The Saudi Arabia VAT rate increase: challenges for UAE-based manufacturers and retailers
The Minister of Finance, His Excellency Mohammed Al Jadaan, announced on 11 May that the standard rate of VAT would be increased from 5% to 15% with effect from 1 July 2020. For many businesses and consumers, the scale and timeframe for the implementation of the rate increase came as a surprise.
While businesses established in the Kingdom of Saudi Arabia (KSA) are likely to be immediately impacted, the rate increase may have a significant effect on the supply chains of manufacturers and retailers based in the UAE, with a business footprint in the KSA. This development could mean that many businesses will have to rethink their current UAE-KSA distribution arrangements.
How has the rate increase impacted UAE-based manufacturers and retailers?
Many local and international manufacturers and retailers have established distribution hubs in the UAE to supply the KSA and the broader GCC region. In our experience, for various commercial, legal, regulatory and tax related reasons, such businesses tend to prefer operating in the KSA, via a third-party distributor, rather than establishing a local KSA entity.
Typically, this presents both the said third-party distributor and the UAE-based business (recipients of distribution services) with an inherent VAT challenge. This challenge arises from the fact that unlike the UAE there are very limited circumstances whereby KSA distributors can apply the zero VAT rate to the supply of cross border services. Therefore, more often than not, KSA distributors tends to treat the services provided to and other recharges made to UAE businesses as subject to KSA VAT at the standard rate of 15% (previously 5%).
In the absence of a VAT registration in KSA, this VAT levy represents an irrecoverable cost for UAE-based businesses. Evaluating their alternatives (e.g. KSA VAT registration/permanent establishment risks on account of running offshore operations), some businesses did tend to bear the additional KSA VAT levy and accept this as a cost of doing business in the KSA.
Can this approach continue to be a viable option for businesses going forward, given the significant impact the rate increase will have on UAE suppliers’ cost base? We suspect in most cases, the answer to this question will be ‘no,’ and we are starting to see UAE suppliers exploring alternative solutions.
How KPMG can assist you?
It is clear businesses must act promptly to assess the implications of the VAT rate increase on their UAE-KSA distribution model and we are already advising several clients on the alternatives available to them. In this regard some of the areas we are assisting clients with include:
- Assessing tax efficient models, including evaluation of the incremental tax costs by comparison of VAT costs versus KSA direct taxes (i.e. zakat, income tax, withholding taxes)
- Alternative remuneration structures/agreements with KSA distributors advising on setting up a local entity in KSA
- KSA transfer pricing related implications
- Setting up a local entity in KSA, related KSA VAT registration obligations and compliances
- General tax reporting obligations
Extension of Waiver of Penalties for Tax Filing and Payment for Three Months
On a related matter, please note that the General Authority for Zakat and Tax (GAZT) extended its waiver of penalties for all tax filing until 30 September 2020. This is an extension of the waiver of penalties for zakat, income tax, withholding tax, vat, and excise tax, which ran from 18 March 2020 until 30 June 2020.
Penalties will also be waived in case of late registration to the GAZT system if the taxpayer registers, submits, and pays all dues by the new deadline. Taxpayers should urgently review their historic business activities in the KSA in light of the above waiver extension.
If you need any assistance to navigate the challenges presented by the KSA rate increase for your business or need assistance with availing of the waiver please reach out to your tax advisors at KPMG or the contacts mentioned below.