Many see value added tax (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?
Yes, the recent introduction of VAT across the GCC will impact business procedures for contractors on many levels. However, 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.
Five percent VAT 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, can well prove to be the difference between winning and losing.
Some contractors have pre-emptively factored in 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 the developer has in place with their end users.
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 sub-contractors quickly creates complexities, making it difficult in to gain a proper overview of transactions.
Many smaller sub-contractors may not be registered for VAT, and are therefore unable to pass the VAT benefits along to their main contractors. The many court cases relating to VAT in the construction industry, even in markets with well-established VAT procedures, is an indication of how common these types of issues are.
With construction projects typically having a long lifecycle, final payments can be delayed for extended periods. It can typically take six months or more to collect payment after construction work is completed. This can make cash flow into a major challenge that gets further compounded when needing to account for VAT upon delivery, before receiving payment from the customer.
VAT applies to each stage of the supply chain and is a transaction-based tax that goes from sub-contractors to suppliers, VAT-accounting errors can occur easily in the supply chain. 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.
In cases where VAT may not have been contemplated from the outset and not addressed in the contracts, disputes can easily arise, particularly with projects already in progress. 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. It is vital that contracts address the new tax and to have accurate cash-flow projections, both for companies as a whole and in the management of individual projects. This will facilitate invoicing and accounting in the overall planning and management.
VAT is a tax aimed at the end user and one can thus view companies as responsible 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. As such, this makes it all the more important to create robust accounting and tax-management systems.
Lastly, for MEP contractors, a priority is to avoid risk and to address uncertainties that can lead to misunderstandings. This is especially true when it comes to contracts. My advice is to maintain an open dialogue continuously, whereby all parties feel comfortable to ask questions, and are afforded the opportunity to iron out any wrinkles at the earliest stage possible.