My peers and I in writing this article were discussing the effect VAT could have on conglomerates.
Might “V Day” – January 1, 2018 – augur the beginning of a disestablishment of the great “Groups of the GCC”, so many of which are family owned?
The western world has largely unwound its lineage-led businesses, although remnants remain. Most migrated towards general ownership through stock market flotations and through a mix of innovation, entropy and core business reorganisations, ceased to exist in their dynastic forms.
It is not that I believe that there is a concerted drive to break up the great commercial estates, but the dawning complexity that VAT brings will raise the question of whether it is worth the effort of nibbling away at a whole lot of pies rather than simply tackling one. Or two.
By way of a hypothetical example let’s look at the new world facing Group ZYX, which, like so many, began trading with the successful exploitation of a mixed-use developments; that familiar blend of residential and commercial.
In developing further purchased sites on a similar basis and to mitigate risk, ZYX funded those projects with different, say silent, partners for an agreed annual return. In one case, ZYX was the investor. A separate legal entity was formed for each site.
Leveraging its property portfolio, it diversified and opened a property management business, appointing it to operate the various sites.
At a glance
What: Compliance with VAT could distract from the primary goal of management.
Why: The region's conglomerates have complex business structures.
Diversifying that, it spun out the security services element merging with a small established player for synergistic purposes.
Maintenance of the sites was facilitated through ZYX’s wholly owned handyman operations, with parts supplied by a similarly owned Kuwaiti-based joinery.
Let us recap: Group ZYX has various joint-venture, mixed-use locations, serviced by its own property management company and repairs business, using products made by an overseas entity. Security is provided by a joint-venture entity. Non-trading support functions, such as accounting and legal, are employed within a central group entity that charges monthly for its work.
VAT will bring a problem for ZYX’s systems orthodoxy as Peter Whatley, the chief executive of Argent Gulf Consulting, points out: “The charging of VAT is relatively simple as residential rental is exempt and commercial rental is standard rated but the recovering of input VAT is far more complex. As goods and services are likely supplied to the whole site, an apportionment must be made between the residential and commercial elements. The basis of this should be agreed with the VAT authorities.
“Should the apportionment be based on revenue stream or square footage? As each development will have its own split between the two, the preferred treatment is likely to be different by location. Presenting multiple approaches of the same concept to the VAT authorities is not likely to sit well.
“As each location has different shareholders, there will need to be a separate VAT return for each location. Likewise with the security business. Shared services, the property management company and the handyman business can choose to report as one entity as they have common ownership.
“It is looking likely that Kuwait may wait until the end of 2018 before they launch VAT, so that entity’s invoices for goods produced will not include VAT. It will, however, require the UAE purchasing entity to process a reverse charge on the goods being imported. This means VAT will need to be added at the point of import and is then reclaimed in the normal manner,” Mr Whatley says.
“There is no guidance as to the treatment of contracted payments to partners in the various developments. It might be considered interest, which would be VAT exempt or it might be considered as investors’ fees, which might be regarded as standard VAT. The tests are likely to involve a number of metrics before a final decision can be made.
“Lastly, shared services; whether or not VAT is reclaimable will depend on the nature of the residential element of each development. Guidance for this is pending, which will result in yet more tests.”
It would be a measure of the relationship between these national champions and governments if the workings of VAT were to be amended, easing the bureaucratic burden. Precedence suggests this is unlikely in a multiplayer environment as each GCC state would probably prefer an even playing field.
As I demonstrated in my last article, a similar body, the EU, is incapable of making the most minor changes to its VAT framework, such is the weight of outstanding issues awaiting their turn.
If this seems very complicated, it is. Remember, conglomerates are likely to have many more entities than my example, across different sectors, which might have variant VAT rules within themselves or that are triggered when they interact with other group companies.
Worse, this is just at a national level. Mix in the other five countries of the GCC with their own VAT peculiarities and we come full circle to my opening question.
How many more administrators are these groups willing to hire to defend their pride in their size? How many fines and interest charges are tolerable due to poor tax planning, lip service to protocols and simple human error? Compliance will distract from the primary goal of management, which is to trade and in doing so make profits.
It is human nature to empire-build. It is not the victories; it is knowing that as your mortal light flickers out, there is a long-life candle for future generations that illuminates your legacy.
Such candles are not made for accountants: no demand. Amatino Manucci, the father of double-entry book-keeping … that is as famous as we get. I doubt if even a handful of readers will have ever heard of him as ultimately it will be for us all.
David Daly is a chartered accountant (Cima) typically serving in chief financial officer or finance director roles.
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