VAT to further distress retail industry

|By K Raveendran| A clear assessment of the impact of the introduction of value added tax (VAT) in the UAE is not available yet, but it is fairly clear that it will have serious adverse results for the retail industry, which is already suffering a dip in demand.

Minister of State for Financial Affairs Obaid Humaid Al Tayer announced the other day after a joint press conference with IMF Managing Director Christine Lagarde that the UAE will implement VAT at the rate of five per cent from January 1, 2018. The revenue yield in the first year is expected to be AED12 billion.

VAT essentially being a consumption tax, most of this revenue will come from the retail and services sectors. To that extent, it would mean retail prices would go up and by implication there would be a proportionate or even larger drop in retail spending, apart from job losses.

It is not known whether any study has been undertaken about the impact of VAT with specific reference to the UAE or even the GCC because the issue has so far been approached only from the perspective of additional revenue generation in the wake of the slump in oil prices.

But a study by Ernst & Young on VAT in connection with the introduction of such tax in the US showed that the burden would shift forward to consumers through higher consumer prices and a consequent fall in consumption. By increasing consumer prices, the VAT also reduces real or inflation-adjusted wages, which would affect labour supply.

The Ernst & Young study estimated that the introduction of VAT in the US would reduce retail spending by $2.5 trillion over the next decade. Retail spending would decline by almost $260 billion or 5.0 percent in the first year after enactment of the VAT, it said.

The report was particularly harsh on impact of the VAT move, saying it would pose serious risks to the US economy itself. The drop in retail spending, jobs, and GDP under an add-on VAT has the potential to further weaken the economy in the near term, rather than strengthen it. Many countries have reduced their VATs in the face of the recent economic downturn, it noted.

The report went to the extent of suggesting that it would rather be more prudent to cut government spending to reduce budget deficit than cause a depressing effect on retail spending through the introduction of VAT.

“Reducing the deficit through lower government spending would have such more favourable economic effects – more jobs, higher GDP, a better standard of living for Americans, and a less depressing effect on retail spending – in both the near term and in the longer term,” Ernst & Young said.

According to the management consultancy, perhaps the most troubling aspect of a deficit-reducing VAT is that its negative effects on GDP, consumer spending, and employment would occur in the face of the current economic climate of weak economic growth, high unemployment, and low consumer confidence. These would raise additional economic worries, rather than shoring up the weak economy, it said.

The introduction of VAT will also pose serious challenges about its administration as the UAE or the GCC countries do not have any infrastructure in place for administering such a tax structure. Also, there are issues about collection, exemptions, procedures etc both at a central administrative level, manufacturing and distribution levels as well as at the retail outlet level, apart from the realignment of existing taxes such as the municipality tax for hotels and special taxes on goods like tobacco. A major challenge would be to equip the retail trade to handle the complex operation.