VAT levy on UAE banking sector could prove to be complex

Banks will be faced with VAT costs that they have a limited ability to recover.

While the UAE VAT Law is yet to be released, details are starting to surface as to how different business sectors will be affected by the legislation. An area that is emerging as one of the most complex is the banking sector.

One of the objectives behind introducing VAT in the UAE is to have a broad-based and low-level, standard rate of VAT, with limited exceptions. This approach can pose a problem when the authorities look to apply VAT to financial products.

Within banking, there are many services and while it is possible to tax all such services, there remain sufficient practical challenges to achieving that objective. These challenges include: "They are too difficult to tax" and what is the "value" for VAT purposes. Particularly in the context of margin-based transactions, it is almost impossible to determine accurately and consistently on a transaction by transaction basis.

As a result, we are expecting the UAE to take a similar approach to the one recently adopted for the banking sector in Malaysia when a VAT-style tax was introduced in 2015. This is that the UAE will recognize the inherent challenge of valuing, and taxing, individual transactions often sold on aggregated interest margins, and treat these as exempt. With anything that is not aggregated or which is at least valued explicitly in the normal course of business, such as cheque book issuance charges, credit card membership and administration fees, all are likely to be subject to VAT at 5 per cent.

Using the example of securing a loan, if the approach described above is implemented in the UAE, we are likely to see VAT charged at 5 per cent on the processing fees, but the interest on the loan itself is likely to be exempt. Therefore, the VAT we will be charged may be relatively minor. Yet this isn't the complete picture: A loan exempt from VAT sounds promising and means that a bank cannot charge you VAT on the interest on your loan, any VAT they've incurred in making that and any other exempt supply is unlikely to be recovered by them.

The likely result is that banks will be faced with VAT costs that they have a limited ability to recover. Banks may react by increasing fees or by changing their product structure to allow them to charge higher fees - both these scenarios will allow them to recover more VAT on their costs. It is also possible that banks will consider absorbing these additional VAT costs, without passing them on to end consumers.

VAT-registered businesses that incur VAT on financial services in the course or furtherance of their business are likely to be able to recover the VAT they've been charged, subject to the usual rules on reclaiming VAT. For us consumers who are not VAT registered, we will not be able to recover VAT, if we incur a fee; it is also likely that an additional 5 per cent VAT will be charged on that fee.

For those looking to take money out of the country, the transfer of money, remittances, are generally for VAT purposes not seen as a supply and no VAT applied. It is likely that the exchange of one currency for another the profit taking on the spread, the margin; will also be treated as exempt. That said for both transactions, there may be a commission or fee and these are likely to be subject to VAT at 5 per cent.

The writer is senior manager of indirect tax at Deloitte. Views expressed are his own and do not reflect the newspaper's policy.