VAT: A continuous learning curve for banking sector

August 26, 2019

Three out of the six GCC member states - Saudi Arabia, the UAE and Bahrain - have already implemented the value-added tax (VAT), with Oman slated to be the fourth.

The date of implementation is currently under review, which allows the sultanate the time and the opportunity to learn from the region’s experience and prepare for a smooth transition. As a multifaceted transaction tax, VAT has an impact across all functions of an organisation, but it is critical for each to prioritise its focus areas during the implementation.

The introduction of VAT will have an immediate impact on the revenues and profitability of the banking sector in particular, with a number of contributing factors. Globally, banks tend to increase their fees to compensate for these factors; locally, it will be necessary to evaluate whether this is a financially and practically viable option.

The pricing of conventional banking products is often regulated by a central bank. In the UAE, the Central Bank of UAE (CBUAE) issued a notice on December 28, 2017, three days before the introduction of VAT, prohibiting banks from increasing their existing fee on account of VAT beyond prescribed caps. This posed two challenges for banks. In case of taxable supplies, it implied that the output VAT of 5 per cent had to be borne by banks. In case of exempt supplies, although there was no output VAT, it implied the cost of irrecoverable VAT paid on purchases also had to be borne by banks. Both cases potentially eroded the banking sector’s revenues and profits. It was only in mid-June 2018 that the CBUAE allowed banks to increase their existing fee to partially recover VAT-related costs.

In Bahrain, the VAT Law required suppliers who had executed contracts prior to introduction of VAT without a VAT recovery clause to treat the consideration received under such contracts as inclusive of VAT ‘regardless of whether it was taken into consideration’ while determining the consideration. For retail customers, this meant that banks had to factor and, if necessary, bear output VAT of 5 per cent on annual revenues like credit card fees collected upfront.

Similarly, in case of business partners like insurance companies, airlines, etc. this meant banks had to factor output

VAT of 5 per cent on revenues like exclusivity/partnership fees collected upfront but amortised over a period extending beyond the introduction of VAT. These statutory measures again translated into an immediate and direct impact on the revenues and profitability of the banking sector.

In the context of expenses, since supply of margin-based financial services is usually exempt from VAT, the VAT on inputs used to make such exempt supplies is not recoverable. Ascertaining the irrecoverable VAT can add to administrative complexity associated with VAT. In the region, while Saudi Arabia and Bahrain follow an output-based approach, the UAE initially imposed an input-based method. Rather than react to which scheme Oman would mandate, a unanimous representation to the tax authorities by the banking sector for a simpler, easier to implement and comply with, globally recognised standard deduction method may help. It may allow banks to forego the VAT paid on inputs used to make exempt supplies at a pre-determined rate, instead applying a revenue/expense formula.

Another factor for banks to consider is probably the technology. Based on our experience, it is not unusual to see a bank deploy multiple peripheral systems to cater to each distinct line of business. Understanding each system’s ability to factor the VAT impact is extremely critical. The implementation, however, remains incomplete without sufficient checks and balances with limited human intervention to monitor the above.

Based on our experience, invoicing requirements, as procedural as they may seem, also need to be taken into consideration. These include deciding whether banks are required to issue tax invoices or just bank statements, whether these documents are required to be issued in Arabic or English, or where should the forex rates be sourced from for foreign exchange transactions. After preparing the systems to deal with all of this, to archive the data for extended periods often requires careful consideration.

Through all of this, it is critical that the banking sector engages in continuous consultation with the tax authorities, to ensure a smooth implementation.

 

Aabha S Lekhak

(Aabha S Lekhak is the director of tax at KPMG Lower Gulf)

The views and opinions expressed in this column are solely those of the author and do not necessarily represent those of Muscat Daily or Apex Media Publication