VAT and the UAE/KSA Construction Market

Given its status as a cliché in the west, it should have come as no surprise to the UAE and Saudi Arabia when Benjamin Franklin’s statement on the certainty of tax finally came to fruition at the beginning of this year.

As an applicable tax in 166 countries, VAT affects two primary parties, individuals and businesses and while the former may feel a slight increase in the cost of living, the latter is required to look carefully at its books and understand the impact of the new duty and while many businesses who are based in other ‘high-VAT’ jurisdictions may scoff at 5%, it is important to first understand the scales of economy and the status quo of the industry at large.

Firstly, let’s talk about scale – the UAE and Saudi Arabia are amongst the most ambitious construction markets in the world, with a combined pipeline of projects worth between an estimated $1.6 – 1.9tn. Summarised in Deloitte’s Value Added Tax in the GCC | Real estate and construction industry, “The scale of many businesses operating in the sector, and the cost and revenue throughput that they manage, by nature creates an environment of risk associated with poorly understood or managed VAT obligations.” Specific challenges highlighted in the report included extensive lead times on major projects, registration of subcontractors and the treatment of residential versus commercial property.

Arguably the biggest impact to the sector has been cash flow. As an industry that is known for its thin operating margins, the requirement to pay an additional 5% on a monthly or quarterly basis has led to many companies having to reassess their capital requirements and or run into liquidity issues, something that has only exacerbated the pre-existing condition of delayed payments to contractors.

This being said, as with the introduction of any macroeconomic legislation, the system needs time to adjust and settle. In June earlier this year, Arabtec’s CFO, Ravi Murthy commented in an interview with Khaleej Times; “I see good potential for the construction sector. I would say VAT has not impacted us that much; however, there is a pressure on cash flow, but people are getting used to it.”

According to recent data published by Fitch Solutions with regards to the effect of VAT on the Saudi economy, “In 2019, we expect a more pronounced deceleration in price growth as the base effects of subsidy cuts and VAT fall off.”

It would appear that certainly, while some companies have felt the pinch more than others, the actual effect of VAT has simply required greater diligence in terms of capital requirements and cannot be blamed for any underlying regulatory or financial issues which were already present.

The additional dilemma of interpreting the impact of VAT on a macro level within just ten months of implementation is just that. The effects of federal taxation and the impact it will have on trillion-dollar pipelines, which may take up to a decade to deliver are extremely difficult to measure in short-term values outside the issues highlighted above, with the real impact becoming more transparent as projects get delivered, economies continue to diversify, and governments gain receipt and allocate the value-added revenues.

With Bahrain’s initiation to VAT just weeks away, it will be interesting to see how it executes the implementation of VAT and whether it will approach any of the challenges faced by UAE and KSA differently.

Certainly, as the remaining GCC countries onboard value-added tax, greater responsibility will be placed on the governments to ensure a fair and transparent way to clear up any grey areas of tax legislation and structure collection in a way that still makes the sector attractive to professional construction stakeholders.