The UAE Cabinet made a seemingly minor change earlier this month in how VAT applies to jewellery sales. It is significant for the way in which the VAT system will hold together in the GCC. It may even define the future of VAT in the UAE and the GCC for the next decade.
Unlike a sales tax, VAT is chargeable at each stage of the supply chain and, through a system of input and output credits, the amount paid is generally refundable to businesses making onward taxable supplies.
Although VAT is intended to be borne by the end consumer, intermediate suppliers will account for the tax on business-to-business supplies. That is why it is called a “value added” tax.
One of the perceived advantages of a VAT over a sales tax is that the cascading effect reduces the incidence of evasion. Because every supplier is accounting for VAT on the value it adds rather than just the end supplier accounting for sales tax on the final sale to the consumer, the system is inherently more robust - it works like a primitive blockchain. In addition, there is no need to define what is the “final sale” on which tax should be charged.
The disadvantage of a VAT over a sales tax is that it can be a bit of a faff for businesses in the supply chain. Why, they ask, should we have to fund VAT payments in one month only to have them refunded a couple of months later?
This appears to be the basis on which the precious metals sector has been able to secure different treatment. I have seen reports, which I don’t believe, that the introduction of VAT has been responsible for a 50 to 60 per cent reduction in wholesale gold jewellery sales in the first quarter of 2018. Under the GCC Unified VAT Agreement, the supply of investment gold, silver and platinum (defined as having a purity level not less than 99 per cent and tradable on the Global Bullion Exchange) is zero rated, and this is already reflected in the VAT laws that came into effect on January 1. This zero rating does not cover diamonds or gold jewellery.
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It appears the change will be effected by imposing a reverse charge between suppliers. This is how I think it will work: at the moment, if supplier A sells gold jewellery to supplier B, supplier A charges 5 per cent VAT on the sale, and supplier B pays VAT to supplier A, recovering it through its quarterly return. Under the new law, supplier A does not charge 5 per cent VAT. Instead supplier B is treated as both the supplier and recipient of the gold jewellery. This means that there is no VAT payable upfront; it is simply accounted for as a book entry by supplier B. VAT is charged only on the final supply to the consumer, although I’ve read some in the sector arguing that the government should also remove VAT on jewellery sales to consumers – don’t ask, don’t get, I suppose.
One has to wait for the legislation of course, but this change would effectively abolish VAT in the jewellery sector and replace it with a sales tax. I cannot see how such legislation could be consistent with the legal principles agreed in the GCC Unified VAT Agreement, as the ability to apply the reverse charge mechanism is limited. It’s not at all clear to what extent there could be any sanction on the UAE. There is no equivalent of the European Commission and the Court of Justice of the EU in the GCC, which have strong powers to sanction any EU member that fails to apply VAT in accordance with the Principal VAT Directive.
Following this announcement, I read reports that the UAE’s maritime industry is also lobbying to remove itself from the VAT regime. Maritime supplies within the UAE are generally zero-rated in any event, and because ships are often in non-territorial waters, a number of supplies will be treated as supplied outside the UAE. But no doubt VAT does arise in the sector and, even though it will almost be recoverable, complying with it does require some effort and, with most businesses of size, a dedicated VAT manager.
So why the claim that introducing the different treatment for the jewellery sector may define how VAT will look in the UAE in a number of decades? A number of reasons. One, it shows that the UAE is prepared to offer special treatment to certain sectors. The problem is that once a government starts making exceptions, other sectors (like maritime) also start asking for them and it’s hard to say no. Two, it shows that the UAE is prepared to diverge from the GCC Unified VAT Agreement to protect key sectors. If it can, why shouldn’t any of the other five GCC countries? Three, the law is starting to look considerably more complicated and less certain than it did six months ago. Four, there is likely to be a revenue cost to favourable measures introduced for certain sectors. That will in turn put upward pressure on the rate of VAT for others.
The moral hazard is clear. The rational response now for other sectors in the UAE is to ask for VAT reform in their sector. But those sectors that are unsuccessful in their efforts are likely to see an increased burden in the near future as the UAE looks to increase revenues from elsewhere. The UAE Cabinet must be careful, or it risks undermining the whole VAT system.
Jeremy Cape is a tax lawyer at Squire Patton Boggs, which has offices in London, Dubai and Abu Dhabi. Follow him on Twitter @jeremydcape