The plan to introduce value-added tax in Gulf Cooperation Council member states could create operational risks for companies and put pressure on EBITDA and cash flows in some industries as markets adjust, Fitch Ratings says. Collecting and remitting VAT to the government will have notable set-up and compliance costs. Businesses with VAT-exempt goods and highly competitive sectors could find themselves, rather than customers, taking on this additional cost.
VAT implementation could be as soon as early 2018 according to media reports, which would create a very tight timetable in a region with little history of taxation of any sort. This will introduce greater uncertainty and operational challenges for GCC corporates than for companies in other regions with established tax cultures that have introduced VAT or reformed their tax systems. However we expect GCC governments to recognise these challenges and show a degree of flexibility during the initial implementation.
Companies will have to replace or update IT systems, implement new procedures and train staff before VAT is introduced. This will be particularly burdensome as it will add to costs when low oil prices and lacklustre economic growth are weighing on corporate performance, particularly for SMEs. Companies involved in supplying goods and services between GCC members, or those operating within or between free zones, are likely to face additional complexities, as agreements between individual GCC members could vary.
In theory, VAT is ultimately paid by the end consumer, so if a company does not fall into that category the planned 5% rate should not have a direct impact on financial performance. Some goods or services may be assigned a zero rate, meaning the business will charge VAT at 0% on sales and will be able to reclaim VAT on purchases. But if the goods or services a company sells are VAT exempt then they will not be able to reclaim VAT on purchases and will have to bear this cost themselves. So it will be important to know the VAT treatment for sectors like healthcare, and education, which could face profit margin erosion if they are VAT exempt and are unable to increase prices to compensate.
Even with no VAT exemption, highly competitive sectors or those with thin margins could face a cash flow burden from having to meet the cost of paying VAT on purchases before it can be reclaimed. Fierce competition in some sectors may also put pressure on companies to cut pre-tax prices and absorb some of the cost themselves. This is most likely in sectors like telecommunications, consultancy and contracting and will vary by country.
The need to renegotiate previously agreed contracts and conditions with customers would pose additional challenges in some industries. The introduction of VAT, alongside other government initiatives to cut spending, could also reduce disposable incomes, weakening demand in more discretionary corporate sectors.
We believe the lack of any significant historical taxation means it will take time for companies to fully pass on costs, but that they will be able to do so eventually. The main long-term risk from the introduction of VAT is therefore the potential for errors in collecting and accounting for the tax that could leave companies liable for the cost themselves. This impact will not be clear until each member state establishes its own national legislation to enact the agreement, which could make the timetable even tighter.