Analysis

Calculating the impact of VAT

Sameer Daoud, chief development officer at Drake and Scull International, tells us what to keep in mind

Funding government services and infrastructure projects from (oil) cash reserves is no longer a viable option for GCC governments. Implementing VAT, and furthermore securing additional forms of revenue from housing charges and tourist fees, is hence under consideration.

I think many see VAT as adding a layer of complexity when the end goal is ensuring that contracts are clear and transparent, in addition to meeting overall accountability and compliance with regulations. However, is that really the case?

I doubt that VAT will have any adverse effect on investment in the long run. The simple reason is that this has not been the case anywhere else in the world. In contrast to income tax, which has a negative effect because there is less money to invest, the introduction of VAT is a corporate tax that benefits the nation as a whole. As a VAT-registered company, this is a simple throughput that is not a complicated process at all, as long as it is clear what VAT applies to, and when.

Ensuring compliance across the supply chain with the new tax entails significant efforts both from within organisations and between business partners. The high number of parties involved with supplier and subcontractors quickly creates complexities, making it difficult to gain a proper overview of transactions.

Contractors also employ a large number of smaller subcontractors that may not be registered, and hence are unable to pass the VAT benefits along to their main contractors. Even in markets with well-established VAT procedures, the number of court cases relating to VAT in the construction industry is an indication of how common these types of issues are.

Construction projects have a long lifecycle and final payments can be delayed for extended periods. Typically, it takes more than six months to collect payment after completing construction work, making cash flow a major challenge. This challenge is further compounded when needing to account for VAT upon delivery, before receiving payment from the customer.

On the other hand, the same applies to barter transactions that need to be balanced. Therefore, companies are required to plan in advance due to the nature of prolonged projects, and are also advised to review their current contracts to ensure that their commercial position is clear and protected.

As a transaction-based tax, VAT applies to each stage of the supply chain. With many parties involved, from subcontractors to suppliers, VAT accounting errors can easily occur in the supply chain. Disputes can arise, for instance, with projects already in progress. Here VAT may not have been contemplated from the outset, without any mention of it in the contracts. In such cases, it is important to figure out who will account for it, and under what circumstances, so as to avoid delays and disagreements leading to conflicts.

Both as companies and as the management of individual projects, it is essential to have accurate cash-flow projections in order to facilitate invoicing and accounting. Each of these steps affects overall planning and management, and therefore it is vital that contracts address the new tax.

Some contractors have pre-emptively factored VAT into prices since even before 2017. However, it is safe to assume that many projects due to be delivered over the coming years have not. It is thus likely that the contractor will need to renegotiate with the client as to how to charge VAT, or risk having to bear the cost thereof. How successful this is will likely depend on what agreements a developer has in place with end users.

All this makes creating a robust accounting and tax management system all the more imperative. VAT is a tax aimed at the end user and, from that perspective, it can be seen as incumbent upon companies to collect VAT for the government. This role involves both cost and risk in that it requires administration and exposure to interest, potential penalties, cash-flow constraints and inadvertent non-compliance with new legislation.

The main priority is to avoid uncertainty, which can lead to misunderstanding. This is especially true when it comes to contracts. My advice is to maintain a continuous open dialogue where all parties feel comfortable to ask questions and are afforded the opportunity to iron out any wrinkles at the earliest stage possible.

Five percent is not a high tax rate by any stretch of the imagination. However, given the slim margins that contractors depend on in large contracts, calculating the VAT correctly and having proper management in place to avoid unexpected scenarios could well prove the difference between winning and losing.

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