VAT offers new opportunity for banks
New tax to show a clear trail of fund movement in a firm
The large and emerging corporates may see their working capital needs going up next year, presenting banks a good lending opportunity.
The introduction of valueadded tax (VAT) in 2018 would mark the beginning of a new era in the economic diversification of the UAE. In the past four decades, the UAE has seen a massive economic transformation from an oil based economy to a well-diversified economy compared to its peers. The GDP of the country went up from a mere $14 billion in 1975 to over $380 billion supported by the growth in oil and non-oil sectors. As a result of the diversification efforts initiated two decades back, oil sector now just accounts for around 30 per cent of the total GDP.
However, the economic paradox is that despite having a well-diversified economy, government revenues are still highly dependent on the oil sector. Oil revenue accounts for over 65 per cent of the total government revenue as per International Monetary Fund (IMF). Though non-oil sector is the new driver of the economic momentum, its contribution to the national exchequer has been relatively subdued.
The revenue profile of the UAE exchequer is set to change with the introduction of VAT, as the contribution from the non-oil sector would rise and reduce the cyclicality of the economy.
Strategic rationale for taxation in UAE
The disruptive rise of electric cars, falling prices of batteries and solar power have created a new economic paradigm in the global transportation industry, the largest consumer of oil. The rise in the viability of the electric cars, could pose a major challenge to the oil based economies. As per the study done by Bloomberg, electric car market growth at the current rate can lead to displacement of two million barrels of oil per day by 2023. With many counties announcing their plans to move away from petrol cars by 2030, it would be a layman’s guess to predict the direction of oil prices in the next decade.
This kind of a massive economic challenge ahead can only be dealt with vision and bold reforms that change the revenue dynamics of the government.
The introduction of VAT is expected to fetch revenues of around 1.5 per cent of GDP in the medium term as per the UAE consultation report published by IMF in 2017. Introduction of VAT over the long run has generated average revenue of five per cent of GDP in many countries in the comparable emerging markets as seen in the IMF study.
While the government revenues could get a shot in the arm, there could be some varying impact on the consumption and business sectors of the economy, albeit in the short term. Effective implementation is the key in ensuring the smooth transition to the new era. Given the steps taken by the government and the various ministries and agencies, including awareness campaigns and clinics by various stakeholders, no hiccups are expected.
The implementation of VAT in UAE would impact the banking system in various ways. The direct impact is that certain banking transactions will come under the purview of VAT. While basic banking margin based products such as deposits, loans are exempt from taxation; products and services with an explicit fee such as asset management services and custodial services would be taxable.
However the real opportunity for banks can come from the major transformation in the business sector in the UAE. While there could be a short-term drag on performance in various sectors as has been pointed out by various experts, banking sector would see a plethora of financing opportunities, which is largely non-existent now. The large and emerging corporates could also see their working capital needs going up next year, thus presenting the banks a good lending opportunity.
SME sector which forms the backbone of the economy receives only four per cent of total bank credit as banks cite the high levels of risk in financing. UAE banks had lost heavily in the past two years in SME financing space due to a host of reasons. In SME lending, banks are challenged by their inability to do right credit risk assessment due to the lack of transparency in small business financials, fake invoicing etc.
The implementation of VAT that ensures a complete fund flow trail would make bogus sales and inflating financial statements a thing of the past. After the initial transitionary issues, a new set of professional SME firms could emerge, thus presenting the banks in UAE a big financing opportunity in this space. Cash flow based financing models can be suitably developed as VAT data would present a clear trail of fund movement in the company. With the increased level of transparency all around this would help the Banks to get into the non-salaried segment which is a major lending opportunity for banks.
The implementation of value-added tax in UAE would be marked in the cherished history of UAE economy as the beginning of a new economic era. Though initial transitionary impact is expected, in the medium term VAT would not just alter the revenue profile of the state, but also increase the transparency in the financial system, thus benefitting the banking system and making it a robust and sound sector.