How the tax is applied to construction projects could have a knock-on effect on property prices
VAT in the UAE construction sector – who wins and who loses?
In less than 80 days, the New Year will usher a novel taxation regime in the UAE in the form of Value Added Tax (VAT) at a moderate rate of 5 per cent. The construction sector is of pivotal importance to the GCC considering it provides infrastructure, commercial and residential spaces for the economic development of the region. Having said that, the introduction of VAT is expected to result in an overall moderate increase in construction costs, as well as in the cost of building materials.
The nature of tax treatment given to the real estate and construction sector globally is quite intricate and different from standard taxation rules. It is interesting to see how VAT will affect the UAE construction industry and in particular, certain migrating construction contracts which are expected to conclude after VAT has been implemented.
It is expected the UAE Government will make a few clarifications for the tax treatment to be adopted for migrating and spill-over contracts – ones that are signed before VAT but the work is completed after VAT implementation date. Contractors and builders will need to agree with their employers and customers that they can charge VAT in addition to the price previously agreed upon as contract prices in the GCC are normally silent for tax treatment.
This will lead to a number of negotiations between contractors and their customers. Contractors will face an increase in procurement costs, and will want to pass on a portion of this to their customers. Will their customers agree to this? That is left to be seen. We might see a number of loss-making projects if contractors do not adequately plan for VAT.
Different categories of property have been given different tax treatments according to the GCC VAT legislation. There are three categories - undeveloped property, developed commercial property and residential property. Bare land has been treated as an exempt supply, irrespective of what the land is being used for.
The first sale of a residential property will be zero-rated, while every subsequent sale will be treated as an exempt supply. As for the sale of commercial property, it will be taxed at the standard VAT rate of 5 per cent.
When we say that residential property is zero-rated, it means construction companies or developers will be able to recover the VAT that they paid to build that property from the government in the form of a refund. This should reduce the impact on prices of household property. Having said that, maintenance fees and facility management (which are subject to VAT) could lead to an increase in costs for residential property owners. Additionally, we are still waiting to see whether developers can claim input VAT immediately at the time of lease/sale or over a period of time.
What all this means is that real estate developers will have to look at their input tax credit very carefully. Especially in the case of mixed developments involving commercial and residential property sale or leasing to avoid unnecessary VAT recovery.
So how can construction companies remain competitive in this environment? There are a number of aspects to consider, most importantly interactions along the supply chain. To offer competitive real estate prices, contractors will require their sub-contractors and any unregistered service providers to register for VAT voluntarily as they largely tend to fall below the registration threshold limit. The risk involved in engaging with unregistered suppliers is that it can block input tax recovery and render these costs uncompetitive, whereas when engaging with registered sub-contractors, these suppliers will be able to charge VAT that the contractor can recover.
The construction sector is also prone to various operational issues that can arise with existing industry practices such as raising pro-forma and final invoices. This can delay the time of supply, and can lead to accounting errors due to incorrect tax periods, thus resulting in delayed VAT payment.
Another area of concern is being able to plan cash flows and maintain a healthy working capital balance. Businesses will need to assess additional cash flow requirements on a case-by-case basis keeping in mind factors that could result in the potential blockage of input VAT.
As we all know, the construction industry plays a vital role in the UAE’s economy coupled with the UAE Government’s goal for the sector to thrive, creating a win-win situation for all. Despite the complex considerations at play, we believe that VAT on the construction sector will not influence the cost of living in the UAE, and will provide an overall better, efficient, and sustainable ecosystem for all UAE residents and citizens.
Pratik Shah is a VAT expert and the resident partner at WTS Dhruva Consultants, a specialist tax advisory firm headquartered in Dubai