To tax or not to tax - that is the Dubai question

The financial crisis has made the logic of having some sort of taxation more compelling but the Gulf residents do pay taxes in many forms.

There has been speculation that the Dubai authorities are on the verge of introducing some form of taxation for at least as long as I've been in the UAE, the past three years or so. Now that the financial crisis has made the logic all the more compelling, and the thinking is coming from so many authoritative bodies, you have to believe there is something in it this time. In late 2006, long before credit crunches and collateralised debt obligations had broken upon the world, the move towards some form of taxation was regarded as a part of the policy of economic diversification away from oil dependency.

The talk was vague, usually involving a sales tax on high value added and luxury goods and services, but it never materialised into policy. There were regular reminders from the IMF and the GCC that taxation was the norm in most parts of the world, so Gulf countries should consider it, at least in some form. The problem for Dubai and other Gulf states was that their appeal to expatriate talent lay in the fact that there were no income taxes and very few other forms of taxation. Expatriates coming from Europe or North America could expect a jump of between 30 and 50 per cent in real take-home pay immediately, as a result of escaping the tax system in their own countries.

If the Dubai authorities began asking for a chunk of that pay, it would at a stroke reduce the attraction of the emirate as a place to live and work. There were also insurmountable political difficulties with the idea of an income tax. "No taxation without representation" is one of the basic tenets of western political systems. Exclusion of expatriates from political representation remains non-negotiable in the Gulf political context. I can foresee no circumstances where that situation would change.

But that does not rule out all forms of taxation, and in fact residents of Dubai and companies doing business there already pay tax on a whole range of goods and services. From the municipality charge that appears on hotel bills - in effect a tax on tourists - to the tax on alcohol sales at licensed outlets, to the Salik charge, residents pay taxes in some form for everyday services and products. Banks and oil companies still pay a form of corporation tax, as they have done since the inception of the UAE. The telecoms service providers pay royalties to the UAE Government for their licences, which, assuming it is passed on to users, amounts to a consumer tax. So there is already a culture of corporate and sales taxes in place in the UAE.

The issue now is whether to extend that culture to a full-blown sales tax or corporation tax system. The IMF says in the report on its recent visit to the country that it was assured a plan was in place to introduce a system of value added tax (VAT) by 2012. The authorities have not given details of any such plan. Value added taxes exist in most parts of the western world, and are essentially a tax on retail sales and service transactions. In the UK, the government recently used VAT as an instrument of monetary policy, cutting the rate from 17.5 per cent - the EU standard rate - to 15 per cent to encourage consumer sales.

All the signs are that Dubai is considering a VAT, but for fiscal rather than monetary reasons. It would probably be much less than in Europe, not more than 5 per cent, and would be applied to goods and services at the discretionary end of the consumer spending range: luxury clothing and branded goods, top-of-the-range electronics and other high-value items and services. Essential foodstuffs and everyday items would be likely to be left exempt.

You can see why Dubai is considering such a scheme now. With the Government's debts and those of government-related enterprises estimated at US$109 billion (Dh400.3bn) by the IMF, every dirham counts. One investment bank recently briefed clients to the effect that: "The problem is that Dubai Government revenues are small (around $10bn) compared to the size of the economy (around $77bn)." The sectors that would be most affected by a VAT-type scheme, tourism and retail, probably account for at least 30 per cent of Dubai GDP, or some $23 billion. To slap a 5 per cent VAT on that would pull in more than $1bn a year in extra revenue.

The question policymakers now have to answer is whether that extra $1bn is worth the cost to the UAE's consumer sector, and the country's image as a tax-free haven. @Email:[e-mail]