Why VAT and IT make for a complex combination

Supplies of IT companies shall be taxable with five per cent VAT in the GCC countries
The UAE's software, hardware and IT services segment continues to register steady and resilient growth, mostly driven by the government sector, through many of the IT projects it is involved in, such as e-government services, IT hardware for education and the 'Smart City' initiative, or indirectly through government-backed enterprises.

According to a report by the Dubai Chamber of Commerce and Industry, sales in the UAE IT market are expected to hit almost Dh22 billion by 2019 and per capita spending to reach above Dh2,000 by 2018. The current IT market value in the UAE is estimated to be close to Dh19 billion, compared to just Dh12 billion in 2010.

There have been great opportunities for both local and international enterprises, especially in the area of cybersecurity and the most innovative areas of IT. The 'Smart City' strategy includes over 100 initiatives on transport, communications, infrastructure, electricity, economic services and urban planning, with about 1,000 government services going 'smart' at the beginning of this year.

High incomes and standards of living, alongside an increased consumer and business confidence are also factors that have contributed to the continuous development of a dynamic, growing and profitable IT market. This growth portends a truly gainful sector for the government as it readies to implement a value-added tax (VAT) regime in 2018.

It's interesting to note, however, that following the publication of the GCC unified VAT framework agreement, the elements of the IT sector are not implicitly defined in the list of activities that are exempt from VAT. This means that goods and services supplied by IT companies are, in principle, fully VAT taxable.

The supplies of IT companies shall in general be taxable with five per cent VAT in the GCC countries (five per cent VAT on their local sales and follow the other VAT treatments of taxable supplies on their cross-border transactions). This means that consumers, non-VAT registered businesses and VAT exempt businesses will experience increase in the prices of IT services, because they cannot deduct this VAT. On the other hand, VAT registered businesses shall not feel the impact in their income statement, because they can - in principle - recover the VAT charged by their IT suppliers (when they make taxable supplies).

Deducting VAT on costs

IT companies which are VAT registered will be able to deduct the VAT on costs that could be attributed to taxable sales. These companies need to make sure that they verify, pay and report the VAT on costs correctly to be entitled to recover this VAT in their VAT return.

The complexity of calculating VAT is minimal when the companies are resellers of software or distributors of hardware. In this scenario, these companies need to charge the correct VAT amount on the net selling price. It is, however, not unusual that these companies also supply a combination of third party software, hardware, in-house developed add-ons and other related services, such as installation, maintenance and outsourced helpdesk services. This combination of services is usually sold as a package with payment conditions depending on the completion of the work or in a specific period that may not be the same as the VAT reporting period.

As a result of these dynamics, the IT services are among the most VAT-complex businesses. In such a complex arrangement, businesses in this industry should look closer into the correct method of determining the place of taxation, the taxable amount and the due date of paying VAT. To complicate this further, services or software delivered electronically have different treatment for VAT compared to the physical delivery or on a physical medium, such as, CD-ROM.

Thus, although VAT may seem to be straightforward for IT companies - as they are not an exempt sector - it has its own peculiarities. If these peculiarities are not taken into account, this may result in tax penalties being imposed by the tax authorities.

IT supplies related to the exempted and zero-rated sectors, such as financial, education, healthcare, oil and gas sectors, may share the same VAT treatment as these sectors. This will, however, be further clarified when the actual VAT laws in the UAE are published. Until then, it is highly encouraged that companies in the IT sectors start preparing for the implementation of VAT as if the industry is not exempt.

The writer, Michel Ruitenberg is Crowe Horwath's tax lawyer. Views expressed are his own and do not reflect the newspaper's policy.