The value-added tax agreement came to reality in order to oblige the GCC countries to have a harmonious, and a unified tax vision.
The agreement imposed many mandatory rules on the member states, leaving no margin of appreciation or reconsideration except in the narrowest limits, taking into account the nature and privacy of each member state in this agreement.
Among the most major gaps of the Gulf agreement, are as the following:
- The tax base was not clearly and accurately controlled. The definition of the supply that leads to the formation of the added value was vague, and its ambiguity was increased by what the agreement called the deemed supply.
- Exaggerating in imposing taxes due to the creation of the term deemed supply; the agreement imposed the tax on transactions outside the scope of economic interactions, to the extent that the tax was also imposed on retention of goods (Article/8 Agreement).
- Separating several Import VAT rules from the regulations of the same tax as if the supply is within the state; where many import issues are subject to the Unified Custom Law, such as determining the value of imported goods and determining the importer who is obligated to pay the tax (Article 42/ Agreement).
- The agreement imposed an arbitrary specific rate of tax, which is 5%, although each Gulf country has its own circumstances that require flexibility in determining this rate and the aim of changing it.
- The deduction mechanism in the agreement demonstrated tolerance when it comes to allowing the supply chain parts to impose a direct and unfair tax policy on the taxpayers, so that the temporary taxpayer becomes a tax collector, up to the consumer, who is the final taxpayer who bears the full burden. This appears to happen without retrieving any guarantees in the agreement that may prevent the supplying elements from abusing these sensitive powers at the expense of the financial balance of the state.
What are impacts of the Gulf agreement in view of the Kuwaiti economy?
Kuwait is already suffering from an investment liquidity crisis, loan failure, dependence on subsidies, low income, high housing costs, and difficulty in developing and moving towards a productive non-rentier investment economy.
What is more important than all these negative circumstances is that Kuwait suffers from an accumulated budget deficit as a result of many circumstances including the low price of oil, which is the only main resource for the budget, and the dependence of large segments of citizens on direct government financial support, in addition to the numerous public sector jobs that are created for the sake of absorbing youth unemployment rate at a time when the employee does not provide a real value which constitutes a hidden unemployment.
Owing to the Gulf agreement, we find that it forcedly applies the value-added tax directly towards consumers by uncompromising law enforcement, and by sufficiently allowing suppliers and traders collect taxes, which will put consumers in direct confrontation.
Although the value-added tax will increase the state’s resources, which will reflect positively on government services, however this reflection may be delayed or going in slow motion due to the slow progress of the government work or simply to corruption.
The other explicit reason is that the Kuwaiti consumer culture depends on the financial and administrative support of the state.
- From financial perspective, for example, we find that the unemployed Kuwaitis and workers in the private sector all receive direct government financial support in the form of unemployment support and labor compensation, and local institutions do not pay any income tax on their net profits.This support is not commensurate with the idea of directly withdrawing the liquidity of these citizens through an added value tax for each commodity they purchase. As the tax in this case will cancel any value of the subsidy or tax exemption, but if the government considers raising the subsidy, the financial burden on citizens will become higher than their financial capacity after the imposition of the value-added tax.
- From Administrative perspective, the tax policy in Kuwait relies on a government task force based on implementing the law on foreign institutions in particular, and it is not experienced in imposing tax on citizens and the way to deal with it; and this task force does not have experience in dealing with every industrialist or trader as a tax collector nor as a taxpayer.
Such unfavorable conditions make the Kuwaiti economy unable to bear at the present time the burden of value-added tax as it was stated in the Gulf agreement.
How does the economic picture of the Kuwaiti economy appear after applying the VAT?
The most important expected matters that might happen in the Kuwaiti economy after the implementation of the value-added tax are the following:
- Adopting the austerity policy; as most segments of consumers will be unable to afford luxury goods and services, being satisfied only with the necessary ones.
- Increase reliance on any government support or services in order to fill the gap between the new expenditures created by the tax and the fixed resources.
- Increase loan failure rate; this is due to the inability to settle loans before imposing the tax, which leads to the expectation of an increase in this deficit after its imposition.
- Housing crisis; the inability of citizens to pay the installments of their properties.
- Increase rental fees due to the high cost of living for real estate owners.
- Concentration of industrialists on goods and services of lower specifications or from an unfamiliar known country; because their goods will not be sold or distributed properly if their commodities have original specifications and from the country of origin due to the high prices of the raw materials or the consumer is unable to afford such products.
- Depreciating of the Kuwaiti Dinar Currency due to inflation, as the consumer will be forced to pay a much higher price than before for the same quality and specifications of goods.
- Imposing value added tax on raw materials will certainly increase the cost of goods and services, then the value added tax will be calculated on goods in which might double the prices.
If the price of a particular commodity is 100 KWD before the tax is imposed, the manufacturer who will pay the value tax on importing raw materials may have to sell it at a value of 150 KWD, and after calculating the consumer tax rate (5%), so its price will reach 157.5 KWD. This increase in price which exceeds 50% will occur if the supply process is directly from the producer towards the consumer.
While in reality, there is a wholesaler and retailer, so the price of the commodity will rise until it reaches the consumer, given the position of each merchant, a profit margin, and thus the commodity may reach the consumer at a price of 200 KWD after imposing the tax; this would mean that the Increase rate has reached 100%.
- The biggest problem is whether the failure to implement the value-added tax leads to a direct withdrawal from FGF (the Future Generations Fund), and so instead of providing an additional financial resource over this fund, its application may lead to the depletion of the fund in the first place.
In fact, the imposition of the tax can immediately lead to a massive catastrophe that includes financial shortfall and social deficit, the negative effects of which may exceed those deficits reaching the public budget.
Does the value-added tax confront with the nature of the Kuwaiti economy?
As a matter of fact, this tax is not one of the failure practice methods in previous international experiences, as we find countries with mega-economies that apply this tax, such as France, and the Kingdom of Saudi Arabia.
Then, why does the tax seem inappropriate for the Kuwaiti Economy?
If we look closely at the countries in which the application of this tax has succeeded, we will find that most of them are countries which based on a free Western economy, and this brings us back to the starting point, which is the study of tax policy in harmony with the role of the state in developing the economy.
As Kuwait’s economy is free from most restrictions regarding citizens’ obligations towards the state, where we find most services at a free or symbolic cost, however on the other hand, we find the state’s obligations towards citizens restricting the state’s budget, as if they burden the state by relaying on its support, coverage and fund savings for future generations.
Is it possible for the state to get rid of the burdens of support at once?
Certainly not, and this is what made the Kuwaiti legislator wary and reluctant to adopt the tax despite the fact that Kuwait has already signed the Gulf agreement; if all of a sudden the state decides to lift the financial and social support from its citizens, it will lead directly to an increase in the need for these supports since they depend on it.
Thus, we find that the appropriate time to apply this tax is the time when the Kuwaiti economy matures and grows to the point where the citizens generate their own income instead of relying on government financial support.
The culture of self-reliance can be established, and the general budget will not be knocked with every financial crisis; unlike to what happened with the mortgage loan crisis, which made a large segment of citizens demand the cancellation of guaranteed loans by the state.
This direct and deep dependence on the public budget is financially, legally and culturally incompatible with the imposition of value-added tax in accordance with the vision of the Gulf agreement.
International Department Team
Dr. Bader S. Al-Otaibi
Law Firm & Intl. Arbitration