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Impact of VAT on Automobile Industry in UAE

The implementation of VAT is a common phenomenon for the development of the economy and currently, VAT is implementing in several others countries. So VAT is a new concept only for UAE members not for other countries. We do not anticipate any noticeable change in demand once VAT is embedded into the pricing mechanism of the vehicles.

It is almost inevitable that sales of motor vehicles will become subject to VAT in the GCC upon implementation of VAT. Even though the anticipated VAT rate of 5% is low by comparison to rates of VAT applied in other countries (the average VAT rate around the OECD is 19%), for a region with a penchant for purchasing expensive motor vehicles, the imposition of VAT is likely to increase the nominal purchase price of the region’s favorite luxury brands significantly, if for no other reason than that the cost of such vehicles is already substantial.

The UAE’s auto sector, which is currently facing multiple challenges with excess inventory, is gearing up for the new VAT era with a cautious outlook. Stakeholders believe the final legislative framework for value added tax (VAT) could give some clarity for efficient operational purposes, both for local and imported vehicles.

“There is excess inventory, consequently supply far exceeds demand. Hence, retail prices are under pressure that is seriously hurting margins and operational profitability. One is likely to see this trend continue for most of 2017. We expect recovery to start by Q4 2017, by which time supply and demand are more or less in balance, provided there are no unforeseen shocks and oil prices stabilise at an acceptable level. Introduction of VAT and its impact is still not clearly known, hence that too needs to be considered,” said K. Rajaram, chief executive officer, Al Nabooda Automobiles, UAE, in a recent Alpen Capital’s report on the GCC automobile industry.

According to Alpen Capital, the number of passenger cars in use in the GCC is expected to grow at a five per cent CAGR from an estimated 10.3 million in 2015 to 13.2 million in 2020.

“There will be both long and short-term effects of VAT on the automotive industry. In the long term, prices will be affected as VAT will be payable on new car sales. In the short term, this may well lead to a spike in demand before VAT is introduced as buyers try to beat the price rise. This could provide a boost to the motor trade towards the end of 2017 and there may be some attractive offers for buyers as traders try to make the most of the opportunity. All of this might, in turn, have an impact on second-hand sales, with a glut of pre-owned vehicles hitting the market,” said Brian Conn, partner at BDO Tax Advisory services.

Fears of VAT affecting vehicle sales persists among industry players. Osman Abdelmoneim, general manager, AGMC, said: “The current automotive market is focused on tactical offers and we do not expect that to stop in the immediate future. With regards to VAT-related plans, we are still waiting for the final framework for implementation to be announced by the government. We anticipate that some customers will prepone their vehicle purchasing decision to make use of the five per cent savings.

Currently, several car manufacturers and dealers are making the automobile industry highly competitive specifically for the SUV, mid- size and SUV segment. Car manufacturers and dealers are trying to lure customers just by providing a discount on the new purchase, loan facility, low maintenance cost and free insurance for the first year. Dealers are doing this just because to clear out the available stock before the introduction of VAT in UAE.

Car manufacturers experience a significant rise in sales of cars. As users replace their existing cars with newer models before and after the year- end. Users will purchase the newer model of cars before the implementation of VAT to avoid 5 percent tax. Car manufacturers or dealers are trying to sell as many cars before December 2017 at pre- VAT prices. Although, car dealerships are trying to evaluate sales campaign to clear the available stock of 2017 models and pre-owned cars in anticipation of the introduction of VAT.

At present, the demand for cars in UAE is low and the supply or available stock of cars is high. It is affecting the automobile industry and making the sector think about clearing their available stock before December 2017.

“This would apply predominantly to private customers as corporate customers are likely to be able to recover the input VAT. The implementation of VAT is a natural part of any sustainable economy’s development. We do not anticipate any noticeable change in demand once VAT is embedded into the pricing mechanism of the vehicles.”

Effects of VAT on Automotive Industry Before Implementation

Implementation of VAT will impact the auto markets in both short and long terms. In the long term, there will be a rise in car prices, as dealers will have to pay VAT on car sales. In the short term, buyers

will try to purchase vehicles before VAT to avoid paying VAT on cars bringing marginal rise in demands of vehicles. To dispose of pre-owned vehicles, car traders will entice customers with special offers toward the end of the year to bring in high sales profit before the year ends.

According to Finbar Sexton, EY Mena Indirect Tax Leader, introduction of VAT on January 1, 2018 will bring a significant shift in the dynamics of auto industry for both consumers and dealers. The consumers will be mindful of rising cost of products before VAT implementation, which will automatically increase the demand of luxurious goods and automobiles.

He further said consumers usually replace their cars with new models before or after the year ends, which pitches the sales higher for dealers. This year consumers will want to replace their cars with new models to avoid paying extra 5%, as rising demand of cars will provide dealers an opportunity to sell as many cars as possible before the year ends. Dealers also wish to evaluate sales campaigns to get rid of existing inventory of new and pre-owned cars before introduction of VAT.

Effects of VAT on Automotive Industry After Implementation

Implementation of VAT in 2018 will bring some challenges to businesses operating in this vast auto industry. They may have to face demanding concerns like logistics, work capital cash flow, pricing and demanding, alternate market and inventory handling.

Auto industry specifically will have to be careful of tax evasion, as it can attract the attention of tax authorities.

Most importantly, other concerns for automotive industry include importation of vehicles, hire and leasing of motor vehicles and margin scheme of secondhand vehicles. It is to be noted that the purchase of the pre-owned vehicle might have a different VAT rule compared to buying a new car. This difference might be owing to the non-recoverable VAT already paid at the time of first purchase of the car.

Answers to all these concerns can only be found after the publication of GCC framework for VAT, which will clarify the operational purpose of both local and imported vehicles. Even after going over all the concerns, it is expected that the automobile industry will find new ways to adapt to the change and would continue growing at a good pace.

In time, the full spectrum of the impact associated with VAT being applied throughout this highly evolved and diverse sector will come to light. We focus, however, on the impacts likely to be felt by those in the business of selling vehicles, and those buying them.

Adjusting to new cash and pricing realities

Most if not all new vehicles are imported into the GCC having been manufactured in third countries. As with most VAT regimes, it is likely that the importation of a car will be subject to import VAT at the time the vehicle is removed from customs control and entered into so-called “free circulation”. The same goes for other purchases made by dealers; VAT will have to be paid on purchases and the additional amount will need to be pre- financed until a credit for it can be obtained from the tax authority.

The lag between payment and credit can be substantial, (certainly during the initial phase of operations under the VAT), with the result that working capital headroom may have to be increased in order to allow for it. Of course, VAT accounting typically allows for the offsetting of VAT on costs incurred against

VAT on sales on the same return and so finding a better timing balance between these two elements of the value chain is vital. Much can be done in this regard with adequate preparation.

The impact of pre-implementation demand is likely to put a fair amount of strain on dealers and their supply chain. This is not necessarily bad news of course – the opportunity to push sales and see a major revenue uptick from car sales, bonuses/rebates, accessory and intermediary fees could perhaps offer a silver lining for Q4 2017, although they will need to be careful with the pricing on any trade in vehicles.

To the extent that the products are themselves price elastic, small pricing changes, and the period over which they are granted could significantly impact purchasing decisions. Understanding the link between pricing changes and the potential impact on demand can be done at a variety of different levels of detail bearing in mind that dealer margins are not necessarily generated wholly or indeed partly at the front-end (i.e. the ticket price), but may also be impacted at the back-end instead (i.e. the bonuses and rebates granted to dealers by manufacturers for meeting targets) and so vary quite significantly by vehicle and manufacturer.

The weirder and more wonderful elements of the motor trade

Motor trade VAT accounting is notoriously complex. So far we have looked at the obvious impacts of VAT, but some of the more challenging aspects of VAT for the automotive trade can be found in the following paragraphs:

The second-hand/margin scheme Generally applicable in some form to second-hand cars supplies where initial VAT recovery has been disallowed for the purchaser (bought-in/part-exchange vehicles) as the supplier (very often an individual consumer) is unregistered and does not charge VAT, but has previously incurred VAT when the vehicle was purchased.

To ensure that there is no ‘tax-on-tax’ cascading, VAT is chargeable on the profit margin achieved on sale by the registered dealer, for ‘margin scheme’ cars. Whilst conceptually simple, dealer systems must be ready to capture these sales, and calculate VAT on profit. Sales staff must also be trained to understand the commercial impact of their actions.

Ultimately, it will be for the GCC to decide whether a ‘margin- scheme’ will be implemented, or whether VAT at 5% will also apply to the sale of second-hand cars. The latter may be preferable for simplicity, but the extra cost would be substantial and, inevitably, would erode margins, with cars taxed multiple times as they change hands.

Financial Intermediary Services

It is, however, unclear whether the GCC will implement an exemption for financial intermediary services, and the impact is therefore likely only to be assessable, once the particulars of the applicable legislation are announced. In Australia, the supply of such services by what are referred to as ‘Financial Service facilitators’ would be taxable in similar circumstances. This would mean that VAT would be due on the intermediary fee – but that VAT is then unlikely to be recoverable by the finance house – leading to further erosion of margin.

It is no secret that motor vehicles have historically been treated unfavorably by tax authorities

Stock-in-trade and demonstrator cars

Recovery of input tax on demonstrator vehicles has often been restricted on the basis that those vehicles are made available for non-business/personal use, such as by sales staff. Where VAT recovery is restricted, some tax authorities assumed that the eventual sale of the vehicle would become subject to the second-hand margin scheme. It will be interesting to see whether the GCC applies the exemption for the sale of items on which initial VAT recovery was restricted, or treats these as taxable supplies. It is important to remember that, as an exempt sale, like financial services, there is a corresponding input tax restriction.

Reliefs for adapted vehicles for the disabled

Cars adapted for use by disabled persons may qualify for VAT relief, such as the application of the ‘zero-rate’ of VAT. However, in territories where similar reliefs have been applied – such as in the UK – abuse of such schemes has occurred, mostly perpetrated by criminal gangs and fronted by individuals who meet the criteria for relief. Tax authorities have previously penalized dealers for failing to ensure that the purchaser is genuinely disabled, and the vehicle is for their own personal use. Again, it remains to be seen whether the GCC states will apply a relief to such vehicles. However, with a potential VAT advantage of 5%, the incentive to perpetrate such dishonesty is likely to be low.

And what about purchasers?

It is no secret that motor vehicles have historically been treated unfavorably by tax authorities. The restrictive nature of recovering VAT on motor cars is largely related to the fact that the system has, historically, been open to abuse, with some individuals and companies having sought to recover the input tax charged in full as a business expense, despite significant ‘non-business’/private use.

With the introduction of VAT in the GCC, on the expectation that the region will follow the European model, and OECD best practice, it is likely that businesses will experience a largely restrictive environment in which to recover VAT charged on the purchase of company. Concerns over whether their systems, processes and people will be able to cope with VAT on January 1, 2018 are likely to be a major focus for program managers up until that time. Unless they do, accurately accounting for VAT on sales on or after that date will become a major headache and at worse, stop sales in their tracks.

END NOTE

Early preparation is key, not only for VAT purposes, but for stocking and aftersales purposes. The trade will shortly be submitting its 2017 sales plans. Ensuring that the impact that VAT is likely to have on customer purchasing decisions both before and after its implementation has been factored into factory orders, will be hugely important to businesses attempting to smooth revenues during the changeover period.

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For any queries connect to vat@nrdoshi.ae OR www.nrdoshi.ae

Written by
Mr. Muhammad Saeed Akbar
– Sr. Manager – Audit & Assurance

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