been adversely impacted by coronavirus. Therefore, it is unlikely that the authorities in UAE and Bahrain will increase the VAT rates at this stage," said Sawhney.
An official response from the UAE's Ministry of Finance was awaited at the time of publishing this report online. The UAE had previously announced that it will not increase VAT for the next few years.
Sources and industry executive said that contrary to the Saudi move, the UAE was mulling dropping VAT temporarily until the situation surrounding Covid-19 is stabilised and economy returns back on track.
In fact, many European and Asian countries are turning to emergency tax breaks to support their economies against the Covid-19 threat. India, China, Finland, South Africa, Bulgaria, the US and the EU have announced some form of relief for their businesses and consumers in taxes to cope with the virus.
Anurag Chaturvedi, CEO, Chartered House Tax Consultancy, says considering current situation surrounding the pandemic and its impact, it will not be favourable decision to increase taxes.
"GCC governments are providing stimulus to support businesses against Covid-19 and any increase in taxes will reverse the effect and may result in deeper recession with increased inflation. KSA has more internal demand and can sustain the increased taxes whereas other GCC countries are more dependent on sectors like tourism, global trade and logistics etc. which will become unattractive by increasing tax," added Chaturvedi, who is also secretary for ICAI - Dubai chapter.
Thomas Vanhee, partner at Aurifer Middle East Tax Consultancy, believes that the UAE and Bahrain could follow KSA given the similarities in their economic conditions but the UAE has different dynamics as compared to other countries.
"Given the similarity and the interdependency of the KSA economy with the UAE and Bahrain, it is not inconceivable that these countries will follow suit. The situation of the UAE may be slightly different since it is a confederation and not a unitary state. The dynamics between the Emirates may play out differently," said Vanhee.
Impact of increasing VAT
Vanhee added that a hike in the VAT rate will impact consumer confidence.
"From a business perspective, those businesses which may have cared less about a mere 5 per cent VAT, will now increasingly turn their attention to transactions subject to VAT to ensure compliance and, more importantly, no VAT leakage. The economy is currently in a fragile state, therefore, this measure will be carefully weighed."
Sawhney of MaxGrowth Consultancy noted that the increase in VAT rates in UAE in the current environment is going to have a significant adverse impact on businesses and consumers in the country.
"It could prompt exodus of more people from UAE, as such move will increase the cost of living while many people struggle to cope up with given their reduced income in the current environment on account of Covid-19," said Mayank.
Anurag Chaturvedi noted that the impact of hiking VAT will depend on the size of the increase.
"Any increase in tax will tend to discourage activity and output. Increase in VAT may distort the choices made by households, businesses, and the foreign sector in some way."
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